All About Stock Buybacks, a $1 Trillion Market Force
Picture yourself as the CEO of a big, publicly traded company. You want your stock to go up, both to keep shareholders happy and justify a big bonus. One option is to invest your profits in developing…
Picture yourself as the CEO of a big, publicly traded company. You want your stock to go up, both to keep shareholders happy and justify a big bonus. One option is to invest your profits in developing new products, building factories or opening stores, but boosting your stock price that way is hard.
It's much easier to have the company buy its own stock. Stock buybacks, as they are known, have come to represent the largest source of demand for US equities, and rose above $1 trillion for the first time in 2022. But their future is more uncertain now that Congress has passed a law that will impose a tax on buybacks.
One consequence might be an increase in dividends, payments companies make directly to shareholders.1. How big have buybacks been?The last several years have been among the busiest on record, according to the S&P Dow Jones Indices. S&P 500 companies flush with cash from a 2017 tax cut bought back $806 billion of shares in 2018, setting a record at the time.
While repurchases slipped in 2019 and 2020, they set a new record of $882 billion in 2021 before reaching $1.26 trillion in 2022. In January, $132 billion in planned buybacks were announced, more than triple the level of the year before. For index members, buybacks have exceeded dividends in every quarter but two since 2010.The Inflation Reduction Act signed into law in 2022 by President Joe Biden included a 1% excise tax on the value of corporate stock buybacks.
There are complex rules surrounding what would count as a taxable repurchase, but the measure is seen as increasing the relative appeal of dividends, which are taxed when issued. The measure is set to take effect in 2023 and is projected by the Joint Committee on Taxation to raise $74 billion over the following 10 years. 3. Why did buybacks become a target?They've been criticized for years by a wide range of politicians.
Senate Majority Leader Chuck Schumer calls buybacks 'one of the most self-serving things that corporate America does.' In 2018, then-President Donald Trump said he was unhappy with companies that used money saved from his 2017 tax cut to buy back shares rather than build domestic factories. In a 2020 debate over Covid-19 relief, Senator Elizabeth Warren of Massachusetts noted that the five biggest US airlines — prime targets for the government bailout funds — had spent 96% of their free cash flow on stock repurchases over the previous decade.4. How did buybacks get so big?Against the backdrop of President Ronald Reagan's deregulation 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.5.
Companies borrowed to buy stock?Yes. For example, Meta Platforms Inc. issued $10 billion of debt in August in its first corporate bond deal, a move that's seen as likely to spur it to larger stock buybacks.
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. 6.
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. Buybacks contribute to bull markets: Over the last seven years, net corporate buybacks made up the largest source of equity demand compared with other investor categories from pensions to mutual funds and households, according to data compiled by Goldman Sachs.
And they mollify activist investors, who have agitated for a piece of companies' cash hoards.7. What are the arguments against?These bonanzas for shareholders have consumed resources that companies might have put to other uses, such as expansion, hiring or raises. Buybacks exceeded capital expenditures over the five years through 2017, while wages stagnated and workers' share of business income remained near record lows, leading some critics argue that they harmed the long-term growth of the economy while 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.8.
Is this an issue elsewhere?While the US leads the way in both the amount of buybacks and the intensity of political scrutiny, the practice isn't unknown elsewhere. In Europe, buybacks had a stellar year in 2021, totaling $204.9 billion, the highest since 2008, after a pandemic-induced lull. The outlook this year is cloudier against the backdrop of a potential recession; data from Barclays showed firms spent $31 billion repurchasing shares in the first quarter of 2022 — the lowest since the end of 2020.
Regulators could also get tougher, particularly on energy firms that posted bumper earnings from surging oil and gas prices. Glencore Plc, one of the biggest winners from the global energy crunch, said in August it would buy back a further $3 billion in stock. But strategists warn that outsized buyback plans could prompt governments to impose windfall taxes.
Italy in May raised its windfall tax on energy company profits to 25% from 10%, and Spain in August was pursuing similar levies for energy firms and banks. In August, SoftBank Group Corp. sought to cushion the impact of its record 3.16 trillion yen ($23.4 billion) net quarterly loss by announcing a $3 billion share buyback. --With assistance from Lu Wang, Kurt Schussler and Sagarika Jaisinghani.More stories like this are available on bloomberg.com