Share Repurchases

In addition to evaluating repurchases, the SEC staff believed that an accurate assessment of repurchases had to account for the growth in market capitalization over the same period. As shown in Figure 2, the increase in repurchases has tracked closely to an increase in market capitalization, with one glaring exception just before the 2007-08 financial crisis.

Further, since the financial crisis, the SEC staff concluded that “repurchases as a percentage of aggregate market capitalization of public companies have remained stable at 2%.” Although the percentage of market capitalization has remained stable and is relatively low, the increased spending from $20 billion to $700 billion raised questions from regulators and elected officials about who was benefiting from this process. Critics say that there is a concerning correlation in the announcement of an intent to repurchase and the subsequent sale of shares by executives.

Additional Disclosures, Restrictions, and Taxes

Some elected officials have called for greater disclosure from companies regarding their use of repurchases. Sens. Marco Rubio (R-FL) and Tammy Baldwin (D-WI) argued in a joint letter to the SEC that repurchases represented a shift in the capital markets toward “financial engineering” at the expense of investing in “trade and industry.” They requested that the SEC require companies with excess capital to explain, in non-boilerplate language, why they use repurchases over other investments. Sens. Rubio and Baldwin justified the increased disclosure on the capital markets enable companies to raise capital to make investments “for the good of investors, workers, communities, and, ultimately, our country as a whole.”

In addition, President Biden’s proposed fiscal year 2023 budget would prohibit executives from selling their shares for three years after their company’s announced intention to implement a repurchase program. The president also included a 1% tax on repurchases in his “Build Back Better” plan and later included the provision in his FY2023 budget. In addition, for an investor to be able to take advantage of the current tax code’s capital gains tax rate benefit, the budget would increase the time a share had to be held from one to three years. The rationale for these policy proposals appears to rely heavily on former SEC Commissioner Robert Jackson’s 2018 speech where he explained his staff’s findings on the growing number of (gross) repurchases and sales by executives.

SEC Repurchase Disclosure Rule

In response to the criticism of repurchases, the SEC proposed a share repurchase disclosure rule on December 15, 2021. The Commission cited a number of concerns with repurchases, including “asymmetries [that] may exist” between companies, their executives, and other investors. It also cited concerns that the repurchase process is not transparent enough for investors. The Commission said that some research showed that repurchases can “serve as a form of real earnings management” when they are connected to short-term objectives that result in management trying to “meet or beat consensus forecasts.” It also made reference to the inherent problem of compensation arrangements tied to share-price or earnings per share (EPS). Last, the Commission referenced former SEC Commissioner Jackson’s 2018 speech when it found that executives can use repurchases to “cash-in” instead of investing in workers.

In response to these concerns, the SEC proposed requiring more-frequent disclosures of repurchase data. Under the current regulation’s safe harbor provisions, companies must abide by guidelines that limit the timing, manner, price, and volume so as to minimize the impact on the public market. Companies must also file repurchase data quarterly, including compiling a table with month-to-month statistics on the number of shares purchased, the average price, and the maximum number of shares or dollar amount in a company’s purchase program. In addition to the existing disclosure framework, the Commission proposed to enhance the disclosure by requiring companies to explain their “rationale or objective” for engaging in repurchases, and that they report any actual purchases within a day, instead of on a quarterly basis along with their other quarterly financial data.

As the increased use of repurchases drew the attention of policymakers, political lines formed consistent with the dichotomy between shareholders and employees. This resulted in a number of proposals that were intended to tilt the scale in favor of employees.

III. Disburse to Employees

It is certainly understandable that policymakers are interested in how successful companies allocate profits. This likely stems from the historical issue of debating pay ratios between senior executives and employees. More recently, it has become an established position to argue that repurchases divert capital away from investing in workers and other opportunities in order to enrich executives and wealthy shareholders. As a result, efforts are growing to condition repurchases on employees receiving better pay, more benefits, and greater control of the company. The correlation is based on the fact that when companies announce their intent to engage in repurchasing, the market typically responds positively, and the company’s shares increase in value. Although the SEC regulates this practice, executives, as well as other shareholders, can and do sell some of their shares as a result of the higher value. However, some critics maintain that the repurchase announcement is a way for executives to work the financial system for their own personal gain regardless of current SEC restrictions.

Prohibition and Safe Harbor Removal

A politically instinctive reaction to a perceived abuse of process is to enact a prohibition. In arguing for an outright ban, some critics say that repurchases are “virtually unregulated,” have a potential for market manipulation, and face “no meaningful” restrictions that could prevent executives from using them for personal gain.30 Further, repurchases are “one of the drivers of [an] imbalanced economy in which corporate profits and shareholder payments continue to grow while wages for typical workers stay flat.” In lieu of a prohibition, some members of Congress have called for workers to have more say in board decisions, such as mandating that they are able to elect up to one-third of a company’s board of directors. The assumption is that if a workers had greater representation, a board would chose to spend more of the excess capital on the workforce instead of shareholders.

