Corporate America spent much of this year celebrating the tax cut that Republicans handed them by dumping truckloads of money onto their investors. Mostly, they did this by spending record amounts of money on stock buybacks.
Now that stocks are crashing—the S&P 500 is down about 17 percent from its September peak—some companies are looking like they overpaid. The Wall Street Journal reports Thursday that the shares Apple purchased are now worth $9 billion less than when they bought them. Wells Fargo and Citigroup also repurchased shares that have declined in value by billions.*
This usefully illustrates one of the problems with share repurchases: Companies have a nasty habit of purchasing their own stocks at the top of the market.
When companies buy back their stock, they increase its value by reducing the number of shares outstanding on the market. The practice was effectively barred as a form of market manipulation until a rule change by Ronald Reagan’s Securities and Exchange Commission in 1982. Since then, buybacks have gradually become the primary way corporations reward their investors, far outstripping dividends in most recent years.
Shareholders are generally just fine with this arrangement, since buybacks offer a nice jolt of instant financial gratification. You can either sell your shares and take a profit, or hold on to them and watch your net brokerage account fatten up without having to pay any capital gains taxes.
But buybacks also have their critics, a group that’s unofficially led by William Lazonick, an economist at the University of Massachusetts–Lowell. The case against share repurchases generally comes in two flavors.
One line of argument says that buybacks are both a symptom and a cause of a business culture in which CEOs strip their companies bare by lavishing cash upon shareholders instead of investing in their operations or workers—what Lazonick calls “the legalized looting of the U.S. industrial corporation.” The idea is that buybacks both make it easier to send money back to shareholders instead of invest, and—unlike regular quarterly dividends—tend to reward short-term investors who want the stock to pop quickly so they can make a quick buck selling it. Because CEOs are rewarded partly based on whether they hit certain stock price targets and are often compensated largely in stock options, there are also incentives for them to spend more on buybacks than they might on normal dividends.
I’ve always assumed that if buybacks were banned tomorrow—which some Democrats would like to do—companies would find other ways to return cash to shareholders that didn’t require them to increase their quarterly dividend (executives hate doing that, because decreasing a dividend later on when profits are down tends to bring a hellish rage from the market). For instance, they could just issue more “special dividends,” which are basically one-off cash payments. Point being, money always finds a way.
But then there’s a second line of anti-buyback argument, which is basically that companies have a habit of doing them at the wrong time. In theory, companies ought to purchase their stock when it’s undervalued—buy low, sell high (not that companies really sell their own stock these days; instead, they tend to use it as compensation for employees or to make acquisitions). But some CEO’s may be tempted to execute buybacks at times that maximize the value of their stock options, whether or not it’s actually a good deal for the company. And more broadly, buybacks tend to be procyclical; they boom when profits and share prices are high, so a bunch of companies end up buying at the top of the market—just like we’ve seen with Apple, Citigroup, and Wells Fargo this year.
Are buybacks really a root cause of our present economic ills? I don’t know. What is clear is that buybacks incentivize corporations to play the market poorly, even as they keep investors happy.
Correction, Dec. 28, 2018: This post, and its headlines, originally misstated that Apple “lost” $9 billion buying back its own stock. Because Apple retires its shares after repurchasing them, the ups and downs of its stock price don’t affect its balance sheet.