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Analysis | All about stock buybacks, a $1 trillion market power


Imagine yourself as the CEO of a large, publicly traded company. You want your stock to rise, both to keep shareholders happy and to justify a big bonus. One option is to invest your profits in developing new products, building factories or opening stores, but increasing your stock price that way is difficult. It is much easier to let the company buy its own shares. Stock buybacks, as they are called, have become the largest source of demand for US stocks, rising above $1 trillion for the first time in 2022. Also that year, Congress passed a law to levy a 1% tax on buybacks, a levy that President Joe Biden later called for to be increased. The 1% tax didn’t immediately curb a wave of new buybacks, but a larger one could lead to an increase in dividends, payments companies make directly to shareholders.

1. How big have the buybacks been?

Recent years have been among the busiest on record, according to the S&P Dow Jones Indices. S&P 500 companies flushed cash from a 2017 tax cut and repurchased $806 billion worth of stock in 2018, setting a record at the time. While buybacks declined in 2019 and 2020, they set a record $882 billion in 2021 before reaching $1.26 trillion in 2022. $132 billion in planned buybacks were announced in January, more than three times the level of the previous year. For index members, buybacks have outpaced dividends in every quarter but two since 2010.

2. What’s Happening Now?

The Inflation Reduction Act, signed into law by President Joe Biden in 2022, included a 1% excise tax on the value of company stock repurchases. There are complex rules about what would count as a taxable buyback, but the measure is seen as increasing the relative attractiveness of dividends, which are taxed when they are issued. The measure, which took effect January 1, was projected to be worth $74 billion over the next 10 years by the Joint Committee on Taxation. In his State of the Union address to Congress in February, Biden called for the tax to be raised to 4%.

3. Why were buybacks targeted?

They have been criticized for years by a wide range of politicians. Senate Majority Leader Chuck Schumer calls buybacks “one of the most selfish things corporate America does.” In 2018, then-President Donald Trump said he was unhappy with companies using the money saved from his 2017 tax cut to buy back stock instead of building domestic factories. In a 2020 debate on Covid-19 relief, Massachusetts Senator Elizabeth Warren noted that the top five US airlines — prime targets for government bailout funds — had spent 96% of their free cash flow on share buybacks over the past decade .

4. How did buybacks get so big?

Against the background of President Ronald Reagan’s push for deregulation in the 1980s, restrictions on buybacks were relaxed, executives were given a safe haven from accusations of stock price manipulation, and a culture of “shareholder value” emerged. A wave of hostile takeovers made sitting on a pile of cash dangerous. And managers’ bonuses were increasingly tied to stock performance, to align their incentives with those of shareholders. The result? Buybacks boomed, often paid for with more loans.

5. Companies Borrowed to Buy Stocks?

Yes. For example, Meta Platforms Inc. in August $10 billion in debt in its first corporate bond deal, a move likely to lead to larger share buybacks. In the Reagan-era worldview, this was a good thing: Tax breaks made debt a cheaper form of financing, and the need to make regular interest payments allowed executives to focus on generating more money. Over the next few decades, the supposed function of the stock market – to raise money for business ventures – was turned on its head, as stocks largely became a means of returning money to shareholders. Any gain in share price resulting from a buyback remains untaxed as long as the shares are not sold, and capital gains are also usually taxed at lower rates than dividends.

6. What is the benefit of buybacks other than enriching shareholders?

Proponents argue that if managers don’t see a better opportunity for profitable investments, maybe there isn’t one. So buybacks are seen as a good way to get money out of the hands of executives who would otherwise waste it on pet projects and speculative investments. Buybacks contribute to bull markets: Over the past seven years, net corporate buybacks have been the largest source of demand for stocks relative to other investor categories, from pension funds to mutual funds and households, according to data compiled by Goldman Sachs. And they appease activist investors, who have been agitating for a share of corporate money supply.

7. What are the arguments against?

These shareholder bonanzas have consumed resources that companies could have used for other purposes, such as expansion, hiring, or raises. Over the five years through 2017, buybacks outpaced capital expenditures while wages stagnated and the share of employees in corporate income remained near record lows, leading some critics to argue that they hurt the economy’s long-term growth and exacerbated inequality. Another criticism says that the widespread use of buybacks is also not good for shareholders. Since most of senior executives’ compensation is tied to company stock, managers often take advantage of a stock’s price increase when a buyback is announced to sell some of the stock they received through grants or options. Record-low interest rates make it easier to build up debt for this, which can be detrimental in a crisis when cash flows dry up.

8. Is this a problem elsewhere?

While the US leads the way in both the number of buybacks and the intensity of political scrutiny, the practice is not unknown elsewhere. Buybacks in Europe had a stellar year in 2021, totaling $204.9 billion, the highest since 2008, following a pandemic-induced lull. This year’s outlook is more murky against the backdrop of a potential recession; data from Barclays showed that companies spent $31 billion on share buybacks in the first quarter of 2022 — the lowest level since late 2020. Regulators could also tighten, particularly for energy companies that posted huge revenues from rising oil prices. and gas prices. Glencore Plc, one of the biggest gainers from the global energy crisis, said in August it would buy back another $3 billion in shares. But strategists warn that excessive buyback plans could prompt governments to impose unexpected taxes. Italy raised its windfall tax on energy companies’ profits from 10% to 25% in May, and Spain introduced similar taxes on energy companies and banks in August. In August, SoftBank Group Corp. cushion the impact of its record loss of 3.16 trillion yen ($23.4 billion) by announcing a $3 billion share buyback.

–With help from Lu Wang, Kurt Schussler and Sagarika Jaisinghani.

More stories like this are available at bloomberg.com

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