Repurchases are “one of the drivers of [an] imbalanced economy in which corporate profits and shareholder payments continue to grow while wages for typical workers stay flat.” Lenore Palladino’s Congressional Testimony

Others, such as former SEC Commissioner Jackson, have argued that the “unprecedented volume” of (gross) repurchases itself requires a call to action. He cites the correlation between repurchase announcements and executives’ ultimate sale of shares, which by his estimate occurs about 50% of the time. Jackson says that on “too many occasions, companies doing buybacks have failed to make the long-term investments in innovation or their workforce.” As a result, he argues, the SEC should rescind the 1982 safe harbor provisions. Presumably, without the liability protections afforded under the safe harbor, companies would go back to a pre-1982 mentality, and repurchases would greatly decrease.

Adjust Tax Benefits for Workers

Other proposals focus more on tax implications and waiting periods. Although some of the tax-related arguments reference the Tax Cuts and Jobs Act of 2017 (“2017 tax cut”) as a rationale for proposed changes, most policy proposals are based on the increasing use of repurchases since 1982. However, the 2017 tax cut provided for a one-time tax waiver to repatriate excess capital held overseas. As a result, companies took advantage of the tax provision and moved some of their overseas capital back to the United States. Critics said that companies “promised” to use the repatriated excess capital to invest more heavily in workers, but instead used the capital for repurchases. Sens. Sherrod Brown (D-OH), Chairman of the Senate Banking Committee, and Ron Wyden, Chairman of the Senate Finance Committee, proposed the Stock Buyback Accountability Act, which would impose a 2% tax on repurchases over $1 million, unless the repurchase funded an employee pension plan or equivalent.

Mandate Additional Benefits to Workers

In addition, other elected officials have proposed to tie repurchases directly to a worker benefit. Sens. Charles Schumer (D-NY) and Bernie Sanders (D-VT), in a 2019 New York Times op-ed, wrote that companies were devoting too much of their profits to dividends and repurchases. They argued that because repurchases do not benefit most Americans or employees, the excess capital should be used for “R&D, equipment, higher wages, paid medical leave, retirement benefits and worker retraining” instead of giving the profits to the “wealthiest 10 percent.” As a result, they proposed a prohibition on repurchases unless a company invests in its workforce by increasing wages to “at least $15 an hour, providing seven days of paid sick leave, and offering decent pensions and more reliable health benefits.” In a similar attempt to tie repurchases to a mandated benefit for workers, Sen. Sherrod Brown (D-OH) introduced legislation to mandate a $1 “worker dividend” to be paid to employees for every $1 million of excess capital allocated to repurchases.

[E]xcess capital should be used for “R&D, equipment, higher wages, paid medical leave, retirement benefits and worker retraining” instead of giving it to the “wealthiest 10 percent.” Sens. Charles Schumer (D-NY) and Bernie Sanders (D-VT)

The common theme in each of the proposed policy changes involves the perception that as corporate profits increase, shareholders are the ones who reap the financial benefits, while employees’ wages, benefits, and training opportunities remain stagnant. The perceived inequality of capital redeployment is amplified when, according to a static analysis, the immediate financial benefit goes to those with the most invested, i.e., the “wealthiest 10%.” However, the dichotomy between employees and shareholders becomes less stark when one analyzes repurchases through a dynamic approach that accounts for a broader set of beneficiaries.

IV. Return to Shareholders

From the shareholder perspective, investments are presumed to be made with the intent of a future return on investment. That return is either through higher value in shares held or through the disbursement of dividends. In their desire for a return on investment, shareholders prudently rely on the fiduciary duty of the board and management to make decisions in the best interest of their investment, i.e., the company.

Increase in Share Value

In looking at business decisions that increase the value of one’s investment, investors must consider both the short- and long-term effects. When it comes to repurchases, studies consistently show that the value of the shares increases after repurchasing announcements and that the higher value is not merely a result of the announcement itself. The argument is that most announcements are a result of a company’s belief that its stock is undervalued. The market typically sees repurchase announcements as a positive sign, and the stock price rises accordingly. Here the studies seem to contradict former Commissioner Jackson who, in referencing a “price bump,” inferred that the announcement itself was merely the cause and not the underlying rationale for engaging in the repurchase. Multiple studies have shown that the vast majority of announcements are a result of management, with oversight from the board, concluding the value of the stock is in fact undervalued. Further, little empirical evidence supports the claim that executives use announcements for short-term gain. In fact, studies have found that “claims of opportunistic or manipulative use of share repurchases by insiders are not supported by economic analysis.” Other studies show that executives are less likely to even sell their individual shares when companies repurchase shares, and they found no evidence of systematic misuse of the repurchase process at the expense of shareholder value.

