Understanding the Post-Tax Cuts Buybacks Surge: A Primer

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By Lydia O’Neal

Much debate over the effectiveness of the 2017 tax overhaul has centered on corporate buybacks, and as November elections approach, that debate is sure to heat up.

Although economists tend to agree that the economic ripple effects of the law won’t be measurable for years to come, as corporations take time to alter their activities accordingly, there are plenty of immediately identifiable truths when it comes to the flood of share repurchases in the law’s wake.

Buybacks accounted for the largest share of cash spending by S&P 500 companies in the first half of 2018—the first time that has happened in a decade—with repurchases increasing by 48 percent over the same period last year to $384 billion, according to a Sept. 14 report from Goldman Sachs.

The report estimated that stock repurchases would reach $1 trillion by the end of the year, a full-year record, but they’re hardly a novel phenomenon.

The Securities and Exchange Commission opened the floodgates when it issued Rule 10b-18 in 1982, creating a list of requirements corporations must comply with to receive a safe harbor, an assurance that they’re following the rules and not considered by the SEC to be willfully manipulating their share prices, when engaging in buybacks.

But a big chunk of repurchases among the S&P 500 is offset by new equity—$3.3 trillion worth between 2007 and 2016, versus $4.2 trillion in buybacks over the same period, according to a Sept. 4 paper from Harvard Law School professor Jesse M. Fried and Harvard Business School professor Charles C. Y. Wang.

The S&P 500 may spend $1 trillion on repurchases in 2018, Fried told Bloomberg Tax, “but they’re probably going to have $500 billion to $600 billion in equity issuances.” The focus on the S&P 500, he said, ignores the many young, growing businesses that employ a much larger slice of the workforce and tend to issue far more shares than they’re paying out.

Here’s how corporate buybacks work.

Who Holds the Stocks?

Many critics of the outrage over buybacks have noted that shareholders are receiving the cash value of the shares they already held, and therefore aren’t further enriched by the repurchase program.

Regardless of whether they’re considered better off, some, such as Rep. Peter Roskam (R-Ill.), a member of the House Ways and Means Committee, have argued that “not all shareholders are wealthy.”

Stock ownership by households is concentrated among the top 10 percent of middle-aged U.S. families. That slice held 78 percent of stock market wealth in the hands of those families in 2016, an amount that’s grown steadily from 69 percent in 2001, according to Federal Reserve data.

Even so, as Douglas Holtz-Eakin, who has served as chief economist to President George W. Bush’s Council of Economic Advisers and as director of the Congressional Budget Office, wrote in a July op-ed that those shareholders are free to take their cash and reinvest it elsewhere.

“Those funds become available to companies, entrepreneurs, and small businesses to make investments,” he wrote in The Hill.

It’s practically impossible to track where that money goes next, but Holtz-Eakin’s argument holds true for the vast majority of stockholders, which are often institutional investors, such as pension funds, mutual funds, and employer-sponsored retirement plans.

“It’s not as though they are taking the money and returning it to their clients,” Donald Marron, director of economic policy initiatives at the Urban Institute, said of institutional investors.

In this respect, buybacks can be a tool that supplement investment and can reallocate capital, said Erica York, an analyst at the conservative Tax Foundation, who wrote a Sept. 19 report illustrating the trillions institutional investors invest in equities.

How Do Shareholders and Executives Benefit?

The remaining shareholders, including institutional investors and the company’s executives, generally do benefit, as the earnings per share of the remaining shares rise, due in part to the shrinking number of shares. But it’s not that simple, Marron cautioned.

“A lot of the commentary you see pretty much assumes buybacks drive up stock prices,” but the real result “is nowhere near as obvious” as critics of repurchases make it sound, Marron said. The shock to the share supply usually causes earnings per share to increase, but the company is losing cash, so it “as a whole becomes less valuable,” he said.

A June report from S&P Global even cited buybacks from repatriation of accumulated overseas earnings as a reason cash balances should “decline over time.” This “should concern investors,” the S&P analysts said, given the record $6.3 trillion in outstanding corporate debt among nonfinancial U.S. issuers and rising interest rates that render that debt more expensive.

Still, “on average,” Marron said, the share prices do rise, delivering gains to the remaining shareholders, as well as to executives who are compensated often based on EPS performance and, increasingly, through company equity.

Stock awards made up 48.5 percent of CEO compensation among the S&P 500 in 2017—up from 32 percent in 2010, according to the findings of a forthcoming annual report by the Conference Board, a business research nonprofit.

Why Haven’t Wages Increased?

The debate, at its heart, rests on whether companies are doing the ethical thing with the flood of new cash from repatriated earnings and the corporate rate, which was slashed to 21 percent from 35 percent.

The Goldman Sachs report said that while capital investments have been the top reason for cash spending for much of the past two decades, those expenses grew by 19 percent in the first half of 2018, which, if continued at that pace, “would represent the fastest growth in capex in at least 25 years.” It said nothing of growth in wages, which, in aggregate and adjusted for inflation, have remained stagnant, according to an August report from the Pew Research Center.

“No one is going to invest in a company that is going to pay workers more than they need to,” said Fried, adding that research and development spending is already sky-high, and that public companies were far from cash-starved before the tax overhaul.

But Matt Gardner, a senior fellow at the liberal-leaning Institute on Taxation and Economic Policy, said the anger over buybacks stems from the idea that, with the passage of the tax law (Pub. L. No. 115-97), Americans “were promised something else” by lawmakers and the administration. Real wage growth, he added, is “flat as a pancake.”

“They weren’t talking about buybacks—they were talking about increasing wages and investment,” Gardner said. “Undeniably, part of the reason we’re seeing no growth in real wages is because companies are doing other things with their money.”

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