End stock buybacks, now

The COVID-19 pandemic has become a crucible of corporate character. At unprecedented speed, pharmaceutical companies have designed, tested and delivered hundreds of millions — and ultimately billions — of vaccines to a pandemic-weary world. At the same time, countless enterprises have shifted, with remarkable agility, to virtual work, providing safe working environments that protect employees from a lethal enemy that continues its assault worldwide, especially in poor and elderly communities.

On the opposite side of the ledger, however, the pandemic has exposed the darker side of the corporate persona. In the United States, for example, disregard for worker health and safety in the meatpacking and agricultural industries has created fertile ground for spread of the virus, as has negligence of Amazon warehouses. Longstanding cost-cutting and consolidation within the for-profit hospital sector have left small towns and rural areas without adequate facilities to cope with surging virus caseloads.

Apart from these specific cases, the pandemic has laid bare a foundational aspect of all publicly traded corporations: the hegemony of share price as the paramount driver of corporate conduct. Notwithstanding the severe stress occasioned by the pandemic, shareholder primacy shows no signs of abatement.

Indeed, evidence suggests the opposite. In a recent Oxfam report, researchers found that since January 2020, payments to shareholders by Microsoft and Google have amounted to $21 billion. Extravagant payments also have occurred at BASF, Toyota and Pfizer. Even the oil giants, which experienced net losses during 2020, continue to extend lavish payouts to shareholders. Between 2017 and 2020, stock buybacks amounted to a staggering $2 trillion plus, a large fraction of which was debt-financed, adding further burden on many firms already under stress.

Buybacks divert resources that otherwise could be channeled to environmental improvements and other investments that strengthen the long-term prospects of the firm.

Stock buybacks represent the embodiment of shareholder primacy, a key instrument for self-enrichment by the already rich at the expense of real value creation by the corporation. Buybacks contribute to the transformation of executives into financiers, reflecting the broader shift from value creation to value extraction that began in the 1980s. They occur through either direct repurchase of the company’s own shares in the open market or, alternatively, through a tender offer that invites shareholders to sell their shares at a specific price within a specified time period.

What drives buybacks? Justifications vary. Reducing the number of tradable shares in the markets to increase the price of each share. Bolstering financial indicators such as return on equity or return on assets. Correcting what management views as the market’s erroneously pessimistic appraisal of the company’s prospects.

But underlying all such motivations is another, even more critical, driver: self-enrichment. In recent years, share-price-linked executive compensation arrangements have accounted for an estimated one-third of the compensation of CEOs of S&P 500 firms. In the three years before the pandemic, the top 59 most profitable companies globally distributed almost $2 trillion to their shareholders. Apple alone distributed $81 billion to shareholders in 2019.

Whatever the motive, the consequences are the same. Buybacks divert resources that otherwise could be channeled to research and development, employee wages and benefits, supply chain resilience, environmental improvements and other investments that strengthen the long-term prospects of the firm. And from a systemic perspective, buybacks benefit the already wealthy share-owning class. Because approximately half of American families own no stock, and because stock ownership among Black and Latino families is approximately half that among white families, buybacks have the effect of deepening inequality across racial lines.

How, then, can buybacks be tamed or outright prohibited? Is new legislation required? Should the SEC take action?

Some restrictions already exist. The SEC, pursuant to rule Rule 10B-18, limits repurchase of shares to no more than 24 percent of the average daily volume of shares traded over the lifespan of the repurchase period.

The pandemic-related CARES Act also restricted buybacks, a reaction to the abuses seen in the bailouts during the Great Recession of 2008-09. Companies with more than 500 employees that had not fully paid back CARES-related loans were precluded from engaging in stock repurchases and, for that matter, increasing executive compensation or issuing dividends for so long as the loans were outstanding and for one year after. These restrictions were not levied across the board, however. The CARES Act gave the Federal Reserve and the U.S. Treasury leeway to waive the restraints, and, in many cases, that is exactly what happened.

Over the years, critics have raised concerns about the short- and long-term effects of buybacks. In 2019, former SEC Commissioner Robert Jackson argued that the SEC should revisit the rule governing buybacks. He cited agency research that found that corporations which permitted insiders to execute stock repurchases performed worse in the long run than those which did not.

Beyond changing laws and regulations, regulators could simply enforce those already on the books. Former SEC attorney William Dolan posits a novel approach that avoids the necessity of congressional action or SEC reform. He argues that the SEC should enforce the existing anti-manipulation and proxy provisions in the Securities and Exchange Act of 1934. At the very least, authorities should demand enhanced disclosure of all details of corporate repurchases to all shareholders. He also proposes full disclosure of the cost versus benefit of a buyback program and justification of the use of capital for this purpose.

While such tweaks to existing regulations are a step in the right direction, they fall well short of what is needed. Buybacks are simply anathema to long-term, equitable value creation. They foster financial volatility and divert resources from long-term investments in product and service innovation, employee betterment, and resilience to withstand future upheavals akin to the COVID-19 pandemic.

Ending buybacks alone will not cure the ills of shareholder primacy. It would, however, send a powerful signal that any mechanism that further enriches the already privileged while undermining long-term sustainable enterprise — and societies — must be dismantled.

Will the Biden administration seize the moment?

The article was originally published on GreenBiz.com on February 8, 2021.