Exploring the Facts About Company Stock Buybacks

Company stock buybacks

A fair number of people are critical of the practice of companies buying back their stock, with some even suggesting that this practice be limited or banned. We need to understand this first.

Public companies both issue stock and buy back stock, according to their needs and strategies. The practice of a company buying back its own stock isn’t all that well understood among the public though, and without a good understanding, it might even seem that companies are cannibalizing themselves or selling their future for a few more dollars now.

Some even think that stock buybacks just serve to pad the pockets of the very rich, the executives that get all those stock options as part of their compensation that so many people love to hate, at the expense of someone at least, although it’s not always clear who is supposed to be harmed by this. No matter, our anger towards these very high-paid people can be plenty enough to have us shaking our fists, and getting upset is not normally a rational and deliberate practice anyway.

If we are looking to take these arguments on the road though, we’re going to need more to justify them than the fact that we think that some people are well overpaid and we want to stop this. We will need some particularly good arguments to undo mutually agreed upon contracts such as someone being paid a certain amount and their employer also being happy to pay it.

These arrangements don’t arise from holding people hostage or through any undue influence at all, they instead represent freely made mutual exchanges of value between parties. To interfere, we need to show that the arrangement isn’t a valid one, and although employers might even want us to cap executive compensation, our just wanting it capped isn’t even a meaningful consideration.

The foundation of this discussion does need to be focused on whether a company has a right to do this or not within the framework of a free market society, where people are afforded the right to spend their own money as they please and exercise the control of their capital as well. There are instances where it may be justifiable to limit these rights but our not liking what they choose and our looking to place constraints upon these decisions based upon our own preferences and not theirs does not even count.

The goal of a company is only to promote their own interests, and in the case of a corporation, their shareholders, and this would include things like taking money out of the company as they please and not being concerned at all about how this may impact the company’s future, because they own the company and are allowed to do such things.

If we buy a new car and decide to fill our gas tank with diesel oil and ruin the engine, we are allowed to, and can do whatever we want to it as long as our actions are confined to our own sphere of control. We can’t drive around the neighborhood recklessly and risk injuring other people or their property, but these things extend beyond our ownership of the car.

We therefore have an obligation not to impinge upon the safety of others unreasonably, either intentionally or by way of negligence, but we can exercise the rights to manage our own property as long as we do not interfere with the rights of others.

Companies do not have duties or obligations to society, even though some may prefer that they did. This is the big mistaken assumption that leftist politicians often make, and they make this mistake with the issue of buybacks as well, assuming that the state has an interest in the management of companies at the level of preference, where the preferences of these politicians or other observers should supersede those of the companies.

There are people who buy companies and then sell off their assets, which may leave people out of work, but they are not obligated in any way toward social goals such as maintaining employment levels, paying any sort of wage beyond what is required by law, or promoting economic growth. When you own a company or a portion of it, all of this is well within your rights, because it is your company.

The discussion of the merits of stock buybacks should be a complete non-starter, if we only take a step back and assess the merits of our having any genuine vested interest in the matter. Governments in free societies can intervene in matters that are genuinely public, but do not have any standing that could be understood as reasonable when it comes to deciding how your money is spent.

Deciding how to manage your own property without interfering with the same right of others is the cornerstone of free societies in fact, and we cannot rightfully be selective with this just because we don’t like the way that some people are managing their own affairs.

Buyback Researchers Speak Out Against the Confusion with Buybacks

Edward Yardini and Joseph Abbott of Yardini Research have stepped up and written another article on stock buybacks, and also have written a book called Stock Buybacks: The True Story. While they do tend to shy away from some of the criticisms a bit, they do share some insights that many people may not be aware of when it comes to this practice.

They do point out that a lot of stock buybacks result from companies issuing new stock to their employees, the part that the left-wing politicians particularly hate, although it really shouldn’t matter why companies do this, because they are entitled to under the principles of a free society. Perhaps not everyone believes in such a society and many don’t, but it is the one that we live in and any changes that we make will have to be made within the framework of our principles and especially our laws.

Laws can of course be changed, but only when it is reasonable to do so, otherwise the judiciary will rightly step in and set limits to these changes. We do not have anything even resembling the power to direct shareholders to not buy back stock, and we really can’t limit them without infringing on the principle that all of us can freely buy and sell stock, and that alone should put an end to this discussion for good.

