Buybacks: OK in Theory; Bad in Practice.

In theory, if a company is unable to invest a portion of its retained earnings at the same level of (risk-adjusted) returns available elsewhere, it is better for its shareholders and the economy as a whole for that company to return that money to the shareholders so that they can invest in higher-yielding projects, leading to a more efficient allocation of capital in the economy. The reality, however, is different. When a majority of companies is repurchasing shares at the expense of investment in research and development, and in some cases borrowing money to repurchase shares, it suggests that something is amiss.

S&P 500 firms have repurchased over $5.4 trillion worth of shares since 2009. Well-positioned staff have been profiting at general shareholders' expense while introducing fragility into the system. Despite the theoretical benefits of buybacks in certain circumstances, the risks created by them have become obvious during the coronavirus pandemic. Some of the companies requesting federal loans and grants were the ones aggressively repurchasing shares during the past few years. There is anger because nearly 17 million American have filed for unemployment in the past three weeks and, as William Lazonick mentioned, "If companies are paying dividends and doing buybacks, they do not have to lay off workers."

In Why Stock Buybacks Are Dangerous for the Economy, Lazonick, Mustafa Erdem Sakinç and Matt Hopkins explain that "When companies do these buybacks, they deprive themselves of the liquidity that might help them cope when sales and profits decline in an economic downturn." During the drafting of the first coronavirus response bill, The New York Times summarized the awkwardness of companies like the major airlines asking the federal government for bailout money after spending $19 billion repurchasing shares over the last three years. President Trump said, "I don't want to give a bailout to a company and then have somebody go out and use that money to buy back stock in the company and raise the price and then get a bonus. OK?" In response to buybacks' financial and political downsides, the Coronavirus Aid, Relief, and Economic Security (CARES) Act signed March 27 precludes certain businesses that receive relief loans through the Act from repurchasing equity securities for up to "12 months after the date on which the direct loan is no longer outstanding."

The negative aspects of buybacks should not come as a surprise. In 2014's Profits Without Prosperity, Lazonick describes how "the corporate resource allocation process is America's source of economic security or insecurity". The shift from the retain-and-reinvest approach, in place between WWII and the 1970's, to the current downsize-and-distribute regime reflects the shift from an economic model in which corporations create value to one in which they extract it. Not surprisingly, the value creation setup is more stable and sustainable. The value extraction setup contributes to the employment instability and income inequality (and slower productivity growth) evident today.

In January 2018, Dan McCrum examined whether US companies' huge repurchases made sense, considering that investment in development was stuck at pre-crisis levels and stock prices were high (buybacks make more sense when a corporation considers its shares to be undervalued by the market). Given repatriation rule changes in 2017's TCJA, it was clear that buybacks were going to remain near record levels. He examines five charges :

Charge	Verdict
1. Staff benefit more than shareholders	Guilty
2. Opportunity for manipulation	Not Guilty
3. Executives can be a bad judge of value	Guilty
4. Buybacks reduce real investment	The Jury is Out
5. Encouraging fragility	Guilty as Hell

Following up on the charge that buybacks encourage fragility, Lazonick, Sakinç and Hopkins (2020) highlight the issue with the corporate buyback boom: up to 30 percent of buybacks in 2016 and 2017 were financed by corporate bonds. These "debt-funded" payouts, encouraged by low interest rates, are a form of financial risk-taking that "can considerably weaken a firm's credit quality." (IMF GFSR)

The Atlantic summarizes the investor-level and economy-level impacts: "The proliferation of stock buybacks is more than just another way of feathering executives’ nests. By systematically draining capital from America’s public companies, the habit threatens the competitive prospects of American industry—and corrupts the underpinnings of corporate capitalism itself."

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Other things to look into:

There are of course factors within the legal framework that help explain why buybacks have increased. The main example is the SEC's Rule 10b-18, which creates a "safe harbor" in which companies are free from risk of liability for stock price manipulation as long as they follow conditions laid out in the Rule.

But I wonder to what extent the economic situation has led to more buybacks. Decreased productivity and population growth, among other factors pulling the "natural rate of interest" down, might indicate that the marginal product of capital is lower today than it has been at any other point since the end of the 1930's, when Alvin Hansen was worried about secular stagnation. Companies might simply not have investment opportunities that stand up to the ROI expectations ingrained in their executives' minds since their 1990's MBA programs where their professors were teaching corporate finance classes and the 10-year Treasury yield of around 7 percent was 10 times higher than it is today. Part of this is a question of capital accumulation and how our society structures itself for the Japanese experience of low growth -- which does not have to be bad!

Lastly, to the extent that federal spending on research crowds in private spending on research and development, how much of the growth in buybacks is a result of the public sector stepping away from its active role in promoting growth? The work of economists such as Enrico Moretti, Mariana Mazzucato (The Entrepreneurial State), and Bill Janeway (Doing Capitalism in the Innovation Economy) shows how government spending on research (and government's ability to create a market for technologies before they are ready for commercial success) "crowds in" private sector spending on research and development.