This article originally appeared in the Motley Fool.
Stock buybacks have become increasingly popular in recent years as successful companies have more money to return to shareholders and seek to do so in the most tax-advantageous way possible. Now, some legislators believe that buybacks are unfairly putting investors ahead of workers and they’re taking steps to rein in the practice in the hopes of encouraging more money to go toward pay increases that would ease wealth inequality.
Yet even if one were to go back to the legal framework that prevailed more than 35 years ago when buybacks weren’t explicitly permitted, it’s unclear whether legislation will have the desired end result of getting workers paid more at the expense of investors.
Getting Rid Of Buybacks?
Sen. Tammy Baldwin (D-Wisc.) introduced legislation that would essentially prohibit companies from doing stock buybacks. Cosponsored by Sen. Brian Schatz (D-Haw.) and Sen. Elizabeth Warren (D-Mass.), the bill would repeal a rule from the U.S. Securities and Exchange Commission that made it easier for companies to buy back their own shares. That rule dates back to 1982, and it explicitly gave companies the ability to do share repurchases without facing allegations that they were improperly manipulating their stock prices by doing so.
In a press release about the bill, Baldwin argued that the SEC rule allowing buybacks rewards corporate executives. “Corporate profits should be shared with the workers who actually create value,” the senator said. “It’s just wrong for big corporations to pocket massive, permanent tax breaks and reward the wealth of top executives with more stock buybacks, while closing facilities and laying off workers.” Baldwin’s comments attributed the continuing problem of wealth inequality and flat wages to the recent surge in buyback activity, and she notes that corporations have announced more than $225 billion in stock buybacks just since the recent passage of tax reform laws at the end of 2017.
The Loopholes In The Bill
Interestingly, the bill doesn’t go very far toward actually stopping buyback activity from taking place. It revokes the SEC rule permitting open-market buybacks, but corporations would still be able to conduct share repurchases through explicit tender offers. Baldwin’s comments suggest that the greater disclosure requirements for tender offers justify that they still should be allowed.
In addition, other forms of shareholder capital payback wouldn’t be affected. Dividends would still be allowed unfettered, despite language in the press release that criticizes the issuance of dividends as “leaving minimal resources for long-term investments in workers, training and innovation.”
Does Restricting Buybacks Make Sense?
Buybacks have been long criticized, and some of those criticisms are justified. Companies often have poor timing with their stock repurchases as they generally have more money to buy back shares when times are good and their stock prices are high than they do when conditions worsen and their share prices are cheaper. Some companies have even done stock buybacks at high prices only to issue new shares at far lower prices after the business hit a rough patch.
Economically, doing a buyback and paying a dividend should have exactly the same effect on the overall company’s value. Both take existing cash off the balance sheet and return it to shareholders, with no effect on the underlying business. The only difference is that the number of shares outstanding after a buyback is less than it is when a company pays a dividend.
Yet when boards of directors allow executives to have their pay pegged to per-share prices rather than overall market capitalization or enterprise value, they create an incentive for executives to favor buybacks. By contrast, because dividend payments don’t go to holders of stock options, executives don’t benefit as much from dividends. Yet that’s a choice that boards and executives make jointly in their pay negotiations. Changes in rules would only push executives to demand different structures for compensation that would put less emphasis on share prices and more on total return, including dividend payments to shareholders.
Getting At The Real Problem
Politically, the proposal is highly unlikely to pass through a hostile Congress and White House. Yet even if it did, corporations could bypass it simply by doing tender offers or reverting to dividends.
If the goal of legislation is to force corporations to pay their workers a larger share of their profits, it’ll take a lot more than buyback elimination to do so. At this point, the kind of regulation that would be needed to divert money that’s currently going to shareholders and aim it at rank-and-file employees would be far more draconian than most lawmakers on either side of the aisle would be willing to stomach at this point.
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