But the way the cash is transferred matters, and it has second order effects. Specifically, as it impacts stock options.
Executives tend to be compensated with options. The more the stock goes up, the richer they get. Distributing $X in dividends should provide an equal total return to the average shareholder as spending $X on a buyback, but that buyback will do it by pushing up the share price.
As the share price goes up more and more, execs with options have disproportionately more to gain than the average shareholder. They have a leveraged exposure to the price!
Some executives are compensated with RSU's. Some with options. If you're negotiating compensation and it's options, you'll take into account whether the company does buybacks or dividends when comparing offers.
In the end the total package is the total package. So I just don't see anything "wrong" here.
Then any regulations should focus on them.
Why should I, as a 'retail investor', be punished for return on capital methods because of the chicanery of executives?
I'm just going to DRIP any dividends anyway (until retirement) since I don't need income now. I want buybacks because that way I do not have a tax event that has (tax) drag on returns.
Edit: sorry about that, I get it now after thinking through it more.
Let's say the stock is truly worth $100 (assuming we could figure that out). Then if the company does buybacks, the stock trades at $100 - great for the executive with stock options. However, if the company pays dividends, then the stock price is reduced by the expected value of those dividends. So total expected value is the same, and long term executive comp is the same because they get the dividends as well, but short term they would prefer the buyback because of the higher stock price. They only benefit the same from dividends if they have a long term view.
If I pay a $1 ps dividend, then the share price should halve, and the share owners get $1 each.
If I buy back 50 shares, at $2 each, there will be 50 shares left at a value of $2 each. But now my earnings/share goes up as if by magic, and my options are worth more than in the dividend case.
Also capgains vs income tax yada yada
That's not correct. The EPS increase is offset by reduction in company value due to less cash. https://business.financialpost.com/opinion/stock-buybacks-ar...
The options bit is a slight fiddle, although empirical evidence supports it.
I do not want to ban buybacks, but now I at least understand an argument for doing so.
Dividends are direct payments to investors who will presumably stay investors — the buy back is a ‘buy out’ of existing shareholders.
There are quite a few more reasons a buy back is different from a dividend - but probably the most interesting bit is this: for a massive company with limited places to compound their retained earnings, by buying back stock the company pays all the dividends it would pay in perpetuity immediately in that instant. This is all fine and sometimes prudent in a net present value equation.... as long as the cash flows remain consistent*
*which is now the issue at hand with Covid-19
I don't think that's true at all. Every day there's massive liquidity -- buying and selling -- of any publicly traded stock.
Buybacks are generally implemented gradually over time, to the best of my knowledge, and are simply buying the shares people are selling daily regardless, the existing liquidity.
Obviously because there's slightly more demand, the price creeps slightly higher, and a margin of people decide to sell (e.g. for $201) where they wouldn't have sold slightly lower (e.g. for $199). But obviously those people were generally looking to sell in the first place.
So the idea that buybacks somehow discourage or reduce investing or discourage long-term investment seems totally mistaken.
If this is a truly capitalistic society - what should really happen is that all the bought back stock needs to be reissued (sold back) into the market — but that would create excess supply, reduce price, then freak out everyone’s 401k.
Finance is a crazy web and really cool - but massively complex. So you are right that there is liquidity every day, but that liquidity does not affect the total number of publicly traded shares until the purchaser is the corporation itself (the buy back).
The real screwed up compounding variable in liquidity is who is actually buying (awesome when it’s actual primary investment aka private fundings and ipos, and messy when it’s the secondary market aka the ticker price) — guess what’s even more messy: Passive Funds like ETFs. Passives (where 401ks live) are now the primary vehicle of investment for average America so really no individual investor is actually buying an individual stock- instead you buy a ‘share’ in a prorated basket of stocks based on ratios set in investor agreements (vanguard ishares etc).
When money goes into the ETF, the fund buys 10% x, 10% y... so on of the basket of stocks they market. No earnings have changed, no cash flows, but external secondary market forces now drive the market.
This is what Michael Barry (of the Big Short) is waiting for next - along with Water, which will be the next decades issue.
