The anticipation that U.S. corporations will repurchase a record $940 billion of their stock has raised significant congressional criticism, particularly from Democratic presidential hopefuls, but also from Republican Sen. Marco Rubio of Florida. The 2017 tax law that lowered corporate taxes from 35 percent to 21 percent has partly fueled their denunciations.
Stock buybacks refer to share repurchases. A buyback occurs when the issuing company reabsorbs that portion of its ownership that was previously distributed among public and private investors.
The theory behind reducing the number of shares — all things being equal — is it increases earnings per share (EPS) on the remaining shares. This benefits the remaining shareholders.
Buybacks can also protect a company from a hostile takeover, or signal that the company plans on going private. With the yield on corporate cash investments slightly above 1 percent, the incentive to buy back stock is high.
Let me give you the rationale for buybacks. Think of a pizza redivided from eight slices to six. It is still the same size pizza, but your slice just got bigger because there are fewer slices.
Warren Buffett utilizes stock buybacks when he feels that shares in Berkshire Hathaway are trading at below their intrinsic value. His company has to date repurchased close to $920 billion. A CNBC article in May 2017 noted that outstanding shares of Exxon Mobil have declined 40 percent and IBM decreased 60 percent since 1995.
According to a Goldman Sachs research report, buybacks top the use of S&P companies’ cash in 2019. S&P 500 companies will allocate 51 percent to invest in growth that includes capital expenditures, research and development and cash acquisitions, while 49 percent will be allocated to buybacks and dividends. In the article, GS noted that companies that buy back their own stock outperform the broader stock market.
In a Sunday op-ed by Senate Minority Leader Chuck Schumer and Sen. Bernie Sanders, they proposed legislation that would require public companies to offer higher wages and more robust benefits for workers as a condition for launching buyback plans.
Schumer and Sanders wrote: “The goal is to curtail the overreliance on buybacks while incentivizing productive investment of corporate capital.” They argued that buybacks benefit corporate executives and large shareholders rather than workers and the broad economy.
Laurence Fink, chairman and CEO of BlackRock, the world’s largest asset manager, wrote: “Too many companies have cut capital expenditures and even increased debt to boost dividends and increase share buybacks.”
In defense of corporate buybacks, MSCI, the world’s largest index provider, argued in an article “Taking Stock” that company buybacks do not impact research, development, and capital expenditures. Instead, they wrote, “There is no compelling evidence of a negative impact from share buybacks on long-term value creation for investors overall. Share buybacks have exceeded cash dividends every year since 1997.”
A corporation has four choices to allocate cash: (1) make capital expenditures or invest in other ways; (2) pay cash dividends; (3) acquire another company or business unit; (4) repurchase their own shares.
I have been fortunate to have served on the board of directors of several companies. We explicitly understood our responsibility to help a number of constituencies — the community, our employees, and our shareholders.
That said, our No. 1 priority was providing profitably with the best possible product at the best price. Otherwise, we would lose our competitiveness and thus face bankruptcy — a prospect that served nobody’s interests, particularly given our exposure to director’s liability.
Since 1996, the number of public American companies has declined 50 percent for a variety of reasons — corporate takeovers, cost of complying with regulations, corporations moving overseas, and going private. America has robustly benefited from our thriving corporate culture. We need to make certain that the cost-benefit of regulation enhances capital formation.
Originally published in the Sarasota Herald-Tribune
