(I did a quick hit on Bloomberg TV yesterday discussing buybacks, but I wanted to dive in in a bit more detail. You can see my brief comments here at the 6:30 second mark.)
In today’s edition of People Are Saying Stupid Things About Stock Buybacks I want to talk about the Chuck Schumer and Bernie Sanders proposal to ban stock buybacks. Here it is in case you want to become a little bit dumber.
Snark aside, I found the op-ed kinda lazy. Their proposal can be boiled down to:
“Share buybacks are manipulative ways to enrich CEOs and avoid having to pay workers higher wages so if firms are going to engage in this behavior then they also need to raise wages.”
First, a stock buyback is just a low risk way of allocating capital for firms that are uncertain about the return on investment of higher wages and R&D. When a firm earns excess profit they don’t necessarily know what to do with the money. They can engage in high risk allocations (like R&D, paying employees, etc) or they can engage in low risk allocations (like dividends, buybacks. etc). For firms that are performing well and earning excess profits dividends and buybacks are a low risk way of saying “let’s return this money to shareholders because we don’t have a high probability high ROI idea for it.” This doesn’t mean the firm doesn’t want to pay employees higher wages or invest in R&D. It just means the firm is performing well and they don’t want to take any unnecessary risks that might put the firm AND all of its employees at risk. This is prudent and better than sitting on the profits and doing nothing, or worse, investing it in employees and R&D, earning a negative ROI and risking the firm’s future.
Second, someone needs to destroy this idea that buybacks are necessarily incentivizing short-termism and manipulating the stock market. If these ideas were right then buybacks would be bad for firms in the long-term. And if buybacks were bad for firms in the long-term then their stocks would underperform in the long-term. But data shows the opposite is true. Firms that buyback shares tend to outperform or at least match the S&P 500 performance over the long-term. This makes sense because a critique of buybacks is really just a critique of firms for making excess profit.¹
Of course, it’s easy for the rest of us to look at Corporate America and say “why do they buy back stock when they could easily pay people more or invest in R&D!?!?!” The simple answer is, those are difficult decisions with uncertain outcomes. Paying a dividend or repurchasing shares is a low risk decision with a fairly certain outcome. And let’s be honest, if the rest of us really knew how to better allocate that capital then we’d be putting our own capital to work and helping to put these supposedly bad decision making firms out of business. The truth is, none of us knows how to allocate that excess capital better than the firms themselves.
More importantly, this general idea to ban buybacks is silly. After all, if a company is allowed to issue stock then why shouldn’t it be allowed to retire stock? It makes no sense to say that a firm that issues a de-facto liability cannot retire that liability if it wants to. If any entity should have the legal ability to retire liabilities surely the liability issuer itself should be the one to have that right!
Specifically on the Schumer/Sanders plan, what do they think will happen if you ban buybacks and dividends? Do they really think firms will automatically start taking more risk? Of course not. They will most likely just buy other low risk assets or leave the cash as it is. Nothing will change except now the firms will likely retain all of their profits and then people will complain about too much cash on corporate balance sheets.
Lastly, Schumer and Sanders are really criticizing firms for retaining too much profit and not paying higher wages. This is a reasonable criticism and there are reasonable ways to combat those problems that don’t involve an indirect and inefficient means of attacking the problem. For instance, they could raise the minimum wage or raise corporate taxes. I’ve long advocated for a change in the treatment of dividends and capital gains so that capital gains taxes are truly long-term (at least 5 years). This would not only tackle the concern about short-termism, but would also treat secondary markets for what they are – a place where ordinary income is earned and “investments” are rarely made. There’s no need for another set of regulations attacking a problem that can more directly be attacked.
Look, I am not saying that all of the critiques of buybacks are wrong. There are decent arguments against buybacks that offset employee based compensation as well as debt-fueled buybacks. But there is nothing inherently evil or manipulative about buybacks. They are essentially just prudent ways for firms to allocate capital that they don’t know what to do with. If politicians understood this they wouldn’t come up with silly solutions to problems that are easily solved with more direct policy proposals.