But your main point in this comment seems to be:
> If this is a truly capitalistic society - what should really happen is that all the bought back stock needs to be reissued (sold back) into the market...
But why should stock buybacks have to result in shares later being reissued, and what on earth does that have to do with "true capitalism"?
None of that makes any sense at all. The entire point of a buyback is to raise the stock price, as an alternative to issuing dividends. Saying that stock needs to be reissued later is like saying all dividends ought to be paid back by investors in the future. It doesn't make sense, indeed defeats the entire point.
This may be what people say now adays (the price going up is the reason for buy backs), but when I went to school and worked on a Convertible Notes desk, the stock price going up is not the reason to issue buy backs - it’s usually because you think your price is so cheap and you can reduce your cost of capital by removing the stock from circulation. The nouveau riche way of doing things is — well we can give you 100% of the cash back now, instead of paying a 5% dividend for x years (x because of compounding / whatever else is your assumption).
[Edit: now that I said this, it sounds a lot like packaging up seemingly derisked assets and marking them as safe (aka CDOs from The Great Financial Crisis (GFC)]
The ETFs are important to understand the full landscape of liquidity - but yes, point taken.
So to your question — in a pure free market, a corporation would tap the shareholder base (like Warren Buffetts cash, like he did in 08) rather than a TARP like agreement. The reason we did TARP was because the engine was seized up (Banks had effectively no funds to lend because a few lost all their assets) — right now it doesn’t look like the engine is seized up (no big hedge funds or banks have blown up [yet I guess]). So really, the company should issue new initial stock back to a Buffet or someone similar at a discount. But the discount is what would make everyone’s portfolio look awful.
So because the government shut everything down - we say... well we made you shut down, so we will take the hit here.
But really the nuance is that, had these airlines not financed buy backs with cheap debt, they could have weathered this storms themselves. These airlines were making so much money they were never thought to be able to lose money again! Matt Levine just put out a great piece on it [0]
So in the free market (and consequence lens), these buy backs financed with debt was a bad business decision - so the natural consequence is to just unwind the transaction, sell back into the market for 80Bn, and restart. Prices would take a serious, serious hit, but the new direct investors would be rewarded with a recovered share price. They would literally be buying the dip.
And just for added info, investors are bailing in these airline stocks because if the gov’t comes in like last time, the shareholders were wiped out first, then the company is allowed to recover. (Fannie and Freddie are still not private... the day that happens, will be a $100Bn transfer from the gov’t to the people)
[0] https://www.bloomberg.com/opinion/articles/2020-03-17/the-go...
And people wonder why anti-'intellectualism' is on the rise. When you see this sort of stuff happening over and over and over again, you start to think that maybe believing people or giving their ideas more credit because of the letters after their name might not be a great idea.
I think its sad, the legitimacy the sciences brought to education and its institutions is being eroded and abused by non-science folks who dress up all their BS in scientism and use that legitimacy to push it onto others.
I don't know how someone could possibly make this statement RIGHT NOW of all times? How many businesses are sitting on the edge of folding right now? Whoops! Looks like all that future revenue didn't show up! Guess who's going to suffer for these decisions? Not the investors, they sold out! How about all the employees who just had all the blood sucked out of their job security and future livelihood?
In what sense are investors in this scenario not just hostile parasites? At least if it were dividends then the investors would have any sort of remaining long-term interest in the success of the company, and not just how they can most quickly disentangle themselves from taking any responsibility for the survival of the company that they ostensibly had ownership over by gulping down revenue it didn't even generate yet? In what sense is the investor not crippling the company and leaving it weaker than they found it? It's vampirism! Just because the money is there for the taking doesn't mean you should, it doesn't mean that what you're doing isn't irresponsible and even morally reprehensible.
You create a nightmarescape of shambling zombie companies just waiting for a global pandemic to remind them that they're all already dead. Enjoy your artificially juiced stock value after it craters because our entire economy is short of legs to stand on.
It's far more reasonable to do business as usual and then take loans if things go south.
As Matt Levine put it: the dividends they gave since the GFC come to $15 billion, and their equity comes to $12 billion. So it's not even given it would have been the appropriate thing.
