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Why Corporate Share Repurchases Are Brewing Controversy

(Note: all the sources listed in the "Balanced" section)

Proponents of tax cuts that went into effect in 2018 argued it would make corporations more competitive and stimulate higher wages for employees and increase capital investment. Critics suggested the cuts would benefit the wealthy with savings directed toward increasing executive compensation tied to stock performance and returning capital to shareholders in the form of higher dividends and share repurchases. With a surge in corporate stock repurchase announcements in 2018, buybacks could attract more attention, particularly from Democratic lawmakers who took control of the House in January.

As a means of returning capital to shareholders, share repurchases offer greater flexibility. Compared to dividends, which generally require a stable and long-term commitment to distributing cash flow, buybacks are more variable and can be executed at management’s discretion. According to data from S&P Dow Jones Indices, S&P 500 companies repurchased shares during the first three quarters of 2018 amounting to $583.5 billion in aggregate, a 52.6% increase compared to the first three quarters of 2017 when share repurchases amounted to $382.4 billion. On a full-year basis, share buybacks amounted to $517.4 billion in 2017 and $536.4 billion in 2016.

Share repurchases promote managerial discipline. Proponents believe that returning capital to shareholders promotes management discipline and dissuades them from wasting money on poor investments or transacting ill-conceived acquisitions.

Share repurchases are tax efficient. Corporate buybacks are a tax efficient means of returning cash to shareholders because unlike dividends, a buy-back is tax-free to investors who don’t sell their shares.

Share repurchases increase shareholder value. With fewer shares outstanding, proportional ownership among existing shareholders increases and profits are allocated among fewer shares thus benefiting earnings per share (EPS) and share value.

Corporate buybacks are manipulated by management. Critics often view share repurchases as a way for managements to manipulate EPS to boost performance and justify incentive compensation. Additionally, some believe buybacks are a means to offset dilution from equity awards to executives.

Share repurchases are often poorly timed. There is a risk that managements will repurchase shares when the company is doing well, and the shares are not undervalued. Through the September quarter, Apple Inc. spent $62.9 billion on share repurchases through open market and privately negotiated purchases, acquiring 342.3 million shares at an average price of $183.90 per share. The company paid as high as an average $222.07 per share during the September 2 through September 29, 2018 period. The acquired shares were worth $54 billion at year-end 2018 when the shares closed at $157.74 per share.

Corporate repurchases have opportunity costs. Some worry that returning capital to shareholders is often at the expense of investment in capital equipment, research or other activities that promote long-term growth and contribute to the economy. Theoretically, managements should weigh the benefit of returning capital to shareholders against returns from other investments.

Share repurchases don’t share the wealth and have damaging long-term consequences. Some believe that the increase in corporate buybacks is driving wealth inequality and wage stagnation in our country by hurting long-term economic growth and shared prosperity for workers. Senator Elizabeth Warren (D-MA) has been quoted as saying “Stock buybacks create a sugar high for the corporations. It boosts prices in the short run, but the real way to boost the value of a corporation is to invest in the future, and they are not doing that.” Senator Warren introduced the Accountable Capitalism Act in August 2018, a proposed federal bill that seeks to shift corporate governance from principally acting in the interest of shareholders to a broader constituency of stakeholders, including workers.

It’s their money. In the end, it is the shareholders’ money and they entrust managements and boards of directors to be good stewards of corporate resources. If not, shareowners can always sell their stock and invest elsewhere. Warren Buffett, the Oracle of Omaha, is a fan of corporate share repurchases, especially if the shares are undervalued. Ironically, it was Berkshire Hathaway from whom Phillips 66 repurchased 35 million shares of stock during the first quarter of 2018 for $3.3 billion, or $93.725 per share. The shares finished 2018 at $86.15 per share. In a 2018 open letter to CEOs, Larry Fink, CEO of investment manager Blackrock, encouraged managements to guard against short-term thinking and explain how the changes to the tax law fit into their long-term strategy, including the use of after-tax cash flow to create long-term value. While there is little doubt that the lowering of the corporate tax rate to 21% from 35% and an incentive to repatriate foreign earnings to the U.S. contributed to the increase in stock repurchases, these programs could taper off over time. However, while bills such as the Accountable Capitalism Act proposed by Senator Warren would likely face opposition, the recent surge in buyback activity could stir more discussion and dial up the sound on corporate governance.

Sources:

“S&P 500 Q3 2018 Buybacks Surpass $200 Billion Mark for the First Time Ever” Howard Silverblatt, S&P Dow Jones Indices, December 18, 2018

“S&P 500 Q2 2018 Buybacks Increase 58.7% Year-Over-Year to Record $190.6 Billion” Howard Silverblatt, S&P Dow Jones Indices, September 24, 2018

“S&P 500 Q1 2018 Buybacks Rose 38% to Record $189.1 Billion” Howard Silverblatt, S&P Dow Jones Indices, June 25, 2018

“S&P 500 Q4 2017 Buybacks Rose 6.0% to $137.0 Billion; Full Year 2017 Fell 3.2% to $519.4 Billion” Howard Silverblatt, S&P 500 Dow Jones Indices, March 21, 2018

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