The Rise of Stock Buybacks: A Controversial Practice
Introduction:
Stock buybacks were once considered a form of stock manipulation, with dividends being the primary method for returning corporate profits to shareholders. However, in 1982, the SEC adopted Rule 10b-18, which provided a “safe harbor” for share buybacks under certain conditions. Since then, buybacks have become a popular means of distributing profits to shareholders due to their selective and non-periodic nature. Additionally, buybacks have the advantage of reducing shares outstanding and potentially boosting share prices, which benefits executives with stock options and bonuses.
The Difference Between Tender Offers and Buybacks:
It’s important to differentiate between tender offers and buybacks. Tender offers are solicitations made by the company or an acquirer to buy back shares from shareholders by a specific date and at a set price. They are often used to consolidate ownership, effect a takeover, or take a company private. On the other hand, buybacks occur when a company’s executives purchase shares on the open market based on their board’s authorization.
The Problem with Buybacks:
While Rule 10b-18 aims to prevent stock manipulation, it is naive to believe that buybacks cannot influence stock prices. Just as central banks intervene to support their currency, companies can use buybacks to sustain or boost their stock prices. Take Chipotle, for example. After a widely reported Norovirus outbreak in 2015, the company’s earnings plummeted. Despite spending over a billion dollars on buybacks in the following quarters, the stock price still declined. It’s impossible to determine whether the decline would have been even worse without the buybacks.
Furthermore, investors struggle to correlate buybacks with stock price movements because the amount of the buyback is only reported in quarterly SEC reports. In contrast, the London Stock Exchange and the Hong Kong stock exchange require immediate reporting of buybacks. This transparency allows investors to make more informed decisions. The SEC proposed a similar rule for the United States, but it was withdrawn after facing opposition from the business community.
Perceptions and Criticisms:
Buybacks have faced criticism for being a form of finance capitalism rather than industrial capitalism. Critics argue that companies prioritize enriching executives and shareholders through buybacks instead of investing in new ventures, employee training, and wage growth. Headlines often highlight companies announcing stock buybacks simultaneously with employee layoffs, causing concern in public policy and political circles. In response, Congress imposed a one-percent excise tax on stock repurchases as part of the 2022 Inflation Reduction Act. President Biden’s 2025 budget proposal aims to quadruple this tax to four percent, appealing to populist sentiments.
The Need for Transparency:
The Biden administration’s excise tax on buybacks is largely seen as political posturing and should be rescinded. Instead, the focus should be on increasing transparency for investors. The United States should aim to match the reporting standards of the London Stock Exchange and the Hong Kong stock exchange. Investors, particularly retail investors, deserve access to comprehensive information to make informed decisions. For the United States to lag behind other markets in terms of transparency is disappointing.
Conclusion:
Stock buybacks have become a widely used method for returning profits to shareholders since the adoption of Rule 10b-18. However, concerns about potential stock manipulation and the prioritization of executives and shareholders over workers have made buybacks a controversial practice. While the Biden administration’s excise tax on buybacks misses the mark, efforts should be focused on improving transparency and providing investors with the information they need to make informed decisions. Ultimately, a well-regulated and transparent market benefits all stakeholders involved.
