Over the years, we’ve seen a good amount of companies announce huge common stock buyback programs (share repurchase plans).
The process works this way.
The company’s board of directors approves the program so it can purchase a certain number of shares or a dollar amount of shares in the open market. Over a period of time, usually a year or two, the company will buy blocks of stock until it reaches the specified amount.
The rationale is that the announcement is good publicity, and the company can help drive the price upward by purchasing large blocks of its common stock. After all, the repurchase does reduce the number of shares outstanding and thus increases the earnings per share.
The assumption is that, if the company announces a plan to buy a huge number of shares, then investors will be inspired to jump on board and buy the stock too. The company is counting on shareholders being impressed by the confidence that the large repurchase plan represents and the belief that its stock price is undervalued, and therefore, will move upward.
However, there are some in Congress that think stock buybacks should be limited.
Schumer and Sanders to Introduce Bill to Limit Buybacks
Senator Charles Schumer (D-NY) and Bernie Sanders (I-Vt.) plan to introduce a bill that would prevent firms from buying back their own stock and instead, pushes for employees to be paid at least $15 an hour. In fact, the two argue in a New York Times op-ed that “corporate boardrooms have become obsessed with maximizing only shareholder earnings to the detriment of workers.”
They say such buybacks are a “practice of corporate self-indulgence.”
The reason it’s a problem, they claim is:
- Buybacks don’t benefit a lot of Americans because a small percentage of people own stocks. (Actually, according to Money.com, almost half of all households own stock either directly or indirectly through mutual funds, trusts, or various pension accounts.)
- Executives receive stock-based compensation and would benefit from share repurchases.
- They limit a company’s ability to invest in wages, R&D, and training.
The big issue here is, this potential legislation opens the way to more government intrusion in business. Does the government have the right to tell a private company what they can and can’t do with their cash?
While there are those that argue that buybacks are incredibly controversial and should be limited, others such as Goldman Sachs’ former CEO, Lloyd Blankfein tweeted that companies “used to be encouraged to return money to shareholders when it couldn’t reinvest in itself for good return.”
“The money doesn’t vanish, it gets reinvested in higher growth businesses that boost the economy and jobs. Is that bad?” he concluded.
Even the Council on Foreign Relations argues that, “The data show clearly that buybacks are being undertaken overwhelmingly by companies that should be returning cash to investors—companies that don’t have good uses for it. That cash is not disappearing into the vaults of billionaires, but is being reinvested in firms that do have good uses for it—like capital investment and worker retention. And isn’t that what Schumer and Sanders say they want?”
It’ll be an interesting debate for sure. Personally, we think that corporations are wiser to spend their money on acquisitions that have the potential to greatly increase revenues and earnings, rather than stock buyback programs.
Stay tuned for more on this developing story from The Cheap Investor.