The Buyback Boondoggle
As the unemployment rate hovers near 10%, the economic debate is focused on how the government should aid recovery. (More stimulus spending? Tax cuts?) But it's business' task to get the economy back on track—by investing in innovation and job creation. And if the recent past is any guide, corporations may stall the recovery by investing instead in something else: stock buybacks.
America urgently needs a debate on stock buybacks. There is no sound economic rationale for these investments. Justified by the notion of maximizing shareholder value, they do nothing for the economy—and a lot for CEOs receiving stock-based compensation.
The amount of money spent on buybacks is staggering. From 1997 through last year, 438 companies in the Standard & Poor's 500-stock index spent $2.4 trillion on them. In 2007, as profits soared, the average buyback bill for each was about $1.2 billion—a record amount. And faced with a dramatic drop in their combined net income in 2008, these companies trimmed buyback spending, but not proportionately: The buyback-to-profit ratio, which was already unprecedented in 2007, more than tripled in 2008, from 0.90 to 2.80.
CASH DRAINUnfortunately, buybacks are rampant in industries where investment in innovation is crucial—energy, technology, and pharmaceuticals. ExxonMobil (XOM), America's No. 1 repurchaser, spent $144 billion to buy back shares from 2000 through 2008—and almost $8 billion in first quarter 2009, the equivalent of 173% of its net quarterly income.
And five high-tech leaders—Microsoft (MSFT), IBM (IBM), Cisco Systems (CSCO), Intel, (INTC) and Hewlett-Packard (HPQ)—are in the Top 10 of repurchasers, each having spent more on buybacks than on research and development from 2000 through 2008. (While spending $73 billion to buy its own stock, IBM increased its offshore employment by 133,000, reducing U.S. jobs by 36,000.) Pfizer (PFE), Johnson & Johnson (JNJ), Amgen (AMGN), and Merck (MRK) have been big repurchasers, too, even as they have argued against regulating U.S. drug prices on the grounds that profits are needed to fund research. From 2000 through 2008, Amgen's repurchases cost the equivalent of 116% of its net income.
The downturn has slowed buyback activity. But consider this: Some companies that fell into financial distress were previously among the largest repurchasers. If bailed-out General Motors (GM) had banked the $20.4 billion distributed to shareholders as buybacks from 1986 through 2002 (with a 2.5% aftertax annual return), it would have had $35 billion in 2009 to stave off bankruptcy and respond to global competition.
And the bailed-out banks? Eight of the biggest spent a total of $182 billion on buybacks from 2000 to 2007. That reduced their ability to cover their bets on derivatives, exacerbating the crisis they created in the first place.
The experience of this decade suggests that when profitability returns, buybacks will again be a top priority for corporations—at the expense of initiatives that could help spur a solid recovery.
Executives claim stock repurchases are financial investments that signal confidence in the company's stock price. Yet companies never sell the bought-back shares at higher prices to cash in on these investments. (To do so would be to signal to the market that the share prices had peaked.) It is the executives themselves who frequently benefit from price boosts generated by repurchases—by selling their personal shares after exercising stock options.
One way to prevent this is to ban buybacks by big corporations using them solely to manipulate their share prices. Such a ban would not apply to repurchases by small companies or to coordinated, transparent efforts to buy back shares to prevent a market collapse. What would be eliminated would be buybacks that help top executives reap outsized pay rewards.
If we want to encourage innovation and job creation, we need to question the value of stock buybacks—as well as, eventually, the mantra of "maximizing shareholder value" that justifies them.
All of America's stakeholders—consumers, workers, retirees—should demand that their elected representatives scrutinize how corporations at the heart of the U.S. economy are choosing to allocate the nation's resources.
Jack and Suzy Welch are off this week.