Jeff Gordon –
People claim to be worried about stock buybacks. In fact, the buybacks are a stand-in for what we can all see: business in this country works for wealthy shareholders, not workers, customers, or communities.
Buybacks are in the news as policymakers contemplate a bailout of several major U.S. airlines, all of which have relatively little cash on hand to weather the current crisis. One reason the airlines have so little cash is that, as Bloomberg reports, they spent 96% of free cash flow buying back shares over the last decade. Senator Elizabeth Warren has proposed that no corporation receiving a government bailout should ever again be allowed to conduct buybacks. But the notion that, with fewer buybacks, the airlines would have saved enough to withstand a world-historic economic collapse is fanciful. To see this, we must recognize that the massive stock buybacks of the past decade are a symptom of heightened shareholder power. Efforts to limit or ban buybacks without addressing that power at its source would not lead to the higher wages, productive investments, or rainy-day savings that buyback critics hope for. Moreover, the narrow focus on buybacks distracts from the bigger opportunity presented by the crisis: to reclaim corporations for the public good.
I. What is the purpose of stock buybacks?
To begin: what is the point of buying back stock? Observers generally name three purposes. First, buybacks are about handing over profits to shareholders. You will usually see this phrased as returning profits to shareholders, but as I will show, much of the controversy stems from a disagreement about what claim shareholders have to corporate profits in the first place. What’s certain is that buybacks hand money to shareholders. In this light, it becomes clear that buybacks and dividends are close cousins. There are differences: buybacks are more tax-friendly to shareholders, and more conducive to federal regulation (dividends are governed by state corporate law). Still, the two devices are alternative means of paying out the firm’s retained earnings, and should be analyzed side by side. If you oppose buybacks, you should oppose dividends as well.
Nonetheless, some critics think that buybacks are uniquely problematic. This view involves a second story about their purpose: buybacks are about manipulating stock prices and earnings per share metrics. Buybacks reduce the quantity of shares outstanding so that each remaining share represents a larger proportional stake in the firm. And yet, there is now less money in the firm, so the impact on valuation should theoretically net to zero. Nonetheless, for various “signaling” reasons, buybacks do tend to produce at least a short-term bump in share price—and this may be enough to enrich executives, who are often paid in stock options and rewarded for hitting earnings per share targets. Critics decry buybacks on this account because executive compensation is excessive, and rightly so. But when people say that buybacks are only about stock price manipulation, they are implicitly claiming that the executives are enriching themselves at shareholders’ expense. We should be skeptical of this, as the evidence suggests that buybacks are a good deal for shareholders—or at least for highly informed shareholders who know when to sell into overpriced buybacks.
Indeed, not all buybacks are created equal. The third story, on this note, is that some buybacks are strategic: firms buy back stock when it is undervalued by the market. William Lazonick disputes this premise, observing that over the past two decades, companies have tended to buy back shares in bull markets and not in downturns. But a more granular cut of the data suggests that the companies most committed to buybacks do have a strategy to their timing. Some researchers divide the universe of buybacks into “low conviction” (less than 5% of the company’s shares outstanding) and “high conviction” (greater than 5%). Seventy percent of buybacks are low conviction, but those in the high-conviction group tend to repurchase shares at relatively cheap valuations. Moreover, the stock of the high conviction buyers outperforms the low conviction buyers as well as the rest of the market.
But what about the low conviction buybacks, which often occur at inflated prices? Why does management do that? J.W. Mason identifies pressure to “disgorge the cash” as the central conflict between shareholders and managers today. That pressure comes first and foremost from activist hedge funds, including the one that pressured Apple, in 2013, to pay out its enormous cash pile to shareholders. Apple has been the single largest share buyer in the intervening years. And the demands are not limited to companies like Apple that had accumulated enormous profits. Over the past few years, the trend has been for companies to borrow in order to pay dividends and buybacks. From a certain old-fashioned view of the firm, this makes no sense. But in the modern, shareholder-driven firm, it makes plenty of sense. When interest rates are low, many shareholders would happily take guaranteed money today in exchange for default risk later. Sure, shareholders will sometimes allow the firm to invest in operations, but only when the projected return is at least as high as the shareholders think they can get elsewhere. Mason names this threshold for permitting firms to keep money the “rentier opportunity cost.”
II. What should be done?
So, we find ourselves in a world where shareholders use corporations as funnels for cash, whether earned or borrowed. What to make of it? Some say shareholders have a right to expect such payouts: essentially, they wouldn’t have made equity investments in the first place if they didn’t expect dividends and buybacks. Against this, critics point out that the stock market plays only a minor role in funding business operations; in recent decades, more stock has been bought back than issued. And yet, while true of the public markets, that diagnosis is somewhat misleading. The decline of public markets is intertwined with the enormous growth of private markets. In recent years, privately placed securities exceeded publicly offered debt and equity combined. When we include private markets, it seems that equity investors still play a substantial role, especially in funding early-stage companies. One can picture a chain from early-stage growth investor, to IPO investor, to buyback recipient. At each link in the chain, someone buys because they believe someone else will come along later and pay more for their stake. As long as we rely on equity financing for growth companies, we need some mechanism for cashing out the investors at the end of the chain. But that doesn’t mean the payouts need to be as large as they are today.
No matter what they “deserve,” shareholders claim the overwhelming portion of the corporate surplus because they can. Limiting buybacks, on its own, would neither ensure that workers take home a fair share of profits nor ensure that firms have enough cash on hand to carry them through an economic crisis. Even if buybacks were somehow banned or limited by law, shareholders would pressure firms to spend the cash pile on mergers and acquisitions, or simply invest in financial assets—i.e. to do the exact same things with the money inside the firm that shareholders would do if they could get it out. The underlying driver is not the availability of the buyback technique itself, but the fact that shareholders are the ones calling the shots.
The only way to guarantee that workers or other stakeholders claim more of the surplus is to amplify their voice in corporate governance. There is no shortage of proposals for rolling back shareholder power. Limit the influence of hedge fund activism. Demand fiduciary duties of activist minority shareholders. Limit the use of stock in executive compensation. Insofar as shareholders retain a voice, empower “quality” shareholders at the expense of both their short-term and passive counterparts. Most importantly, establish worker control of the firm, whether through board seats or placing corporate stock in an employee ownership fund.
And never fear, there will be plenty of room for strategic, “high conviction” buybacks at a worker-controlled firm. When management views stock as undervalued by the market, it may well be a prudent use of corporate resources to buy it up. Still, it is unlikely that worker board members would agree to spend over 90% of free cash flow on dividends and buybacks as firms did this past decade. Worker-run firms would decide to invest in a project based not on the rentier opportunity cost, but on whether the project would help the firm survive as a going concern. That survival instinct naturally includes saving money for a rainy day, essentially bringing the logic of corporate finance closer to the logic of household finance. A firm governed as a going concern would also be inclined to share cost-cutting across the board in a recession to avoid any layoffs.
The economic hardship unfolding today will once again demonstrate the consequences of organizing the means of daily life around the whims of capital. But it is also the perfect opportunity to reclaim the corporation as a public thing, a vehicle for providing the food and medicine and shelter that we all need. Let’s channel the justifiable anger at buybacks into that bigger conversation about corporate purpose.
Jeff Gordon (@jeffgordon12) is a second-year law student at Yale Law School and a doctoral candidate in sociology at the University of California, Berkeley.