Why Are Stock Buybacks Bad?

BroStocks is a financial entertainment and education web site. We are not licensed financial professionals. All information on this site and in the following post should not be construed as investment advice or a specific recommendation. Do your own research and/or consult a financial professional before investing your money.

In the wake of negative United States economic news this month, there’s been a lot of talk about stock buybacks. The controversy is this: should major companies that have been buying back their own stocks as a means to prop up their share prices and give back to investors during the long bull run be allowed to receive taxpayer funded bailouts? Some politicians have called for a ban on stock buybacks for any company that receives a government bailout. Some legislators have historically called for banning the practice outright. What’s clear is in these hard times, buybacks will continue to be a subject of debate.

Portrait of a bull run with a rapid collapse. (Graphic: CNBC).

What is a stock buyback?

According to Investopedia, there are two types of stock buybacks which are “tender offer” and “open market”. A tender offer is when the company requests shareholders to submit or “tender” a portion of their shares within a given amount of time. The shareholders then state the amount of shares and price they are willing to sell for. The company then puts together all of the offers and picks the combination resulting in the lowest price.

Open market purchases are as simple as it sounds, the company purchases stock on the market at the going rate. One should note that, as intended, typically once a company buys shares on the open market it results in a rapidly increased price for the stock.

When Did Stock Buybacks Begin?

According to a Bloomberg piece, the earliest traces of stock buybacks go back to after the stock market crash in 1929. Companies were trying to prop up their prices in the Great Depression by purchasing shares on the open market. The practice was controversial at first and subject to scorn by investors, stock brokers and the press. The critique was that by putting money into buybacks, it weakened a company’s cash on hand by risking the precious capital to the ebbs and flows of the stock market. Essentially, it is gambling the company to the stock market.

There was a two pronged response to this practice. The Governing Committee of the New York Stock Exchange discouraged the practice of companies trading in their own shares. Congress weighed in in 1934 by passing the Securities and Exchange Act. This New Deal era law cracked down on companies manipulating markets. As a response to the belief that corrupt practices of publicly traded companies led to the great crash of 1929, the law was so cryptically worded that many companies were too spooked to repurchase shares for fear of being in violation.

The practice was largely absent from that point on until the 1980s. President Ronald Reagan was elected on a more anti-government platform that promised deregulation of businesses. In November of 1982, the Securities and Exchange Commission passed a new rule that protected companies from prosecution for buying their own stocks. Companies were not even required to disclose if they were doing so, only needing to share on a voluntary basis. This essentially opened up the floodgates.

What’s the Problem With Stock Buybacks?

Stock buybacks often only can pump up a stock price in the short term and can sometimes only benefit an often revolving door of executives at the expense of a long term investor. As one CNN opinion piece puts it simply and rather eloquently: “(the) company is trading in a safe asset (cash) for a risky one (stock) when it buys back stock.”

Let’s look at the context of our present situation. Two major industries indisputably impacted by the Coronavirus crisis are the airline and hotels industries. The airline industry is struggling in this very difficult climate they find themselves in with an unprecedented number of flights canceled. According to Barron’s, the airline industry is seeking a bailout of over $50 billion, even though Delta bought back $2 billion of stock in 2019 and $11 billion since 2013. Similarly, American Airlines has bought back $12.4 billion since 2014.

Marriott International, the world’s biggest hotel chain, has stated that they will be furloughing workers. Just last year, Marriott purchased 17.3 million shares of their own stock at a cost of $2.3 billion. Just a month ago, in February 2020, Marriott purchased $150 million worth of their own stock as it traded at $145.42, as of our publishing the company is trading just under $80.

These examples can be provided across many other companies and sectors, not just the ones we outlined. The bottom line is this, there’s no question that many Americans will be dealt a tough hand this year. The general public will have to learn to deal with less. In any major market correction or tough economic times, there’s often a populist revolt against big corporations. A cynic looks at stock buybacks from this angle: as companies looting their own assets to pad executive pay in good times, and shift the burden of their lack of cash reserves on taxpayers in bad times.

The memory of the 2008 recession is not so far in the rearview. There’s a bailout fatigue among the public. Companies that received bailouts the last go around, many would argue, received the funds rather unconditionally. American (and global for that matter) politics took a major populist turn even during a major bull market run and relatively stable economic conditions. There’s animus toward stock buybacks on both sides of the political aisle in the United States Congress. While it is difficult to imagine the practice being banned outright, it is fairly easy to imagine some strings attached on buybacks for companies accepting a US taxpayer bailout.

One thought on “Why Are Stock Buybacks Bad?

Leave a Reply