Aside from 2020- which marked the lowest annual real GPD growth in the US since World War II- there has been a consistent annual growth in GDP. Despite this consistent growth in corporate growth, a significant reason why most of us fail to feel this substantiated growth is due to stock buybacks. This has been referred to as a technique in which companies use to ‘finesse’ their stock price and increase the value of stock options.
Post World War II, wages rose in a linear progression along with the cumulative annual change in per hour productivity. However, in the 1970s, they became out of sync. Wages started to lag behind despite workers continuing to help generate sturdy and consistent productivity gains. This issue exacerbated during the next three decades where workers have received consistently less of the growing corporate growth gains. On the other side, the top 0.1% of income recipients (including most of the highest-ranking corporate executives) reap practically all of the income gains.
The cause of this: the allocation of corporate profits to stock buybacks. However, it must be noted that not all stock buybacks are bad. This article will specifically focus on the downsides of buybacks.
Corporate Profits
When companies receive cash from profits, they have various options as to what they can do with surplus cash. First, the most common option is to reinvest it back into the company. Within this, the cash can have a multitude of uses- whether that be capital investments such as innovation/infrastructure advancements; increased pay/benefits; lateral hires; or simply increase diversification of goods and services offered (very common for companies looking to expand into new markets).
Second to this, as with many public and private companies, cash may be used to pay dividends to shareholders. In turn, this can often have a multiplier effect where shareholders can put money back into the economy by re-investing in other companies and new ventures.
Third, and the topic of discussion of this article, is where a company repurchases its own shares (stock buyback). Put simply, this is where a company will purchase its own shares, causing a reduction in the number of its shares in the market- thus leading to an increase in the company’s earnings per share (EPS).
Growing Stock Buybacks
Despite the first option being favoured by advisors to compete with competitivity, however, companies have been relying on the latter 2. In the 1980s, stock buybacks were negligible but the cash spent on dividends hit 50% of net income. By the late 1980s, buybacks increased and both of them combined accounted for, on average, 80% of the net income. This has received concern even from shareholders, ‘it concerns us that, in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies’ (Laurence Fink, Chairman and CEO of BlackRock).
Buybacks have now (since the 1990s) surpassed the amount on dividends. During the 2000s, the 449 companies listed on the S&P 500 (between 2003 and 2012) spent 54% of their earnings ($2.4 trillion) on buybacks and 37% went to dividends (9% for productive reinvestment).
As companies use less money for reinvestment, they ask the public to pay for it instead. In terms of the Nanotech industry, it has been found that industry leaders have pleaded for publicly funded research- arguing that the US cannot remain competitive without it (this led to the National Nanotechnology Initiative US which spends about $1.5bn a year).
Implications of Stock Buybacks
In short, stock buybacks foster inequality and stiffer innovation and growth. As a result of diverting cash reinvestment into wages and advancements in innovation and efficiency, this creates a larger divide in inequality where top executives continue to reap the bonus and benefits of increasing corporation profits (which has doubled or tripled since the first half of the 1990s- adjusting for inflation), compared to workers who are failing to receive the financial compensation for the company’s growth.
These issues associated with the downsides of Stock Buybacks can only be avoided where the government and business leaders take steps to control stock buybacks and executive pay- thus enabling a more equal distribution of income and providing stable employment.
How are Companies Getting Away with this?
Executives give 3 main justifications for buybacks:
'Their company’s shares are undervalued', meaning that the share price is lower than what it should be. Companies buyback their stocks when prices are high (not when prices are low). Buying back stock raises the EPS and raises the stock price to match what leaders think the value should be.
'Buybacks offset dilutions of EPS that happens when employees are granted stock options'. Lazonick’s research shows that the volume of buybacks far outstrips the options granted. Further to this, buybacks belie the point of granting options in the first place- to motivate people to work hard to increase the value of the company.
'Buybacks return unneeded cash to shareholders at companies with limited investment options because they are mature companies'. Lazonick believes that this failure to find opportunities worthy of investment is a failure of corporate leadership.
What are the Real Justifications for Buybacks?
Lazonick cites two explanations. The first is that it is a way to manipulate the stock price for the short term. This undoubtedly pleases the investors. In line with this, stock buybacks also provide a personal gain for top executives, who will receive bonuses and an increase in pay. A huge form of executive compensation is in the form of the company’s stock. In 2012, the 500 highest paid CEO’s of US public companies received (on average) around $300m- 42% came from stock options and 41% from stock awards. Through increasing demand for a company’s shares, buybacks lift stock price, even if this may only be for a temporary period, and thus can enable companies hit quarterly EPS targets. Note that, the ten companies (2003 to 2012) that have bought back the most stock spent 68% of their combined net income (almost $900bn). Despite the 10, only 3 outperformed the S&P 500 index in that time.
Shifting back to Reinvesting in Wages
Despite the recent growth of stock buybacks, the SEC has failed to launch proceedings against companies using them to manipulate its stock price. Lazonick believes that if companies won’t voluntarily shift back to normal reinvesting in wages, they must be made to do so with 4 solutions:
Ban buybacks.
Change executive incentives to encourage value creation and not value extraction.
Change regulations to rein in stock-based executive pay.
Change corporate boards from including only CEOs and other executives to include more stakeholders (especially workers and taxpayers).
Fix the tax regime which focuses on tax breaks as incentives.
By Max Davies
Penultimate Year Law Student
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