Record Stock Buybacks Generate Backlash

By Congress FOXBusiness

U.S. companies have been on a historic spending spree in recent years. But much of the spending hasn’t gone toward acquisitions, research and development, or new factories.

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Instead, the spending has been earmarked for stock buybacks that have rewarded shareholders (any many CEOs) and contributed significantly to the long-running bull market in U.S. equities.

After a record year for buybacks in 2014 in which S&P 500 index members increased their buyback totals by 16.3% to $553.3 billion compared with $475.6 billion in 2013, the pace has picked up even stronger momentum in 2015. 

Specifically, many companies are taking advantage of extremely low interest rates – and trying to get out ahead of an imminent rate hike --  to borrow money and then use that borrowed cash to buy back their own stock. Apple (AAPL), AT&T (T), MetLife (MET) and Rite Aid Corp. (RAD) are just a few of the well-known companies to borrow billions for buyback programs in recent months.

Now the practice has caught the attention of some high-profile politicians who argue buybacks are merely another way for already-wealthy corporate insiders to further enrich themselves at the expense of middle-class workers and the broader U.S. economy.

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Senator Elizabeth Warren (D-Mass.), a frequent critic of Wall Street, has referred to buybacks as “stock manipulation.” Her colleague, Senator Tammy Baldwin (D-Wis.), has asked the Securities and Exchange Commission to take a harder look at the practice, arguing that it benefits a few at the expense of many. 

“There is mounting evidence to suggest that buybacks have a negative effect on jobs, wages, and investment,” Baldwin wrote in a recent letter to the SEC.

In short, the argument against buybacks goes something like this: Companies, often to appease shareholder activists (namely rapacious hedge fund managers), are investing money that could be used to expand and create jobs to instead reward shareholders, a practice that does little to benefit U.S. workers and grow the economy.

What’s more, the practice benefits shrewd CEOs whose compensation packages are tied to the stock prices of the companies they lead. Buyback programs reduce the number shares in circulation, which helps push the price higher when demand rises.

The Ultimate Beneficiaries

The critics argue that buyback programs do little more than appease agitated shareholders by providing a short-term boost to a company’s stock price.

Even Goldman Sachs (GS), hardly a Wall Street outsider, has made this case. 

“We recognize activist investors often advocate for firms to return excess cash to shareholders via buybacks. Tactically, repurchases may lift share prices in the near term, but in our view it is a questionable use of cash at the current time when the P/E multiple of the market is so high. In our view, acquisitions – particularly in the form of stock deals – represent a more compelling strategic use of cash than buybacks given the current stretched valuation of US equities,” Goldman analysts wrote in a recent report.

But some finance experts question how much, say the government, should be involved in how companies reinvest cash obtained either through profits or via bond sales.

“It’s hard to say whether companies as a group are investing too much or too little (in growth and expansion). It’s hard enough for managers to know what is the right amount to invest. It’s even more difficult for politicians to micro-manage,” Jay Ritter, a finance professor at the University of Florida, said.

Ritter noted that some industries – the airline industry a decade ago and drug store chains currently – have been guilty of “over-investment,” mishaps that tend to lead to closures and layoffs. Investors in those sectors may have been better served had companies chosen to buy back shares and increase their dividends rather than pumping money into overreaching expansions.

Ritter also took issue with the argument that buybacks only benefit top executives and wealthy investors. Most stock holders these days, he pointed out, hold their shares through pension and mutual funds and exchange traded funds (or ETFs) rather than hedge funds. That being the case, a broad swath of American workers benefits when stocks move higher for whatever reasons.

In addition, there is little evidence to back up allegations that CEOs are using stock buybacks to pad their compensation packages.

“The ultimate beneficiaries (of higher stock valuations) are middle-class investors,” Ritter said, adding, “I find it difficult to believe that politicians know the right level of investment for each company.”

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