20190226 stock buyback

The case for banning stock buybacks

Updated 1750 GMT (0150 HKT) February 26, 2019

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Rita McGrath is a professor at Columbia Business School and author of The End of Competitive Advantage. The opinions expressed in this commentary are her own.

Perspectives rita mcgrath

The widespread use of share buybacks among publicly traded American firms has reached an inflection point. Although academics and researchers at think tanks have been critical of the practice for years, politicians and the public at large are starting to pay attention, too. Proposals from politicians such as Chuck Schumer, Marco Rubio and Tammy Baldwin seek to give the SEC greater oversight over buybacks by restricting them, ending their tax advantages or by banning the practice altogether. Indeed, buybacks disproportionately benefit investors and executives, with little heed for the other stakeholders who have spent the time, effort and money on creating the profits the company is redistributing in the first place. It's time to ban stock buybacks.

That may be a tall order. Buybacks make some investors and many corporate executives very, very rich. There are also some legitimate reasons for companies to repurchase shares — for instance, if their leaders believe the stock is undervalued, or to make shareholders whole after employees receive stock grants. And they represent one reliable way for management to boost the company's stock price — which makes sense, given the uncertainty around Brexit, trade wars and government shutdowns. And they are decisions that mostly fly under the radar — ordinary people seldom wake up in the morning breathless with anticipation about the latest buyback news.
But we should care more. The bulk of executive pay is now tied to a company's stock price, creating an incentive to make that price as high as possible. Prior to a 1982 SEC rule change, buybacks were illegal, as they were seen as a form of stock price manipulation. You don't have to be a genius to realize that if the bulk of executive compensation is tied to a company's stock price and buybacks make that price go up, that there will be powerful incentives for executives to put money into buybacks. Even buyback proponents recognize that the current lack of transparency and incentives to make decisions for the benefit of executives is problematic.
Still, though, stock buybacks are rife with unintended consequences.

Increased risks for long-term shareholders

Essentially, a company is trading in a safe asset (cash) for a risky one (stock) when it buys back stock. The value of cash doesn't change with the vagaries of the market, but the value of a company's stock can vary.
    Further, companies tend to invest in buybacks when they have cash and times are good; and they refrain from the practice in hard times. In other words, they're using current shareholder's money to, in effect, buy high and sell low.

    Less money for investment

    Money used to repurchase shares extracts capital from the organization that could otherwise be used as a buffer against hard times, to pay and develop workers, to invest in innovation, to create the foundation for a more robust future and to contribute to healthier local communities. The numbers are staggering. In 2018 alone, companies spent a record $1 trillion on buybacks. Unlike other ways of returning excess cash to investors, such as