How the Stock Buyback Bazooka Has Been Silenced by Virus
(Bloomberg) -- The effort to shore up U.S. businesses battered by the coronavirus pandemic has brought new attention to the single biggest investment most big companies have made over the past decade: their own stock. The defenders of share buybacks say it’s often the most efficient use of capital. Critics say it has left firms vulnerable to the kind of shock the virus has produced. Either way, it’s been a vital support for equities -- but one that will probably be sharply curtailed for a while, for both economic and political reasons.
1. How big have buybacks been?
The past two years have been the busiest on record, according to a report by S&P Dow Jones Indices. Companies flush with cash from a 2017 tax cut bought back a record $806 billion of shares in 2018, a figure that slipped to $729 billion in 2019. For members of the S&P 500 Index, buybacks have exceeded dividends in every quarter since 2010.
2. What’s happening now?
Buybacks started to slow in the beginning of the year, with U.S. repurchases totaling $122 billion in January and February, down 46% from a year earlier, according to the report. This slowdown -- which coincided with a peaking stock market -- gathered pace in recent weeks as a growing number of companies across the world suspended the practice to conserve cash. The S&P report described second-quarter prospects as “dismal” and said buybacks may be slow to come back due to potential government restrictions as well as public-image concerns.
3. Who’s pulling back?
Eight giant U.S. banks responsible for some of the largest buybacks globally in the past year, including JPMorgan Chase & Co. and Bank of America Corp., agreed to stop buying back their own shares through the second quarter. The banks had planned to spend a combined $119 billion in the four quarters after the Federal Reserve’s stress tests last June. Among Europe’s most prolific buyers of its own shares, Royal Dutch Shell Plc, canceled the next tranche of its $25 billion buyback program. For whatever reason, cutting off buybacks removes one more prop of a shaky equities market. And not just in the U.S.: Barclays Plc strategists wrote in a note to clients on March 25 that European equities are losing support from buybacks, which “acted as a crucial backstop during periods of rising market volatility last year.”
4. What do buybacks have to do with stimulus packages?
In short, it’s the horrible optics of a company using money from the government to enrich shareholders. Buybacks have been denounced by both the right and the left. President Donald Trump said earlier this month he was unhappy with companies that used money saved from his 2017 tax cut to buy back shares rather than build domestic factories. A repeat of this would go against the intention of any bailouts, which is to support workers, he said. Democrats like Senator Elizabeth Warren of Massachusetts pushed to include a permanent ban on buybacks as a condition for government aid. She and others noted that the five biggest U.S. airlines -- prime targets for government bailout funds -- spent 96% of their free cash flow on repurchases over the past decade.
5. What was decided?
A bipartisan bill agreed to in the Senate included a requirement that any company receiving a government loan would be subject to a ban on stock buybacks through the term of the loan plus one additional year. Those companies also would have to limit executive bonuses and take steps to protect workers.
6. How did buybacks get so big?
Against the backdrop of President Ronald Reagan’s deregulatory drive in the 1980s, restrictions on buybacks were loosened, executives were granted a safe harbor from stock-price manipulation charges and a culture of “shareholder value” was born. A wave of hostile takeovers made sitting on a pile of cash seem dangerous. And managers’ bonuses were increasingly tied to stock performance, to align their incentives with those of shareholders. The result? Buybacks boomed, often paid for with increased borrowing.
7. Companies borrowed to buy stock?
Yes. In the Reagan-era worldview, this was good: Tax breaks made debt a cheaper form of financing, and the need to make regular interest payments could focus executives’ minds on generating more cash. Over the next few decades, the stock market’s perceived function -- raising money for business ventures -- was turned on its head, as stocks became a vehicle largely for returning money to shareholders. Any gain in the share price caused by a buyback goes untaxed as long as the shares aren’t sold, and capital gains are also usually taxed at lower rates than dividends.
8. What’s the benefit of buybacks beyond making shareholders richer?
Proponents argue that if managers can’t see a better opportunity for profitable investment, perhaps there isn’t one. Buybacks are thus seen as a good vehicle to get funds out of the hands of executives who might otherwise waste them on pet projects and speculative investments.
9. What are the arguments against?
Some critics, including Warren and U.S. Democratic presidential candidate Bernie Sanders, argue that buybacks are great for shareholders but bad for employees, harming the long-term growth of the economy and exacerbating inequality. A different line of criticism says that the widespread use of buybacks isn’t good for shareholders either. With the majority of senior executive compensation tied to company stock, managers often take advantage of the pop that a stock price gets when a buyback is announced to sell some of the shares they’ve received through grants or options. Record-low interest rates make it easier to pile on debt for this purpose, which can prove detrimental in a crisis when cash flows dry up.
10. Is this an issue elsewhere?
While the U.S. leads the way in both the amount of buybacks and the intensity of political scrutiny, the practice isn’t unknown in Europe or Asia. In Japan, electronics powerhouse Sony Corp. announced a 100 billion yen ($900 million) buyback last year -- its first-ever major repurchase -- followed by another one twice as large just months after. The European Central Bank said earlier this month that it expects banks to take “prudent decisions” after unveiling support measures, while Germany’s financial watchdog Bafin said that lenders should avoid buybacks.
The Reference Shelf
- In 1986, Michael Jensen published a seminal paper on the advantages of paying cash to shareholders.
- AQR Capital Management authors take aim at some popular criticisms of buybacks.
- Roosevelt Institute paper examines whether corporate insiders use stock buybacks for personal gain.
- Economist William Lazonick assesses the economic drawbacks of share repurchases.
- Economists at the University of Illinois link share buybacks to investment and jobs.
- International Monetary Fund warned in October that debt-funded payouts can considerably weaken a firm’s credit quality.
- A Harvard Business Review article makes the case for buybacks as promoting innovation.
- J.W. Mason of the Roosevelt Institute explores whether share buybacks broke the link between borrowing and investment.
- Researchers describe the history of share-buyback regulation.
©2020 Bloomberg L.P.