Share buybacks, once an American eccentricity, are now sweeping the globe. Companies bought back their own stock last year to a global record of $1.3 trillion, three times the level of a decade earlier, according to research by Janus Henderson. While U.S. companies remain the biggest buyers, the deals have quickly gained favor in continental Europe and the U.K. since the pandemic began.
But it takes something more than the unscrupulous support of activist investors or the instinctive disapproval of progressive critics. Instead, we should welcome new efforts to give repos the thoughtful scrutiny they have long needed.
Historically, companies with excess cash returned it to shareholders as dividends. But in recent years, more and more companies, especially in growth industries such as technology, have opted instead to buy back stock, sometimes even taking on debt to do so.
Some investors, especially those who are short-sighted or worried about spending money to build an empire, like this way of doing things. They’d rather see buybacks provide an immediate boost to stock prices by reducing the overall share count. Capital gains taxes are generally lower than taxes on dividends, and the recipient controls the timing because the tax is only payable when the shares are sold.
Executives in cyclical industries also like to view share buybacks as contingent rather than expected benefits. That means they are easier to stop in a bad economy than their dividends, where cuts are seen as a sign of acknowledgment of weakness. Share buybacks accounted for nearly half of the cash global companies returned to shareholders last year, up from a third in 2012, according to Janus data.
But we have good reason to be skeptical. Take the Invesco ETF, which invests in companies that have repurchased 5% or more of their shares in the previous year. If buybacks actually improve performance, that’s a winner. Instead, it has underperformed the S&P 500 both this year and over the past decade, even though it fared better during the first phase of the pandemic.
Critics argue that companies are so addicted to instant gains in stock prices that they mortgage the future by underpaying employees or cutting research to pay for buybacks. We should think about who really benefits when companies pay their employees with newly issued shares and then buy back shares to offset the dilution they just created. That’s why U.S. President Joe Biden introduced a new 1% tax on buybacks in last year’s inflation-reduction bill. Now he wants to quadruple it.
I disagree with this hate. It’s far better for companies to return cash than to make high-profile acquisitions that ultimately destroy value, or to put money into pet projects like Facebook’s huge bet on the Metaverse. Climate activists should cheer the recent rise in buybacks by oil and gas companies. Not only does the industry have a history of overinvestment, but its shareholders can reinvest funds directly into green energy.
But buybacks are no substitute for thoughtful growth investing and decent employee compensation. They can be abused. When the SEC staff looked at share buybacks in 2018, they found that insider trading spiked immediately after the announcement, allowing executives to personally profit from rising stock prices. Such sales may not be illegal, then Commissioner Robert Jackson observed, but it smacks of self-dealing.
This month, the SEC finally took some action on the problem, enacting a new rule that requires companies to disclose at the end of each quarter their daily stock buybacks, why they did so, and whether executives made the purchases before and after the buybacks. Buy or sell stocks instantly.
The U.S. Chamber of Commerce immediately sued, calling the rule an affront to free speech and an attempt to micromanage corporate decision-making. The group argues that much of the increase in insider trading around buybacks has been driven by a small number of outlier companies, so it is unfair to impose the disclosure burden on everyone.
The reverse is more likely to be true. Both insider sales and total buybacks must be reported, so companies should be able to compile quarterly figures. The new disclosure will immediately make it clear which corporate executives, if any, are using buybacks to their advantage.
More sunshine around buyback programs would reduce the heated debate among investors by helping them distinguish the good from the bad.
brooke.masters@ft.com
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