Commentary: Should government bailouts restrict stock buybacks?
Much depends on governments’ specific objectives for the bailouts and whether supporting the stock market is a key goal, says NUS Business School Emir Hrnjic.
SINGAPORE: Amid the COVID-19 pandemic, governments have allocated trillions of dollars to businesses and financial institutions to boost the economy and prop up share prices.
In this, regulators are calling for emergency assistance to companies to come with strings attached, particularly with respect to potential stock buybacks. Most notably, influential US Senator Elizabeth Warren proposed a permanent ban on stock buybacks for all companies that accept emergency federal funding.
A recent article in the Harvard Business Review argued stock buybacks made companies vulnerable in an inevitable economic downturn when their cash flows dry up. The article reported that S&P 500 companies spent US$4.3 trillion on buybacks over the last decade, roughly half of their net income.
Notably, the six major US airlines spent about US$47 billion buying back their own stock in the last decade. Cynics noted the money spent on buybacks might have been put to better use in the current crisis when the same six firms asked for a combined US$58 billion in federal assistance.
MORE BUYBACKS IN ASIA
While stock buybacks have traditionally been concentrated in the US, they are increasingly popular in Europe and Asia. Japan reported US$52.5 billion of buybacks in 2018.
Softbank announced doubling its buyback plan to 2.5 trillion yen (US$23.5 billion) in April, sending its stock soaring by almost 40 per cent, despite posting an annual operating loss of 1.35 trillion yen.
Closer to home, while the Straits Times Index lost almost a fifth of its value in a month of March, SGX reported that total share buybacks for Singapore-listed stocks in just that month – roughly half a billion Singapore dollars – almost matched the total amount of buybacks for the entire last year.
While buybacks in Singapore were dominated by DBS, UOB and OCBC, the US Federal Reserve ordered the country’s largest banks to suspend their stock buyback programmes.
BUT MANAGERS’ AND SHAREHOLDERS’ INCENTIVES ARE ALIGNED
As lawmakers weigh whether emergency assistance should come with stock buybacks restrictions, observers wonder whether this stand is restrictive or justified.
The answer depends on whether we believe in laissez-faire capitalism. The phrase laissez-faire capitalism simply means that governments stay away from the workings of the free market.
In laissez-faire capitalism, companies should be investing in projects expected to provide a rate of return higher than their cost of capital. If firms run out of such projects, they should return cash to shareholders in the form of dividends or stock buybacks. So stock buybacks are in the best interest of the shareholders.
From the perspective of the overall economy, firms with no profitable opportunities return cash to shareholders so they can invest in other profitable opportunities.
In principle, buybacks could help the economy by reallocating resources to the best possible use. However, the problem may arise in a crisis if investors who sell their shares during a buyback choose to hoard the cash and do not reinvest in the economy.
Furthermore, since buybacks reduce the number of outstanding shares, they automatically improve many valuation ratios such as earnings-per-share. While economists argue the effect of artificially inflated valuation ratios should have no effect on valuation, an increase in share price is a well-documented consequence of stock buybacks.
Critics point out managers conduct stock buybacks for selfish reasons such as to boost the value of their own stock holdings and stock options. Nevertheless, stock buybacks should be seen favourably as managers’ and shareholders’ incentives are aligned.
On the other hand, when governments are involved in markets, the key question becomes why they help companies. If governments’ main objective is to help improve shareholder wealth by propping up share prices, supporting stock buybacks using federal money may be justified.
However, if their objectives include supporting investments in the real world, boosting the economy, or slowing down rising unemployment, stock buybacks help very little.
Stock buybacks do not invest in the real world, do not create positive externalities, nor do they slow down rising unemployment. Stock buybacks only help augment shareholders wealth and they may boost positive market sentiment that could spill over to the real world.
Theoretically, rising shareholder wealth may have a positive impact on consumption and thus the real economy (also known as the wealth effect). However, the research study by Karl Case, John Quigley and Nobel Laureate Robert Shiller found “at best weak evidence” of a stock market wealth effect.
Given the above, if companies are calling for emergency assistance, then governments around the world need to carefully consider their objectives for acceding to these requests for bailouts. If the reason is to prop up the stock market, the stock buybacks are a useful way of investing the bailout money.
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On the other hand, if the reason is to prop up the economy and stop skyrocketing unemployment, lawmakers should be calling for conditions to be attached to buybacks.
Stock buybacks using shareholders’ money may be the right thing to do, but stock buybacks using taxpayers’ money is probably not.
Emir Hrnjic is an adjunct assistant professor at National University of Singapore Business School. He is a co-founder of Block’N’White Consulting. The opinions expressed are those of the writer and do not represent the views and opinions of NUS.