Stock Buybacks in Time of Crisis

Stock buybacks are a huge part of the economy. In 2018, 1,1 trillion USD of stock was bought back by companies. Stock prices keep rising, as wages and investments flatline. People are now calling into question whether buybacks are good for the economy, or just benefiting executives and investors. In this in-depth-article, we will explore the rise and fall of buybacks, and the dangers they pose in times of crisis.

Before 1929, companies mostly spent their excess cash by investing into the company or by increasing wages. If money was left over, companies would return money to shareholders by distributing cash dividends. After the 1929 stock market crash, CEOs discovered another way to spend cash; stock buybacks. By buying back stock, the number of shares outstanding decreased, resulting in a higher EPS, and thus a higher share price. Stock buybacks became more and more common, until 1934, when rules on insider trading were sharpened, making buying back shares very difficult. Companies started using their cash for investments and workers again, resulting in rising productivity and wages. In 1982, under Ronald Reagan, stock buybacks were reintroduced. Wages started to flatline and pay-gaps widened. 

Currently, stock buybacks are back in full force. The amount of cash spent by companies on their own stock is reaching new all-time highs, with Apple leading the race (by far), with a record amount of 67 billion USD spent on buying back shares in fiscal 2019. Experts point out that most of 2019’s capital gains can be attributed to buybacks, instead of company performance. A main driver of this trend is the corporate tax cut Donald Trump introduced. I think we can all agree that buybacks have been great for the stock market in 2019, however, problems are starting to surface.

The first is an obvious one. Workers are not at all benefitting from buybacks. When Donald Trump reduced the corporate tax rate, the main point was to increase investments and wages, but this did not happen, as companies spent it on buybacks instead. A perfect example of workers standing to lose because of buybacks happened in 2015, when General Motors announced to be buying back 5 billion USD in its own stock. The next year, GM laid off 2000 workers in that same year. This is a perfect example where you can see that company interest is with shareholders, instead of workers. One can certainly understand why not everyone is a fan of buybacks.

Another driver of stock buybacks are low interest rates. Money is very cheap right now (again, with the purpose of driving investments and wages, in order to stimulate the economy). In late 2019, Fortune reported that half of all stock buybacks are now funded by debt. This itself does not have to be a problem. Companies with great earnings like Apple can certainly pay the interest. But for other companies with very high leverage this could pose a threat, certainly in times of crisis. One example of such a company, is American Airlines Group. According to Goldman Sachs, American Airlines Group has a net debt of 4,5 times EBITDA. Despite this, it still bought back around 1,1 billion USD worth of stock in 2019.

So why are highly leveraged companies spending money they don’t have on buying back shares? The answer is fairly simple. CEOs are directly compensated for a rise in stock prices. This form of compensation is quite strange when you relate it to buybacks, because CEOs are also the ones who decide what to do with company profits. The easiest way of benefitting their own is through buybacks, rather than investing in the company’s assets and workers. In the short term, buybacks are great for shareholders, as the worth of their portfolios rise with every buyback. In the long term though, it is questionable if buybacks are really that good for the economy. Especially right now, with the economic impact of COVID-19, we could see companies starting to get in trouble. When your net debt is 4,5 times EBITDA, and all of a sudden air travel sinks as much as it is doing now, this could pose as a real threat.

In Asia, there has already been an increase in firms looking for professional advice in preventing insolvency. Other companies have started emergency equity raises or have issued high yielding bonds in order to quickly raise cash. In New Zealand, more extreme measures have been taken, as the government bailed out the country’s national airline with a 500 million USD loan.

In the US, the first signs of the COVID-19 impact are starting to show as well. Eight of the largest US banks have announced to be suspending their share buybacks the coming year. The expectation is that some bailouts will also be happening in the US, although there is still disagreement whether small or large companies are deserving government aid. If large companies are bailed out, there is a chance that those companies will not be buying back shares for a long time. Mark Cuban appeared on CNBC last week to encourage the government to focus more on workers when bailing out companies. A way of doing this as suggested by Mark Cuban, is to restrict buybacks for these companies. Donald Trump has already stated to not be against this idea.

Robert Foppen