Investing

Stock Buybacks: A Major Issue With Minor Attention

The last few years the amount of stock buybacks has increased significantly. Last year the amount of stock buybacks exceeded to over one trillion dollars. Even as an investing journal, The Golden Investor is a great supporter of banning stock buybacks.

Where stock buybacks used to be illegal and seen as a form of stock manipulation, in 1982 this rule was changed and all of a sudden stock buybacks became legal. Over the last few years the amount of stock buybacks has grown significantly, but the reasons for that remain inconclusive. The strange thing about buybacks is that the decision of doing stock buybacks is made by corporate directors and executives which themselves own many stocks. One thing is sure, buybacks have made investors richer over time, and the workers of these companies haven’t seen anything change for them. In 2018 the Roosevelt Institute showed in an analysis that McDonald’s could have given its 1,9 million workers an additional $4000 dollars each year instead of doing stock buybacks (Brands et al., 2018). In other words: they could have given a fifty percent income increase for the median worker, but decided to give it to the increasingly rich top 10 percent of the world.

Figure 1 – Buybacks Per Worker – (Brands et al., 2018)

Long term stockholders don’t benefit from buybacks, as they’re going to hold stock for a long period of time. The current spending on buybacks only benefits the investors who sell. The Golden Investor would like to see this mentality change. We shouldn’t reward the CEO’s and main shareholders with more cash, but the whole company with a better long term outlook. This can be done by increasing spending more on R&D, which is the main driver of innovation and leads to higher productivity. This increase in productivity then leads to more revenue and ultimately leads to a company with an increased market value which then can be accurately reflected in the stock price. In those companies also workers should benefit from the achieved goals. In this way the overall structure of the company remains well balanced and not distorted in a way. However, at the moment with the current policies inequality rises due to perverse incentives for corporate executives.

Stock Buybacks Hurt Productivity

In 2015 research showed that EPS-motivated repurchases are associated with reductions in employment and investment, and a decrease in cash holdings. Managers are apparently willing to trade off investments and employment for stock repurchases that allow them to meet analyst EPS forecasts. (Almeida et al. 2015). They actually should invest in their workers in order to improve productivity, profitability and stock market performance. All these effects are commonly known and proven, so why still invest in stock buybacks?

Supporters of buybacks still argue that stock buybacks can increase productivity through shareholders. If a company has too much unused capital, stock buybacks can stimulate investors to invest in other companies with a lack of cash, but with potential investing opportunities. However, these effects are limited. Actually the share of investment in start-ups has been declining and the CEO to worker wage ratio has risen immensely over the last decade. It is argued that banning stock buybacks could lead to increased dividends, which in turn leads to the same effects. But this is not entirely the case at all, because as mentioned before, stock buybacks lead to short term inflation, while increased dividends are more closely related to the real value of a business. Moreover, dividends are less sensitive to over-inflation, because shareholders expect dividends to be more stable. A volatile dividend payout reduces certainty and predictability and that’s the last thing big investors like.

Tax Payers Pay For Large Buy-backs

With the current 50 billion bailout of airlines in America, many wonder what would’ve been if these airlines didn’t do so many stock buybacks. American Airlines has been spending over 15 billion dollars on stock buybacks over the last 6 years. It seems as if big companies can inflate their stock market value and then sell it for a premium to the government during a economic downturn. Only now, as a condition of getting a bailout package, strict rules on buybacks are implemented. This should’ve been done way earlier, it’s time for a more equal playing ground. But with quantitative easing accelerating and future government spending at risk of being cut, more unequal times lie ahead. Many more problems will arise in the aftermath of the corona crisis, or as The Golden Investor likes to call it: The Ultimate Debt Crisis.

Bibliography

1) Brands, Y., Hut, P., & International, R. B. (2018). The High Costs Of Stock Buybacks For Workers. The Roosevelt Institute, 8–9.

2) Almeida, H., Fos, V., & Kronlund, M. (2016). The real effects of share repurchases. Journal of Financial Economics, 119(1), 168–185. https://doi.org/10.1016/j.jfineco.2015.08.008

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