In a recent New York Times article (February 3, 2019), U.S. senators Chuck Schumer and Bernie Sanders announced a forthcoming bill to severely curtail corporate share buybacks (repurchases). Why, you ask?
“… rather than investing in ways to make their businesses more resilient or their workers more productive, [companies] have been dedicating ever larger shares of their profits to dividends and corporate share repurchases.”
The rest of the anti-buyback arguments in the article are essentially repetitions of the above: share buybacks are made at the expense of corporate long-term growth and employee productivity and welfare (higher wages), to enrich shareholders, and particularly executives.
First, let’s examine the logic of this argument. Schumer and Sanders claim that in our highly competitive, globalized economy, corporate managers are intentionally weakening the resilience and long-term growth of their companies, as well as the productivity of their employees, to repurchase shares. And why will managers commit this Kamikaze? Because, say the senators, buybacks “… boost the value of the stock to the benefit of shareholders and corporate leadership.”
So, you are asked to believe that corporate managers will sacrifice the competitive position of their companies, and their own reputation as successful leaders for a 2-3% gain in stock price, which is the average reaction of share prices to share buyback announcements. Seriously harming the company for an average daily share price move. Does this make sense to you? I sincerely doubt it, but it surely does to the senators.
Perhaps logic isn’t the appropriate test for politicians. So, how about facts? Let’s look at the evidence. Professors Manconi, Peyer, and Vermaelen (2015, “Buybacks Around the World.”) examined 20,000 share buybacks in 32 countries, including the U.S. By the way, the buyback practice quickly spreads around the world―so, it’s not only “greedy U.S. executives” who commit this sin. The researchers’ main finding flies in the face of Schumer and Sanders: Buyback companies’ market value grows after the share repurchase faster than other companies. So, where is Schumer-Sanders’ sacrifice of corporate resilience and growth, as well as employee productivity for the buybacks? Definitely not in the data.
The researchers’ finding is consistent with an argument often made by managers that they repurchase shares when they perceive the stock price to be undervalued in the market. On average, buying undervalued shares yields above-normal subsequent returns.
The research also support another advantage of buybacks: reducing agency costs, namely the conflicts between shareholders and managers (the agents). By distributing excess cash to shareholders―a major reason for buybacks―managers have fewer opportunities to squander money on failed investments, or on “vanity projects,” like mergers, corporate jets (recall former General Electric CEO Jeff Immet who used two corporate jets for his flights), or corporate-named stadiums.
Finally and particularly relevant to our case, the researchers examined an EU regulation which requires, shareholders’ approval for a buyback, rather than just board approval. The result: this regulation didn’t have any effect on shareholder returns. At least the regulation didn’t do any harm, which isn’t the case with the Schumer-Sanders proposal.
Back to Schumer and Sanders, their main argument that buyback impede corporate investment in R&D, technology, and employees puts the cart before the horse. As studies have shown, it’s the absence of attractive investment opportunities that motivates managers to distribute excess cash to shareholders, not the other way around. The biggest share repurchasers, Apple, Microsoft, IBM, Oracle, Cisco, and Pfizer, are also the largest spenders on R&D and technology and their employees are very well paid. U.S. firms invest in intangibles (R&D, IT, brands, human resources) over $2 trillion annually (Corrado and Hulten research), while having spent, according to the senators, $4 trillion on buybacks over the 10 years, 2008-2017. Buybacks at the expense of investment? Doesn’t seem so.
Schumer and Sanders, non-accountants, can be excused (though their assistants cannot) for the following inaccuracy: “Between 2008 and 2017, 466 of the S&P 500 companies spent around $4 trillion on stock buybacks, equal to 53% of profits. An additional 40% of corporate profits went to dividends. When more than 90 percent of corporate profits go to buybacks and dividends, there is reason to be concerned.” This reflects a basic misunderstanding of how profits are measured, or rather mismeasured. As I have noted many times in previous posts, the most important long-term investments of companies (R&D, IT, brands, business processes) are expensed in the income statement, namely depress accounting profits. Most of the annual $2 trillion corporate investment in intangibles is expensed. So, the 90% ratio buybacks plus dividends to profits mentioned by the senators is vastly overstated, given the depressed reported profit figures by companies.
Finally, I have one serious concern with buybacks, which is not even mentioned by the senators. By reducing the number of outstanding shares, buybacks temporarily raise earnings per share (EPS). Studies have shown that some companies use buybacks to beat (surpass) analysts’ EPS consensus estimate. This manipulation is indeed a concern, but it doesn’t require legislation to fix, just alert accounting rule-makers. Simply require firms to report EPS net of the buyback effect, namely based on the pre-buyback number of shares outstanding. This will alert investors to the mechanical impact of buybacks on EPS, and will reduce the number of manipulative buybacks.
So, what about the Schumer-Sanders legislation? My suggestion: Let’s forget it (it won’t pass a Republican Senate anyway).