by Cydney Posner

Data compiled by S&P and Bloomberg shows that companies in the S&P 500 spent 95% of their earnings on repurchases and dividends in 2014, including spending $553 billion on stock buybacks in 2014. The number was $1 trillion for 2013 and 2014, the biggest two-year total ever (well, really since 1998, when they started reviewing the data for the study.) As it turns out, stock buybacks may, in part, be fueling the recent bull market.  Indeed, this article from Bloomberg asserts that the “biggest source of fresh cash in American equities isn’t speculators or exchange-traded funds — it’s companies buying their own stock, by a 6-to-1 margin….Repurchases by U.S. companies averaged $46.1 billion a month in 2014, compared with $7.1 billion in ETF and fund inflows.”

Now, as reported in this article in the International Business Times, some members of Congress have begun to pay attention to the issue. Wisconsin Senator Tammy Baldwin has sent a letter to the Chair of the SEC requesting that the agency revisit the rules on stock buybacks. In 1982, when the Rule 10b-18 safe harbor for buybacks was adopted by the SEC, the Senator observes, “buybacks were near zero. Last year, over $500 billion was spent on share repurchases.” In her letter, Baldwin requested that the SEC, provide “any analytic work done by the SEC on the long-­term economic impact of the 1982 rule; an accounting of all investigations undertaken by the SEC into possible violations of the rule; and, an assessment of whether this rule is adequate for the SEC’s stated mission — to foster capital formation and prevent fraud.” 

Baldwin then expressed her concern about the impact of buybacks on wages and investment: “U.S. corporate profits have been at post-World War II highs since late 2011, yet the nation’s gross domestic private investment remains below historical averages. American workers’ wages have not increased either; in fact, average hourly real wages have stagnated since 1979. A growing body of research suggests that the vast amounts U.S. corporations have spent to repurchase their own stock is a chief cause of the stagnation of American wages and investment, and could be a potential source of long-term national decline.”  To illustrate that point, Baldwin gave IBT an example from her home state: “’Wisconsin’s paper industry has been targeted by hedge funds seeking to ‘unlock value’ by consolidating facilities and firing workers to boost share prices in the short-term.’”

The Senator contended that historically, money now used for stock buybacks

“went to productive investments in the form of higher wages, research and development, training, or new equipment. Today, cash is being extracted from companies and placed on the sidelines.  Buybacks are now undermining the stock market’s role in capital formation. From 2005-2014 the value of shares withdrawn from the market surpassed the value of stock issued by an annual average of $399 billion. The increase of stock repurchases worryingly corresponds with the increase in executives receiving stock-based compensation. In 2013, the 500 highest-paid U.S. executives named in proxy statements received 84 percent of their compensation from stock-based instruments. A recent study has found that buybacks are more likely when a CEO’s bonus is directly tied to the company’s  earnings per share. Buybacks aiming for earnings per share targets were associated with corresponding reductions in employment and investment at the company.”

In her letter, the Senator cited the work of Professor William Lazonick, with whom Baldwin worked in crafting her letter, according to IBT. In “Profits without Prosperity,” published in the September 2014 Harvard Business Review, Professor Lazonick argues (see this post) that there have been serious negative side effects of the buyback trend: “[b]y favoring value extraction over value creation, [buybacks have] contributed to employment instability and income inequality.” In his view, “trillions of dollars that could have been spent on innovation and job creation in the U.S. economy over the past three decades have instead been used to buy back shares for what is effectively stock-price manipulation.” And in “Stock buybacks: From retain-and-reinvest to downsize-and-distribute,” published by the Center for Effective Public Management at Brookings, April 2015, Lazonick  contends that massive stock buybacks have damaged companies and the economy:

“Stock buybacks are an important part of the explanation for both the concentration of income among the richest households and the disappearance of middle-class employment opportunities in the United States over the past three decades. Over that period the resource-allocation regime at many, if not most, major U.S. business corporations has transitioned from ‘retain-and-reinvest’ to ‘downsize-and-distribute.’ Under retain-and-reinvest, the corporation retains earnings and reinvests them in the productive capabilities embodied in its labor force. Under downsize and-distribute, the corporation lays off experienced, and often more expensive, workers, and distributes corporate cash to shareholders. My research suggests that, with its downsize-and-distribute resource-allocation regime, the ‘buyback corporation’ is in large part responsible for a national economy characterized by income inequity, employment instability, and diminished innovative capability – or the opposite of what I have called ‘sustainable prosperity.’”

As part of his policy recommendations, he calls on the SEC to ban open-market repurchases, followed by reforms of the “disincentives to invest in innovation created by the current system of executive stock-based pay, with a new system seeking to ensure that the remuneration of senior executives depends on the innovative success of the business organization as a whole.”

Of course, Baldwin’s view is not universally shared. As IBT reports, many “companies adamantly maintain that buybacks have no impact on the workforce. Many investors, moreover, doubt that share buybacks are destroying innovation. Research and development expenditures grew 12 percent between 2009 and 2012, according to the National Science Foundation. Investors argue that excess corporate cash, now at near-record highs, is more productive in the hands of shareholders than in corporate bank accounts.”

What further steps, if any, this letter prompts the SEC to take remains to be seen.

Posted by Cydney Posner