As I was staring blankly at my computer screen in Himes Hall, a thought occurred to me — other than the thought that I should have studied for my test. This empty stare and hazy confusion is probably how a friend of mine felt when I was ranting about the abhorrence of stock buybacks. Her eyes glazed over much like mine had sitting in Himes, and while I was talking, she had probably regretted asking me what my next column was going to be about.
In retrospect, I probably should have started by answering the most basic questions someone who isn’t familiar with stock buybacks would ask: what’s a stock buyback? And, why does it matter it to me, the average person?
A stock buyback, formally referred to as a stock repurchase, is when a company with idle or excess cash buys the stock it originally issued to raise money back from the open market where the stock is traded, which is most often on the New York Stock Exchange. It does this in order to reduce the amount of shares of stock it has outstanding, for which it can increase the value of each individual share when there are less shares to distribute profit.
Each individual share gets a larger piece of the pie. This matters for investors who rely on a company’s projected earnings per share, commonly referred to as EPS, to indicate when they should invest. When investors sense a company may start buying back its stock, such as after a corporate tax cut, they’ll increase their holdings and stock prices will subsequently rise.
So, what? Stock buybacks appear to be a sound corporate strategy with positive reverberations throughout the economy. Companies simply invest excess or idle cash into stock buybacks, EPS increases, investor confidence increases, stocks rise and consumer confidence increases. Everybody wins. Corporate executives are happy, investors are happy and politicians are happy.
Most importantly, the American public believes rising stock prices reflect a favorable economic climate so they too are happy and GDP growth increases. Unfortunately, the public is not aware that the economy is essentially a house of cards propped up on artificially high stock prices.
When stock prices rise in spite of the fact that no fundamental value has been added to the company, the economy, which relies on consumer and investor confidence, is only experiencing a nominal short-term increase. Due to the underinvestment in capital expenditures, research and development and the labor force, the long-term growth of the economy is jeopardized by corporate investment in stock buybacks.
Before 1982, stock buybacks were classified as illegal stock price manipulation, but Rule 10b-18 of the Securities Exchange Act changed that without explicitly saying so for fear of public outcry. Instead, Rule 10b-18 essentially provided legal discretion for senior executives to issue stock buybacks as long as they kept the daily volume of stock buybacks at or under the 25 percent “safe harbor” of average daily trading volume.
To put 25 percent of average daily trading volume in perspective: Apple, which recently announced a $100 billion stock buyback, could spend roughly $1.4 billion per day on stock buybacks. So yes, stock market manipulation is technically legal, and corporations do it on a regular basis with stock buybacks.
Corporate tax cuts add fuel to the fire, but after the temporary boost from stock buybacks corporate cash dries up, investor confidence sinks and a market correction occurs to account for artificially high stock prices. The economy reverts back to what its real output reflects with the added acknowledgement that long-term investments weren’t made to protect its current growth rate.
It’s similar to waking up with a hangover on a Sunday morning and remembering you failed that test you took in Himes last week. Now you’ve got two problems: a splitting headache and a lower GPA.
An economy after a blitz of stock buybacks is in perilous shape. Not only is the short-term economy potentially amidst a recession with a domino effect of investor stock sell-offs, but an economy deprived of valuable corporate investment must also face lower long-term economic growth projections. Houston, we have a problem.
Or, do we? Our current economy is booming following passage of the Tax Cuts and Jobs Act in 2017. To hell with naysayers who point out the trillions added to the federal debt!
The U.S. GDP growth in the second quarter of this current fiscal year is a blistering 4.2 percent following up a sluggish first quarter of 2.2 percent. A preliminary analysis by the Brookings Institution, a renowned think tank, found that the TCJA would stimulate the economy in the near term with residual effects in the long-term.
However, a more scrupulous analysis of the effect tax cuts would have on our economy involves taking a look under the hood to see how the corporate tax cuts will drive the economy. In theory, tax cuts provide corporations with more cash to invest in capital expenditures, research and development and job training. If that were the case, I wouldn’t be as worried about a looming market correction.
However, slashing the corporate tax rate from 35 percent to 21 percent spawned a stock buyback boom. In 2018 alone, stock buybacks are projected to eclipse $800 billion, which outpaces the $7 trillion spent between 2007 and 2016.
Instead of long-term investments for future economic growth, corporations have sent a clear message: they don’t care. Corporate short-termism puts shareholders before workers or Americans in the broader economy. Ultimately, stock buybacks are to the detriment of all stakeholders, except for one group of people — executives.
Patrick Gagen is a 21-year-old mass communication and finance senior from Suwanee, Georgia.