> How about all the employees who just had all the blood sucked out of their job security and future livelihood?
Right. It's like banks. How do we handle it?
Insurance: if you want to be a FDIC-insured bank, you must pay the FDIC insurance, and in return they will backstop your creditors up to a certain limit if they go bankrupt.
Why couldn't we do the same for employees? If you're an employer of systemic importance, you must have employee bankruptcy insurance: if you go tits-up, your employees get their salary paid up to a maximum limit of $X/yr until they find a new job. The insurance premiums are set by the free market, purely capitalist.
How can a business take out loans when things go south if it already leveraged itself in good times? Why would new investors buy into a company saddled with debt used to pay the old investors?
This is the most shocking hubris I've witnessed in a long time.
1. Steadily pay out dividends or buy-back stock based on profits. Buy-backs benefit those who hold onto an unwinding venture longest, whereas dividends provide an even return. Eventually when the company has nothing left to sell the business shuts down.
2. monetize the companies balance sheet and distribute money to the investors - Mortgage the assets and borrow against future earnings. The goal in this approach is to steadily transition from low-risk to high-risk debt and eventually bankrupt the company. Naively one would expect such an approach to yield ~5x the value of an otherwise mature business, and leave creditors on the hook.
The latter approach needn't be malicious either, simply leveraging a mature business until it can only support interest payments would be viable - bankruptcy would occur when the company runs into trouble and has no assets to invest.
The latter path needs to be regulated to have a healthy and stress resistant economy.
Not if interest rates are low.
Suppose interest is 1% and a company takes out a 5-year loan. They pay ~$1.05 to distribute $1 per share now instead of waiting 5 years to distribute it.
I, as an investor, can take that distributed $1 and reinvest it at, say, an expected rate of return of 5% -- so that in 5 years I'll have ~$1.28.
Obviously that's a much better total deal in the end. I, as an investor, want the company to take on reasonable low-interest debt for dividends or buybacks. Which is exactly why companies are doing this.
This is the middle ground between your options #1 and #2, which is financially wise for companies who expect to continue to have healthy profits. Which is exactly why companies are doing it.
This is where I get confused. Say APPL was $100 share, and so many people buy it that it goes up to $200/share. How does this really benefit APPL? They don't ever issue more shares from what I can tell (they don't need to raise capital).
Why does the share price of APPL/AMZN/TSLA matter to them? To attract investors/keep a board of directors happy, sure
But what do they financially gain by their market cap going up?
With this kind of mindset, I'm about to say fuck it, let's not bail these companies out. Let's let capitalism take its natural course.
Weak companies (such as the airlines during the COVID-19 outbreak) need to be allowed to die. If we rescue these poorly managed companies, they will continue to be poorly managed and will need to be rescued again. If they die, they will be replaced by new, better managed companies who won't make the same mistake (because nobody will want to own their stock otherwise).
This virus will likely turn out to be a 2-3 quarter demand shock, something that any well-managed company should be prepared to survive.
Is there much evidence to support this?
I'm not saying I've studied the data, but just thinking about what has happened over time it seems reasonable to suspect there are companies that have gone bust, only to be replaced by new companies that then also go bust. This is true of natural selection too: it doesn't necessarily produce organisms that are immune to unexpected shocks.
Edit: I also want to add: if the airline hadn't done the share buy back, wouldn't it still be suffering from the unexpected economic shock?
So yeah, a "stronger" company will emerge from the ashes. But only because other people took a bath.
It's like if the bank forecloses on your house. You owe $200k, but they sell it at auction for $50k. The above argument is like saying the new owners who bought your house will be a much stronger financial situation. This is true, but it ignores the fact that majority of involved parties are worse off (you & the bank).
Say you're a business that has razor thing margins but huge turnover, like airlines for example.
Do you need to save for 14 rainy days, or 1400? When your war chest is exhausted do you then go looking for bailouts?
I suppose one answer is to allow government bureaucrats and industry interests to nut out some regulations, but that's different to what you're suggesting.
The reason people are angry is because individual citizens are left to figure it out on their own when a downturn happens, but corporation's are allowed to be flagrantly irresponsible and then still get massive subsidies or bailouts when in trouble.
