Confronted with a sluggish global economy, US companies have settled on a controversial tool that rewards shareholders and executives: share buybacks.
First permitted by the US Securities and Exchange Commission in 1982, the use of share buybacks has spread rapidly over the past five years due in part to pressure from activist investors anxious for a quick payoff.
When companies buy back shares, the shares remaining on the market rise in value due to the tighter supply, an immediate boon to shareholders. Executives also benefit when their compensation is tied to the share price, often through rich stock options.
However, critics point out that companies spending billions of dollars of shareholder funds on buybacks means the funds are not being invested in new plants, higher salaries and other areas that boost the company and the broader economy.
Over the past two years, at least 20 percent of S&P 500 companies have trimmed their share count by at least 4 percent, S&P Dow Jones Indices analyst Howard Silverblatt said.
The net effect is to increase the companies’ earnings-per-share by at least 4 percent. However, as a study by University of Chicago professors Daniel Bens, Franco Wong and Douglas Skinner showed, that gain “cannot be attributed to improved firm performance.”
The surge in spending on buybacks has been huge. In 2009, the 500 biggest publicly traded companies in the US spent 27.5 percent of their US$500 billion in operating profits on buybacks, according to S&P Indices.
By last year, they had spent 64.7 percent of US$885.3 billion in earnings on buybacks.
Apple Inc led the way last year, putting US$37 billion in buybacks, followed by Microsoft Corp with US$17.9 billion and Qualcomm Inc with US$11.6 billion.
Making that possible has been the companies’ lofty cash holdings, which stood at US$1.3 trillion at the end of last year among the S&P 500, according to Silverblatt.
They “have to do something with their cash,” Silverblatt said.
However, some also take advantage of low interest rates to borrow money to fund buybacks. Apple in February announced a debt offering of US$12 billion to finance buybacks and share dividends, even as it holds more than US$200 billion in cash, much of it overseas.
The market has taken a kind view of buybacks. Shares of 100 companies that undertook buybacks in 2014 outperformed competitors who used funds to build factories or hire employees, according to a study by Barclays PLC. And buybacks have accounted for about 21 percent of the rise of the S&P 500 since 2009, according to S&P Dow Jones Indices.
However, not everyone is sold.
For one, critics point out that frequently, buybacks mask poor performance: A buyback can increase a company’s earnings per share even as overall earnings fall.
William Lazonick, an economist at the University of Massachusetts at Lowell, said buybacks also do not ensure companies stay prosperous by investing in their businesses.
“You are manipulating the stock prices,” he said. “And then you are not creating value. You are extracting value that workers and taxpayers and others created. The only logic is that the people who are making those decisions want to get stock prices up so they can sell the stock and enrich themselves.”
Politicians, too, have taken up the issue.
Democratic US presidential hopeful Hillary Rodham Clinton, the favorite to win her party’s nomination for president, last year said that she supports reforms to ensure that buybacks are not used just to boost share prices.
US Senator Elizabeth Warren from Massachusetts also favors reining in the “sugar high” from buybacks.
Critics say there is also a link between runaway buybacks and the rising gap between rich and poor.
“If the US is to achieve economic growth with an equitable income distribution and stable employment opportunities, government rule-makers and business decisionmakers must take steps to bring both executive pay and stock buybacks under control,” Lazonick wrote in an April 2014 paper.
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