The bogeyman of redemption is back. How worried should we be?
Even more aggravating: Exxon and Chevron announced last week that they would spend billions of dollars of their profits to buy back their own shares, fattening investors’ wallets.
But a recent paper from a bipartisan think tank suggests the buyouts might not be as harmful to ordinary people with no money in the market as critics suggest.
Buyouts, which increase the value of a company’s stock and immediately reward shareholders and executives, have been a hot political issue since they were legalized in 1982. That’s when the Securities and Exchange Commission passed a rule allowing companies to buy their own shares without being accused of market manipulation.
They are also incredibly common. Last year, S&P 500 companies bought back a record $882 billion of their own shares. Executives sell more stock within eight days of their company’s takeover announcement than at any other time, according to SEC data.
These takeovers have soared in recent years as corporate America has posted huge gains and excess profits during the biggest boom since World War II. Washington Democrats also refocused their review of the practice after former President Donald Trump cut corporate tax rates to 21% from 35%. The change resulted in a rapid growth in redemptions. In 2019, America’s biggest companies spent $728 billion buying their own stock, up 55% from 2018, according to the Senate Finance Committee.
What the critics say
Critics and lawmakers argue that buyouts allow ultra-wealthy executives to manipulate markets while funneling corporate profits into their own pockets instead of the economy. Company shares are largely owned by wealthy Americans: the richest 10% of American households in terms of wealth own about 90% of corporate capital. The money would be better spent on long-term business growth and on employees, they say.
Senate Democrats like Sherrod Brown of Ohio and Ron Wyden of Oregon proposed at the time to institute a 2% tax on buyouts.
Now, as the country teeters on the brink of recession and faces historically high rates of inflation, the practice is back in the spotlight.
Policymakers, worried that companies are using their money to help shareholders instead of consumers and workers, are proposing increased scrutiny of the practice.
The White House has proposed new rules meant to curb stock buybacks as part of its $5.8 trillion budget plan for 2023. The plan would require corporate executives to hold company stock for a number of years and prohibit them from selling shares for a certain period of time after a scheduled redemption. The White House did not specify the exact number of years.
Discouraging stock buybacks “would align the interests of executives with the long-term interests of shareholders, workers and the economy,” said the proposal, which echoes a longstanding Democratic position that buybacks manipulate stock prices and divert money from business growth and innovation.
The big picture
Companies counter that they use buybacks as a way to efficiently distribute excess capital.
His argument rests largely on a trickle down effect from shareholders to the rest of society. “Buyouts provide investors, including beneficiaries of 401k and pensions that are invested across the market, with additional financial resources they otherwise would not have had,” they write. “These additional resources can in turn be reinvested or saved, which can provide the capital needed by small businesses and others to facilitate innovation and growth.”
Claims that buyouts hurt other forms of investing are also wrong, says Harvard Law School professor Jesse Fried.
“In short, the S&P 500 shareholder payout numbers cannot provide much basis for the idea that short-termism has starved public companies of needed capital,” he wrote.
Buybacks are down
At the start of the year, Goldman Sachs estimated that 2022 would see a record $1 trillion in buybacks. This is unlikely to happen. To date, 58% of companies have announced takeovers in Q2, and they’re down 12.9% since Q1 (although they’re still up about 7% from last year), according to data from Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
JPMorgan halted its buyback program in July, signaling a more cautious outlook as the economy flirts with recession. The suspension also came after the largest US bank failed the Federal Reserve’s stress test, sending it scrambling to generate more capital.
Bank of America and Citigroup also performed poorly on the test, which assesses a bank’s ability to lend during a severe global recession with unemployment hitting 10% and a sharp drop in asset prices.
Big banks accounted for 19.5%, or $54.7 billion, of all takeovers in the first quarter of 2022. Takeovers in the financial sector are currently 56.4% lower than last quarter and 50% of what they were last year.