By Andrew Ross Sorkin at The New York Times
Should corporate stock buybacks be regulated? Or made illegal?
Those are the questions not-so-quietly being floated in Washington by a group of elected officials and others trying to get elected, including most recently, Hillary Rodham Clinton.
Is the government really going to outlaw buybacks, which over the past decade have become one of the business world’s favorite corporate finance tools?
On its face, the issue may seem like a nonstarter. But a growing debate has emerged around the topic of buybacks that increasingly has Wall Street and corporate America worried.
Goldman Sachs sent out a note to its clients earlier this summer, warning that Washington was raising concerns over buybacks. “Some lawmakers have linked share repurchases with stagnant wages and a lack of business investment,” the note said.
Since 2004, companies have spent nearly $7 trillion purchasing their own stock — often at inflated prices, according to data from Mustafa Erdem Sakinc of the Academic-Industry Research Network.
That amounts to about 54 percent of all profits from Standard & Poor’s 500-stock index companies between 2003 and 2012, according to William Lazonick, a professor of economics at the University of Massachusetts Lowell.
The buyback craze, in which virtually every big company from Apple to General Electric to Walmart has participated, has led to a backlash from some investors and government officials, who have questioned whether such use of profits is a productive way to deploy capital rather than reinvesting in businesses and jobs.
Laurence D. Fink, the founder of BlackRock, the largest asset manager in the world, with more than $4 trillion under management, started a debate about the topic this year among chief executives, suggesting the buyback phenomenon “sends a discouraging message about a company’s ability to use its resources wisely and develop a coherent plan to create value over the long term.”
A renewed focus on the issue has taken place recently as a result of one of Mrs. Clinton’s speeches, in which she discussed all the money that companies are pouring into buybacks. “That doesn’t leave much money to build a new factory or a research lab, or to train workers, or to give them a raise,” Mrs. Clinton said.
But this next sentence in her speech really got the attention of industry: “We also have to take a hard look at stock buybacks. Investors and regulators alike need more information about these transactions. Capital markets work best when information is promptly and widely available to all.”
She then offered what some think is her first salvo in the regulation of buybacks: “Other advanced economies — like the United Kingdom and Hong Kong — require companies to disclose stock buybacks within one day. But here in the United States, you can go an entire quarter without disclosing. So let’s change that.”
Mrs. Clinton raises an interesting point about the disclosure rule, one that, if changed, would most likely make it much tougher — or at least more expensive — for American companies to buy back shares. Indeed, international companies have done a lot less of it.
Her point tiptoes around a more explosive claim from Senator Elizabeth Warren and Senator Tammy Baldwin that buybacks might be a form of market manipulation. Both senators have urged the Securities and Exchange Commission to investigate the practice.
In discussing buybacks in an interview with The Boston Globe, Ms. Warren provided a bit of a history lesson: It wasn’t until 1982 that the S.E.C., under the chairmanship of the Reagan appointee John S. R. Shad, gave companies so-called safe harbor against charges of manipulation if they bought their stock in the open market under certain circumstances. (The provision is known as Rule 10b-18.)
“These buybacks were treated as stock manipulation for decades because that is exactly what they are,” Ms. Warren said. “The S.E.C. needs to recognize that.”
Indeed, it was that rule change that led to the surge in buybacks, which were considered shareholder friendly. And it’s considered tax efficient: Unlike a dividend, there is no tax to be immediately paid.
But companies were also driven to pursue buybacks by executives seeking to lift their pay. Buybacks enable companies to issue more stock to executives without diluting other shareholders because they can buy shares to offset the dilution that occurs when executives exercise their stock options.
It also led to another point of contention in executive compensation plans because buybacks have the effect of increasing earnings per share, a metric that some compensation committees use to determine the pay of their executives. It also has the impact of increasing the stock price in the short term irrespective of operational success, potentially letting executives cash out of some of their shares at artificially high prices.
Buybacks are enticing for corporate executives, but they can create other problems, including the risk that they repurchase their companies’ shares at the exact wrong time, when their stock prices are too high. Worse, some companies take on debt to buy their own shares.
Still, Warren E. Buffett, the investor, has repeatedly said he is a big fan of buybacks — but only when used prudently: “I favor repurchases when two conditions are met: First, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company’s intrinsic business value, conservatively calculated. We have witnessed many bouts of repurchasing that failed our second test.”
So what could the S.E.C. actually do about buybacks?
Goldman’s research note said that the two most obvious policy changes would be “securities rules related to the transactions themselves, or tax changes that increase the relative cost to corporations of buying back their own stock instead of paying dividends or making investments in productive capital.”
Those may be worthy goals. But it is hard to tell a company how it can or cannot spend its money. Ultimately, the pressure for companies to invest in their operations and new jobs is only going to come when managements see a real business opportunity — and shareholders demand it.