COVID-19 Stimulus and the Politics of Stock Buybacks

(755 words, three-minute read)

Opposition to companies buying back their stock has historically been a partisan issue, with Democrats opposed, Republicans not. Both sides, however, agreed to prohibit companies that accepted stimulus money from doing so. How might independents think about this issue? The short answer is “it depends.” Here is why.

There is one answer for “normal times” 

In normal times, the anti-share buyback argument goes like this: Buying back stock only benefits wealthy shareholders and executives at the expense of working people. Rather than buying back stock, companies should use their cash to expand production, add workers, and increase benefits. 

This assertion reflects little understanding of how companies operate. No company makes hiring or compensation decisions based on their total cash balance. They make such decisions based on their production needs as well as the market for labor. They have an obligation to their investors to be competitive, and being competitive requires production at the lowest possible price. No one will invest in a company that over-hires, overpays, or produces in a location that is more expensive than another. You can review a prior Analysis entitled The Price of Capitalism for a fuller discussion of this.

So, if you prohibit share buybacks, there is no reason to think that companies will hire more employees or raise wages. In fact, it is more likely that companies will find other ways to distribute cash to their investors, such as increasing dividends. 

There is another answer when taxpayers become investors 

In times of crisis, a second argument surfaces that is an extension of the first one. It goes like this: Since buying back stock only benefits wealthy shareholders and executives at the expense of working people, companies that request bailouts should be prohibited from buying back stock. Unlike the first argument, part of this one has merit.

In a crisis, government, and hence taxpayers, may conclude that some companies are important from a national security or employment perspective. Bailing them out is not an act of charity, but rather is deemed to be in the interest of the country. In these cases, taxpayers should be fairly compensated for their risk. 

Consider the bailout of Chrysler and General Motors in 2009

In 2009 the government bailed out Chrysler and General Motors. In return for their investment, the taxpayers received equity in both companies. The government exercised all the prerogatives of a shareholder; they changed management, influenced executive compensation, and forced a merger of Chrysler with Fiat, to name a few. 

In bailouts, taxpayers should have all the prerogatives of shareholders

Like then, if taxpayers provide rescue financing to companies during the current COVID-19 crisis, they should obtain fair compensation in terms of company ownership. Their interests should be senior to the common shareholder. Depending on the value of the equity versus the size of the rescue, existing common shareholders may be left with little or nothing in order to provide an adequate return to the taxpayer/shareholder. 

These prerogatives include all governance, not just buybacks

Also like in 2009, the taxpayer as shareholder has the right to influence management policy that any shareholder has. Eliminating dividends and stock buybacks as well as reducing executive compensation might all be justified in order to increase the company’s liquidity and ensure a return to profitability and a return on the taxpayers’ investment. 

One more thing; do buybacks cause bailouts? 

A third argument currently being made is that, had companies not bought back their stock, they would not require bailouts during this crisis. This argument has the quality of being both true and irrelevant at the same time. Here is why.

Investors have choices. They provide capital to companies that provide the risk-adjusted rate of return that they require. This is a voluntary activity. No one is obligated to make an investment in a company that can’t provide a competitive rate of return. When a company fails to provide the required rate of return, investors sell its stock and buy others. 

Companies maintain cash in order to provide a level of liquidity they deem prudent and to fund investment opportunities. Holding cash balances in excess of this level reduces investment returns and is not in the interest of the shareholders. The right thing to do in this case is to return the cash to shareholders and let them redeploy their capital to other companies that meet their requirements. Companies do this by increasing dividends or buying back stock. 

In normal times, if a company miscalculates its liquidity needs and suffers financial consequences as a result, the management is punished by the shareholder and the market. This would be true whether their liquidity problem is the result of paying dividends, buying back stock, or maintaining insufficient bank lines of credit. Poor risk management results in failure. 

But to argue that a company should always have enough cash to survive a black-swan event like COVID-19 is impractical. No shareholder would invest in a company that did so. Accordingly, to automatically conclude that companies were irresponsible pre-COVID for buying back stock or paying dividends is off the mark.