Are stock buybacks as bad as they’re made out to be? The ubiquitous corporate practice of repurchasing shares has been the focus of much political and media scrutiny. The federal Inflation Reduction Act of 2022 included a 1% excise tax on repurchases (which President Biden has proposed increasing to 4% in his 2024 budget). In addition, senior Democrats have shown interest in barring executives from selling shares for three years after a repurchase, the federal government has suggested that companies that give up buybacks will receive preferential treatment, and the Securities and Exchange Commission has proposed a significant increase in the extent and frequency of repurchase reporting.
The debate on the economic consequences of stock buybacks has so far tended to focus on small samples or cherry-picked examples. Given that thousands of companies repurchase their shares each year, and aggregate repurchases have exceeded $500 billion annually for the past five years, we decided that a large-sample study of repurchasing behavior was warranted. Our study, published in the journal Financial Management, outlines the benefits of the practice, as stated by its proponents, and provides evidence that casts doubt on the alleged costs cited by its critics.
Get Updates on Innovative Strategy
The latest insights on strategy and execution in the workplace, delivered to your inbox once a month.
Critics of buybacks typically make three arguments against the practice. First, they claim that share repurchases enable companies to manipulate the market either by increasing the demand for — and therefore the price of — shares or by tricking naive investors by inflating earnings per share (EPS). Second, they allege that share repurchases enable insiders to benefit through compensation contracts or the sale of shares at inflated prices. And lastly, critics charge that share repurchases crowd out investment and thus sacrifice innovation and long-term economic growth.
Meanwhile, those who support or engage in stock buybacks offer several justifications for the practice. First, payouts to shareholders align manager and shareholder incentives by reducing the potential misuse of free cash flow. Second, using repurchases instead of or in addition to dividends gives corporations flexibility in the amount of cash returned to shareholders, the ability to award repurchased shares to employees as equity compensation, a modest tax advantage to shareholders (less pronounced since the 2003 dividend tax cut), and the ability to signal the company’s good prospects to the market. Finally, share repurchases represent well-disclosed and regulated arm’s length transactions at current market prices between willing participants.
Nicholas Guest is an assistant professor of accounting at the Johnson Graduate School of Management at Cornell University. S.P. Kothari is the Gordon Y. Billard Professor of Accounting and Finance at MIT’s Sloan School of Management, where he was previously deputy dean. Parth Venkat is an assistant professor of finance at the Culverhouse College of Business at the University of Alabama.
Critics of buybacks argue that the practice represents taking away resources that would be better spent on employee wages and benefits or investments that could lead to more jobs later.
For most of the 20th century, stock buybacks were deemed illegal because they were thought to be a form of stock market manipulation. But since 1982, when they were essentially legalized by the SEC, buybacks have become perhaps the most popular financial engineering tool in the C-Suite tool shed.
The Inflation Reduction Act imposed a new excise tax on stock repurchases equal to one percent of the aggregate fair market value of stock repurchased by certain corporations during the taxable year, subject to adjustments. The stock repurchase excise tax applies to repurchases after Dec. 31, 2022.
Biden is hoping a higher tax on buybacks will yield two results. First, it will incentivize companies to spend excess cash on workers or to explore methods to keep costs down for consumers, rather than boosting executive compensation and rewarding shareholders.
This income would also be counted as profit which would help push one's stock even higher. Overall, the ability to use one's own profits to buy back their own stock is harmful to the average American. It diverts money away from investing in workers or physical capital and disproportionately aids the wealthy.
If a management team is buying stock at any price, rather than at a good price, it may be wasting shareholder capital. So if a stock is really only worth $100 but a management team is buying it for $150, that destroys value.
As a shareholder you are not required to sell your shares back to the company in a share buyback; the company cannot make you do so; however, companies do offer a premium over the market price of the share to entice investors to sell.
“Prior to 1982, stock buybacks were considered illegal stock manipulation, but President Reagan's Securities and Exchange Commission implemented a rule to exempt them.
Properly applied, a share buyback can help a company significantly enhance its value to shareholders. Managers must ask themselves if they are embarking on the buyback for the right reasons, and they should take pains to make sure that the way they implement the buyback is appropriate to their goals.
Stock buybacks can have a mildly positive effect on the economy overall. They tend to have a much more direct and positive impact on the financial markets, as they lead to rising stock prices. Another way improvements in the financial markets impact the real economy is through lower borrowing costs for corporations.
But it has remained the largest stock exchange in the world by market capitalisation ever since the end of World War I, when it overtook the London Stock Exchange.
Apple seems to see buybacks as an effective way to distribute profits back to those who own their stock in addition to dividends which are regular payouts to shareholders.
Buybacks are unfair and damaging to long-term investors for two reasons. First, money that belongs to all investors goes to only a few. Second, because buybacks reduce capitalization, the company has diminished capacity to increase earnings, to withstand bad times, and to pay dividends.
A buyback can benefit investors because they receive their capital back and are often paid a premium over the stock's market price. In addition, there is a boost in the share price for investors who still hold onto the stock; however, buybacks aren't necessarily always good for investors.
Introduction: My name is Wyatt Volkman LLD, I am a handsome, rich, comfortable, lively, zealous, graceful, gifted person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