For everyone here coming up with excuses about how this is a good thing to bailout these companies, please answer me this.
Why do the leaders of companies in a recession always end up with more money from bonuses funded by the government bailouts, while individuals have to tighten their belts?
The average person doesn't believe your arguments when it boils down to "heads I win, tails you lose" everytime we have economic turmoil as a result of greedy actions by corporations
Will it also be accompanied by a sudden and unexpected shock like a global pandemic?
I agree with your point about executives being paid too much while the company and staff suffer, but that's a separate issue.
My point I was trying to make is that we are treating individuals with the cold hard truth of full boned capitalism, but when it comes to corporations we suddenly have all these excuses and help for them.
If we are fully capitalist then the only answer to the right sized war chest is one large enough for the next recession. Whether or not its difficult or impossible to determine what that size is, if you don't have one big enough your company will go into bankruptcy.
If that sounds like a ridiculous burden to put onto companies, _then why do we put it onto individual citizens?_
Yep, generally agree.
A strong social safety net seems important to me. Here in Australia we do have social security and a healthcare benefits program. So there's that.
its not like someone can just do an airline startup and flights are mandatory for a modern economy.
we're in a big ol' interconnected world, where the way things are going a fairly large sector (tourism/travel/food industry is a little less than 15% of GDP [or was 2017]) is likely going to get decimated. 1 in 100 of those firms will not be able to survive for 3 months the way things are going, much less 9. that's no fault of their own, it's just that most businesses can't be expected to plan for disaster-level events within their wheelhouse - a great many have trouble hitting payroll every 2 weeks.
Btw this sort of state-run "capitalism" isn't really socialism either, to me it is more reminescent of the 1930s in Southern Europe.
On my next tshirt
For the record, I would bail these fuckers out, but it would come with some hefty costs. Loans at 12%, reserve requirements, no ability to carry forward losses, more leg room, emissions requirements, and no more share buy backs. You want to return money to investors, you do it through dividends.
Leveraged stock buybacks are essentially a bet that the company will fail as it maximizes investor ROI to fail with as much debt as possible. That destabilizes the economy and should be flat out illegal due to moral hazard.
It’s really simple. If companies can’t issue buybacks or dividends with outstanding debt or unfounded pension liabilities society is simply better off. Compromising to say cash on hand + 1/2 the value of physical property > debt is probably fine. Notice how neither of them would change the theoretical stock price of a company and thus invested returns, yet it’s a significant difference in reality.
This is just the sort of fun financial engineering challenge that will not end the way the rulemaker intended...
https://en.wikipedia.org/wiki/Troubled_Asset_Relief_Program#...
Airlines spending every spare penny they had, and in some cases taking out debt, to gamble on the market and keeping nothing in the bank as a safety net is one such side-effect.
Dividends pull the share price down, and allow the recipient to choose whether to reinvest or take cash.
If the goal were simply to return capital or concentrate ownership, dividends would be more than sufficient.
Buybacks have a different goal. Their goal is to inflate the stock, provide liquidity on selloff days, and take cash off the firm's balance sheet in a way that improves metrics used in fundamental analysis that compare the company's value to its earnings.
Some companies compensate executives based on share price appreciation. In that environment, a share repurchase has tangible benefits for the executives who choose to do it.
A lot of these monkeyshines were stopped by the recent tax reform, which brought US corporate tax rates down to levels comparable with most of Europe.
This seems to be the crux of the article, and it appears to be completely unsubstantiated.
First of all, this article isn't about just stock buybacks -- the argument of the article applies broadly to dividends just as much, save for minor details.
The point the article is making is that profits ought to be reinvested rather than paid out. But obviously mature firms often can't find ways to reliably re-invest. They don't need to grow any further, nor should they. So investors want them not to re-invest, and throw off dividends or buybacks instead. This way investors can fund the next generation of companies.
And taking on debt to do it isn't inherently irresponsible. In fact, it's just a wise financial decision when interest rates are low. New revenue streams aren't required to be generated -- it's just shifting a subset of future revenue to the present.
So I really don't get this article at all.