One of the purposes of stock buybacks is to prevent dilution by new stock issuance by a company, and while this isn’t the sole reason, it’s one of the main ones to be sure.

Companies choose to base some or even a substantial portion of the compensation that they pay their employees in company stock, but this actually benefits the company over just paying them a similar amount in cash, because it’s simply better to just give them some stock as well as cash.

The reason for this is that the value of the stock that they get isn’t just the cash value, it also contains future value, and is also connected to their performance. Sure, you could pay them this extra in cash and they could just go out and invest it themselves, but you want them to buy your stock of course and be motivated to perform better so that their investments appreciate in value more.

This extends well beyond just the people at the top, as Yardini and Abbott point out. 13% of employees get at least some of their compensation in stock options, and 35% of people who work for companies whose stocks are traded offer stock as part of their benefits, where the company match their buying stock in their company.

It’s not that this should matter though, because we cannot stop this even if this was confined to just the CEO, because we would need a good reason to be able to interfere with this right, but this does extend well beyond the top people.

This does not lay to rest the argument that stock buybacks or stock options increase income inequality, but this is not a goal of a company in the first place. If stock buybacks increase income inequality, so does allowing anyone to buy stock, or invest in anything, or even get paid an above average wage.

Governments may tax these people more, and they do, but there are limitations to looking to level the income playing field and redistribution through taxation is where the line is actually drawn. How much of this we want to do is a matter of debate but while we can force people to pay more, we can’t tell them what they can invest in provided that the investments are legitimate.

From the data provided here though we can at least say that the distribution of the benefits of these stock buybacks extends well beyond the C level and not only involves a pretty high percentage of employees, 35% of them in fact, it also benefits anyone owning shares of the company, which is a lot of people indeed.

Buybacks Don’t Even Do All That Much

If we curtail or disallow this, what would happen is that the stocks of these companies would not see the dilutions compensated for, and the value of a company’s stock would drop lower than it would be otherwise. Yardini and Abbott are concerned about the dilution of earnings, but there’s an even bigger issue here, which is the dilution of their capital as well, the capital of all stockholders.

Sure, we could pay out extra dividends instead, but to understand how bad of an idea this is, we have to look at how much of the value of owning public shares comes from capital appreciation and how much comes from dividends. Dilutions such as what would happen if companies could not buy back their stock would stimulate the wrong kind of momentum, instead of creating positive momentum with the buybacks.

To shed light on the extent of this avoiding dilution, the authors point out that since 2011 with companies in the S&P 500, 72 billion shares were purchased by these companies and 50 billion new shares were issued. While not all of these shares issued were for the benefit of employees, that part doesn’t matter as these 50 billion shares need to be balanced off.

They also argue that buybacks don’t influence prices very much, to try to combat those who think that somehow this would be a bad thing. Only the real bears would be upset with this, but some are, and have the strange belief that companies should act more contrary to maintaining their stock price so that the bears may benefit.

Yardini and Abbott reason that stocks rise in value from earnings increasing, not because of stock buybacks, but from their data we can see that the buybacks do matter at least to some degree. However, this impact tends to be grossly overstated and they found that the difference in price performance between companies who bought back shares on a net basis only averaged a 5% advantage since 2011. That’s a pretty paltry amount.

Stock buybacks are coming even more into fashion over the last couple of years though, although this does not have anywhere near as big of an impact on stock prices as many may think. You see a stock rise quite a bit, you hear that they bought back a lot of stock, and then we can’t resist jumping to conclusions without needing to even look at the facts.

Stock buybacks actually serve a very useful purpose, and their main purpose is to get their stock price higher than what would otherwise be the case if the buybacks weren’t made. That’s actually a worthy goal for a company and is perhaps the embodiment of what they do, which ultimately is to gain more value for their owners.

We need to perish the thought that someone might even try to limit this, but the chances are lower if those who are against them spend more time evaluating the merits of their beliefs, and especially gain a proper understanding of what stock buybacks do and what impact they actually have.

They still might be shaking their fists, but a lot of fists get shaken in the run of a day and it’s only the ones with substance behind them that should concern us.


Editor, MarketReview.com

Monica uses a balanced approach to investment analysis, ensuring that we looking at the right things and not confined to a single and limiting theory which can lead us astray.

Contact Monica: [email protected]

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