Buybacks and Dividends
When Companies Give Their Cash Away
Picture yourself as the CEO of a big, publicly traded company. You want to keep your shareholders happy and justify a big bonus for yourself. One solution is to invest your profits in developing new products, building factories or opening stores. Making money this way is hard: It requires identifying opportunities, managing new initiatives and waiting for them to pay off. An alternative is to give stockholders the cash the company has earned. This is easy: You just buy back some shares or increase dividends. Which is the better thing to do? The answer might be different for you, the company, its stockholders and the economy.
Giving money back to shareholders has become very popular among U.S. CEOs. Since 2009, S&P 500 companies have purchased $2 trillion of their stock. In 2014, nonfinancial companies returned almost $1 trillion in the form of share repurchases and dividends. As a percentage of gross domestic product, that’s among the largest payouts on record. Besides pumping up bonuses based on stock prices, the payouts have brought many benefits for CEOs. They make it easier to meet quarterly earnings-per-share targets, by reducing the number of shares. They’ve been a major factor in the bull market that began in 2009: In some years, shares bought in buybacks have outnumbered purchases by mutual funds by as much as 6 to 1. In early 2016, buybacks seemed to be the only thing keeping a bull markets in equities alive. The payouts also mollified activist investors, who have agitated for a piece of the cash hoards that companies built up after the crash, which led to a big cutback in business spending. With interest rates at rock bottom, companies including Home Depot have been borrowing billions to hand back to shareholders. On a smaller scale, stock repurchases are on the rise in Japan and Brazil. Buybacks are rarer in Europe, where investors prefer dividends. These bonanzas for shareholders, though, have consumed resources that companies might have put to other uses, such as expansion, hiring or raises. Buybacks grew much faster than capital expenditures over the five years through 2014, while wages stagnated and workers’ share of business income fell to record lows. With corporate debt levels high and interest rate increases on the horizon in the U.S., it could be that the buyback boom may be about to take a breather.
Big stock buybacks are a relatively new development. As recently as the 1970s, they were effectively banned in the U.S., amid concerns that executives would use them to manipulate share prices. That changed in the 1980s. Against the backdrop of President Ronald Reagan’s deregulatory drive, restrictions on buybacks were loosened and a culture of “shareholder value” was born. The idea was that the market should act as a disciplining force: Executives who couldn’t find attractive projects should give money back to investors, who would put it to better use. A wave of hostile takeovers made sitting on a pile of cash seem like a dangerous thing to do. And managers’ bonuses were increasingly tied to stock performance, to align their incentives with those of shareholders. Suddenly, buybacks boomed, often paid for by increased borrowing. In the new worldview, this was good: Tax breaks made debt a cheaper form of financing, and the need to make regular interest payments could focus executives’ minds on generating more cash. Over the next few decades, the stock market’s perceived function — raising money for business ventures — was turned on its head, as stocks became a vehicle largely for returning money to shareholders.
Investors, academics and political candidates are beginning to wonder whether buybacks have gone too far. Some money managers, including Larry Fink, the CEO of BlackRock, have called on executives to place the longer-term interests of companies and employees over the short-term boost that cash payouts can give. Researchers have linked buybacks to declines in investment and employment, and even suggested that companies are contributing to inequality by enriching shareholders at the expense of workers and the broader economy. Hillary Clinton, the Democratic presidential candidate, criticized buybacks and called for faster disclosure of stock repurchases. Others are less concerned. Executives, the logic goes, can’t be blamed for giving back money if they don’t see any attractive opportunities. In such an environment, throwing cash into new projects would be a waste. Eventually, investors will reallocate the funds to other enterprises with better ideas — indeed, this is the best way for the economy to adapt and remain competitive. On the other hand, a Bloomberg Intelligence analysis suggests that many buybacks are so poorly executed — buying high and selling low — that they can leave shareholders worse off.
The Reference Shelf
- In 1986, Michael Jensen published a seminal paper on the advantages of paying cash to shareholders.
- Economist William Lazonick assesses the economic drawbacks of share repurchases.
- Economists at the University of Illinois link share buybacks to investment and jobs.
- J.W. Mason of the Roosevelt Institute explores whether share buybacks broke the link between borrowing and investment.
- Researchers describe the history of share-buyback regulation.
First published May 11, 2015
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