The splurge in share buybacks is doing more harm than good, hurting both businesses and long-term investors, says new study.
Share buybacks by US companies have rocketed following president Donald Trump’s tax cuts. The windfall the cut provided has allowed firms to dedicate record-breaking amounts to buying back their own stock. Almost $437 billion in buyback plans were announced in the second quarter of 2018, up from $242 billion in the previous three months, according to investment research firm TrimTabs.
These buybacks have helped boost firms’ share price, helping to prolong the US’s 10- year bull market. However, according to a new study from the Roosevelt Institute, titled ‘Curbing Stock Buybacks’, this splurge in buybacks is doing more harm than good.
The study first notes the scale of buybacks per sector between 2015 and 2017. The restaurant industry was the most generous, spending a total of 136.5 per cent of net profits on share buybacks. The excess amount was funded via debt and cash reserves.
Meanwhile, companies in the retail and food manufacturing sector spent 79.2 per cent and 58.2 per cent respectively. On average, US public companies spent almost 60 percent of their net profits on buybacks.
That’s a lot of capital, which the authors of the report argue could have been funnelled elsewhere to the benefit of both the longevity of the companies and the wider economy.
The authors point out that the restaurant sector, as well as being the most generous for buybacks, also has some of the US economy’s lowest-paid workers. Capital spent on buyback shares could have been allocated towards staff bonuses or wage hikes which, the authors claim, would have a positive impact on the US economy.
AT the same time, share buybacks are also leading to lower overall corporate reinvestment, they say. The growth of buybacks has coincided with companies having ‘reduced spending on developing new businesses, hiring workers, and establishing new operations,’ the reports notes: the average firm used to spend 20 cents of each dollar of their operating returns on reinvestment. Since 2002 that has fallen to just 10 cents.
The report isn’t the first to make these criticisms. Larry Fink, the CEO of BlackRock has made a similar argument, warning against businesses looking to ‘deliver immediate returns to shareholders, such as buybacks…while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.’
However, not all agree that share buybacks stifle investment and innovation. According to Jesse Fried and Charles Wang, professors at Harvard Business School, capital flowing to shareholders in the form of buybacks is often put to productive use. The professors argue that shareholders use much of the cash to invest in smaller public and private firms, which in turn supports innovation throughout the economy.
The authors of the Roosevelt Institute study, however, dispute this argument, noting that greater amounts are being pulled out of the market rather than reinvested in it. ‘Across the economy, the scale of shareholder payouts via buybacks in recent years dwarfs new stock issuances by publicly traded companies,’ they note. ‘In fact, the share of investment in new and small companies is actually declining.’
The report also argues that even the idea that share buybacks ‘reward shareholders’ is mistaken. ‘Buyback activity may benefit certain shareholders in the short and even medium term—especially those engaged in speculative behaviour,’ they note. ‘But shareholders that have a decades-long stake in the growth and well-being of companies—including institutional investors…lose as these companies reinvest less in growing and expanding their operations relative to growth in profits.’
Dividend payments the authors argue, are much preferable to buybacks. While the issues of worker compensation and underinvestment may still go unaddressed, dividends ‘require a longer-term commitment on the part of corporations than do stock buybacks.’
With the exception of special dividends, once a firm has instituted a dividend it is expected by shareholders to be permanent and increase over time. Therefore, ‘presumably, executives treat the decision to issue dividends in relation to the future profitability and growth of the company. This form of shareholder payout is, hypothetically, not oriented toward plundering a company’s resources at the cost of a company’s long-term wellbeing.