Why Are Stock Buybacks Bad for the Economy and Workers

Stock buybacks have been a hot topic in recent years, and for good reason. They've become a favorite tactic of many large corporations, but the impact on the economy and workers is not as rosy as it seems.

One of the main issues with stock buybacks is that they can drive up stock prices, making it harder for regular investors to buy in. This is because companies are essentially using their own money to buy back shares, which reduces the number of shares available and can drive up the price.

As a result, the wealth effect is skewed towards the top 1%, who own the majority of the shares. This means that the benefits of rising stock prices are mostly enjoyed by the wealthy, leaving the rest of the population behind.

Stock buybacks can also divert funds that could be used for more productive purposes, such as research and development, employee training, or infrastructure investments.

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Stock buybacks are a way for companies to purchase their own shares from other investors, and they're also known as share buybacks, share repurchases, or share purchase authorizations.

Most stock buybacks happen on the open market, where companies buy their shares from an exchange just like any other investor.

Companies can also perform stock buybacks at a fixed price, by auction, or by negotiating directly with a few large shareholders.

Stock buybacks can be done in various ways, including purchasing shares on the open market, buying at a fixed price, or even negotiating with large shareholders.

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Stock buybacks can be a major blow to workers. They can reduce the number of shares available for employee stock options, making them less valuable.

This can lead to a decrease in the value of employee stock options, which can be a significant portion of a worker's compensation package. For example, if a company has 1,000 shares available for employee stock options and buys back 200 shares, the remaining shares become more valuable to the remaining employees, but the total value of their options decreases.

Many companies use stock buybacks as a way to artificially inflate their stock prices, which can be a short-term gain but ultimately hurts workers in the long run.

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Stock buybacks have a negative impact on workers. They divert funds from investments that could benefit employees, such as higher wages or improved benefits.

Research shows that companies that prioritize stock buybacks over investments in their workforce have seen a decline in productivity and employee satisfaction. This is likely due to the lack of resources allocated to training and development programs.

The median worker in the United States has seen a decline in real wages over the past few decades, while corporate profits have skyrocketed. This is a clear indication that the benefits of corporate growth are not being shared equitably with employees.

In fact, the top 10% of earners in the US now hold more than 70% of the country's wealth, while the bottom 50% hold less than 1%. This stark wealth inequality is a direct result of the prioritization of stock buybacks over worker benefits.

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Opportunistic buybacks, where managers repurchase stock for their own benefit, are not as prevalent as you might think. Before 2000, these types of buybacks were more likely in companies with poor corporate governance, but that's not the case anymore.

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Sub-par corporate governance appears to have limited effects on post-repurchase performance. This is likely due to enhanced regulations and disclosures that have been put in place.

Executive pay incentives also don't seem to drive repurchase patterns as much as you'd expect. Companies tend to prefer paying out with buybacks over dividends when managers hold more stock options, but the effect is mostly confined to the choice of capital distribution method.

Compensation practices have evolved, making executive stock options less popular and replacing them with arrangements that don't negatively affect executive performance pay by dividend payments. This has weakened the incentive to distribute capital with repurchases rather than dividends.

Despite the presence of executive stock options, buybacks don't cause negative market reactions. In fact, long-term stock returns are typically positive following buyback announcements and higher than for non-repurchasers.

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Stock buybacks can increase share prices, but whether they're a good use of company money is a more complicated question. Some companies use stock buybacks to reward their largest shareholders, often managers and executives themselves, rather than investing in the business.

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This can concentrate ownership to fewer, larger investors, without increasing the efficiency or productivity of the firm. Stock buybacks can also be a sign that a company can't think of a good way to spend its surplus cash flow internally.

Perhaps they're generating so much cash that they don't need to invest it in their business, as has been the case for many big tech companies recently.

Stock buybacks can increase share prices, but whether they're a good use of company money is a more complicated question.

Some companies buy back shares because they're generating so much cash that they don't need to invest it in their business.

A stock buyback can be self-serving for the people who run the company, rewarding the largest shareholders, often managers and executives themselves.

It's not actually increasing the efficiency or productivity of the firm in any way, but rather concentrating ownership to fewer, larger investors.

Stock buybacks can be bad for investors in some cases, especially when company management sacrifices long-term investments to focus on short-term returns.

Company executives often have incentives to prioritize short-term gains over long-term growth, which can lead to missed revenue opportunities.

Companies that issue debt to fund share buybacks may struggle in the long run, as they'll have to repay the debt and make interest payments that reduce earnings for years or decades.

This can be a major risk for investors, as they may see their returns decrease due to the company's debt obligations.

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Stock buybacks are often used as a leverage management tool. This means they help companies manage their debt levels by buying back their own shares.

Between 2010 and 2019, corporate assets grew faster than equity, leading to a noticeable rise in median leverage, with debt climbing from 21% to 32% of book assets. This increase in leverage was similar for the more leveraged firms, with debt amounting to nearly 60% of book assets in 2019.

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Buybacks supported the increase in leverage, and adding them back to company assets would have substantially dampened the rise. In fact, the effect of adding back share repurchases would have been much greater than that of adding back dividends.

Firms with leverage below the level prevalent in their main industry, or "target leverage", were more likely to use buybacks to keep up with their peers. This is evident in the fact that companies below target leverage accounted for around 60% of total buybacks each year.

The effects of buybacks on other key ratios, such as cash and short-term investments, were limited. High-buyback firms did see material declines in liquid assets relative to book assets over time, but leverage targeting was not strongly linked to changes in these holdings.

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During the pandemic shock in March 2020, leverage became a clear driver of stock returns, with high-leverage firms experiencing substantially lower returns than low-leverage firms.

High-leverage firms lost appreciably more than low-leverage firms between mid-February and end-March, a pattern that held regardless of the amount of equity bought back during the previous three years.

Past repurchases adversely affected stock returns, but only through leverage, not independently of it. This means that share buybacks didn't drive company risk on their own.

Low-buyback/high-leverage companies actually experienced lower risk-adjusted returns than high-buyback/high-leverage companies, which is a key finding from the study.

An important distinguishing feature of low-buyback firms is that they have tended to pay out more dividends, which might have made investors retrench from them as the pandemic worsened and the likelihood of dividend cuts increased.

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Rising interest rates can make stock buybacks less appealing to companies. According to Koski, companies that issue debt to buy back stock are less likely to do so when interest rates are higher.

Companies might opt to buy bonds instead of their own shares as bond interest rates increase, as suggested by McConnell.

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The stock buyback tax is a relatively new concept, introduced by the Inflation Reduction Act of 2022, which came into effect at the beginning of 2023.

A 1% excise tax on stock buybacks is now in place, and some lawmakers want to bump that tax up to 4%. This is the proposal put forward by Democratic Sens. Ron Wyden of Oregon and Sherrod Brown of Ohio in the Stock Buyback Accountability Act of 2023.

The tax might incentivize companies to pay dividends instead of buying back shares, according to two think tanks - the Institute for Taxation and Economic Policy and the Tax Foundation. They also predict that the tax could raise billions of dollars in the next few years.

If the tax on stock buybacks increases, it's likely that companies will do fewer repurchases.

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Rising interest rates can have a cooling effect on stock buybacks. Companies are less likely to issue debt and use the money to buy back their own stock when interest rates are higher.

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Some companies deliberately issue debt to buy back stock, but this practice may be less appealing during higher-rate periods. A 2019 report from the Congressional Research Service suggested that low interest rates in the 2010s contributed to the surge in stock buybacks.

Companies might opt to buy bonds instead of their own shares as bond interest rates increase. This shift in investment strategy could impact the demand for stocks.

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