With share buyback programs under consistent attack from a variety of sources, including traditional progressive groups, certain SEC Commissioners, and Democrat senators, the Wall Street Journal recently published an opinion article by investment management firm AQR Capital Management which responds to the arguments against buyback programs. The key theme throughout the article is that attacks on buybacks are mostly empty criticisms which have been utilized to attempt to link key messages, including the negative effect of the recent tax cuts, income inequality and corporate short-termism. The article, however, takes on three arguments against buybacks based on the authors' analysis of buyback and corporate financial data:
Buybacks starve investment and amount to “self-liquidation”: The first, and most common, argument against buybacks addressed in the article is that buybacks are being conducted at the cost of needed corporate reinvestment. However, the article looks at the investing section of the statement of cash flows for the Russell 3000. Accordingly, if normalized by either total assets or market cap, net investment is lower than in the 1990s, but much higher than in 2008. The more significant point, however, is that the criticisms of buybacks as starving investment overlook the costs of alternative sources of capital that reduce companies' cost of capital. The article notes that good economics is to utilize the lease costly source of funds. Thus, as the article states, over the past few years outflow from buybacks has been “more than replaced by cash gained from borrowing” – meaning "companies have been raising money – not liquidating" due to the low interest rate environment.
Buybacks “artificially” raise earnings per share and inflate the stock market: First, that buybacks artificially raise EPS, the article notes that this is the case “only if the rest of a repurchasing company’s business is unchanged and the cash used for the buyback was completely idle.” Otherwise, the long-term impact buybacks have on EPS growth is only determinable by the return the company would have assumed had it retained and employed the cash. This, according to the article is “how it is supposed to work”. As for buybacks driving the market rise, the article states clearly that the numbers do not support the claim. The article notes that share prices do tend to increase by 1% after the buybacks are announced. However, the article states that there are several explanations for this increase, including that buybacks often signal to investors that management believes the shares are undervalued. Finally, the article notes that it would be impossible to determine how much of the 15% annual Russell 3000 annual returns since the financial crisis are a result of buybacks but that there is no compelling evidence which says its more than a small fraction.
Some companies are “scams” fueled by buybacks: The final argument addresses the claims that companies like Apple are the size they are due to buybacks and, for example, that the company’s approximately $1 trillion in market cap is an “illusory artifact of share repurchases”. According to the article, this is backwards since buybacks reduce market cap.
The article also talks about the impact buybacks have on executive compensation should be addressed through adjustments and other executive compensation contractual provisions – not through eliminating buybacks. The article closes by noting that, despite the legion of attempts to demonize buybacks, there is no real case against them. The logic in the article notwithstanding, it is unlikely that the criticisms of buybacks stop anytime soon, especially since they appear to be a major component of political campaigns of prominent politicians.