By Greg Brown, Executive Director, Kenan Institute of Private Enterprise
Recent Congressional proposals have advocated restricting companies’ ability to buy back their own shares. Some would suggest that imposing such restrictions is a bad thing. But why? The argument goes something like this:
Let’s start with what has to happen for underinvestment to be a problem:
First, as share buybacks increase, corporate investment must decline. But the historical evidence doesn’t support this. Over the past 10 years, as the number of buybacks has increased, private sector investment as a percentage of GDP has actually increased slightly. Specifically, if we measure U.S. business investment as private non-residential fixed investment as a percent of GDP, then the average over the last 10 years was 10.9%. The average over the previous 20 years was 12.8% and the long-run average since 1947 is 12.1%.
Attribution: Data Source: U.S. Bureau of Economic Analysis
Second, corporations should be capital constrained, because money going into buybacks prevents investment. The reality? Companies currently hold more cash than any other time in history, both in absolute terms and as relative to investment. Especially in the past decade, constraints on investment just haven’t materialized.
Third, shareholders have to make worse investment decisions than company executives. The argument for buyback restrictions makes the unwarranted assumption that the more limited investment decisions company executives would be able to make under buyback restrictions would still be wiser than the voluntary and deliberate decisions currently made by shareholders, who reinvest the money they receive from buybacks somewhere within the economy.
This is a pretty dim view of capital markets – and if you believe this, then you probably don’t believe in markets at all.
But what if otherwise thoughtful and sensible shareholders are being hoodwinked into approving bad compensation policies that incentivize executives to act contrary to shareholders’ best interests? This is certainly a possibility, and I’m sure this happens in some cases. However, with the large and growing presence of activist institutional investors, this is a dangerous game for executives to play, as they’re likely to find themselves in the crosshairs of a campaign to reform corporate policies and thin out the ranks of wayward management.
From looking at the empirical evidence, it’s pretty clear that buybacks are not restraining investment in the U.S. Even the very real possibility that some executives are gaming the system at the expense of shareholders and the broader economy has a simple solution that precludes buyback restrictions: a government mandate for same-day public disclosure of share buybacks.
So, is there any evidence that buybacks are more than a purely imagined threat to companies and the economy? Not that I have seen. In fact, research shows that companies that repurchase more shares have higher than average investment, profits, growth and employee pay. These include such economy-boosters as Apple, Google, Cisco and AT&T.
So, while the argument for tighter restrictions on buybacks might sound good on the surface, a more informed look through the lens of corporate investment policy makes it clear that share buybacks don’t negatively affect the economy in any meaningful way.
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