There are also claims that repurchases are used to reach earnings per share targets. However, the SEC staff found that “most repurchase activity does not represent an effort to artificially inflate stock prices or influence the value of option-based or EPS-linked compensation.”52 To the extent that these market manipulations occur, critics argue that investors are typically able to discern these actions through the existing regulatory framework. As indicated at a 2019 Congressional hearing, the financial services industry has models that can determine when a company’s decision to repurchase will not have long-term value and instead focuses on short-term metrics. Furthermore, the use of short-term metrics or “financial engineering” occurs in less than 1 percent of the cases.

Therefore, from shareholders’ perspective, provided that the decision to engage in repurchases is prudent and increases the value of their shares, the majority are likely to support the decision to repurchase.

Response to Restrictions

Shareholders will also likely reject the posited rationale for the SEC policy changes, arguing that, without calculating net repurchases, gross repurchases are greatly exaggerated. The increased use of repurchases seems to be one of the foundational arguments for proposed action. Next is the claim that companies are diverting excess capital from investments. However, studies show that “repurchases are made out of the residual cash flow after investment spending.” Repurchasing decisions are typically made after the board of directors has determined that other investment opportunities—such as R&D, capital expenditures, mergers and acquisitions, and work-force-related issues—have been adequately funded. Further, peer-reviewed research has found that “net shareholder payouts don’t appear to impair investment capacity or firms’ ability to pay workers … and total capital expenditures as well as R&D expenditures by public firms are both at the highest level ever.”

“[N]et shareholder payouts don’t appear to impair investment capacity or firms’ ability to pay workers … and total capital expenditures as well as R&D expenditures by public firms are both at the highest level ever.” Professors Jesse Fried & Charles Wang

Dilution and Tax Benefit

Repurchases have an additional benefit besides increasing stock value: They help to alleviate the problem of share dilution when companies grant stocks or issue stock options. Share value often falls when a company issues new stock or when those with stock options exercise the options. Dilution becomes even more of an issue with the increased use of equity-based compensation.

Shareholders also receive the benefit of increased share value without having to pay additional taxes. Unlike dividend distributions that are taxed at standard income tax rates, increases in share value are not taxed, and if the shares are held for longer than one year, selling them will result in a capital gains tax of no more than 15% (and may be lower for those with lower income). Tax policy restrictions on repurchases are also concerning to shareholders. As previously discussed, arguments to impose tax-related measures appear to be, in part, a response to the 2017 tax reform. Although repurchases rose in 2018, studies have shown that companies also gave bonuses, raised wages, increased benefits, and hired more workers.

Market Failure and Regulatory Costs

Another cost that shareholders will ultimately bear is that of increased regulation through the SEC’s enhanced disclosure mandates. Reasonable investors are entitled to material information with which to make sound investment decisions, but increased disclosure must be based on a “market failure.” Here, the SEC indicated that more frequent disclosures and more detailed explanation of repurchases were “important” to investors. However, some argue that the benefits have not been adequately explained and that they fail to outweigh the additional costs of the proposed enhanced disclosure requirements. In testimony before Congress, Professor and former SEC economist Craig Lewis stressed that when promulgating regulations, the Commission must identify the market failure it is intending to address. After the release of the proposed rule, Lewis indicated that he believed that the SEC’s economic analysis failed to adequately identify a market failure upon which to base the rule. Specifically, he argued that the SEC has ignored “empirical evidence refuting the notion that repurchases necessarily harm investment and employees.” If the rationale for the enhanced disclosure of repurchase data is based on a misuse of authority for personal gain, the Commission should explain how the existing regulatory framework does not protect investors, and then show how the proposed rules would protect investors, shareholders, and employees.

From a shareholder’s perspective, repurchases increase share value, mitigate dilution, and produce a tax benefit. Under a static analysis, support for repurchases is certainly understandable. However, from a dynamic analysis, shareholders must realize that repurchases are not always in a company’s best interest. The management and board must decide about how best to reallocate excess capital. In some cases, additional investments to improve employee morale and retention, as well as enhance retirement options, may be the most prudent use of capital.

V. Impact on a Broader Group of Beneficiaries

Seemingly since the 2019 Business Roundtable’s restatement of corporations’ role in society, much of Wall Street and many policymakers in Washington have focused on how stakeholder capitalism would replace the previously dominate view that companies exist to serve shareholders. Even before the restatement, most agreed that in serving shareholders, well-run corporations had to consistently focus on their customers, employees, suppliers, communities, and shareholders if they were to remain profitable. However, in a static analysis, one of the inherent problems with assessing companies’ performance under a stakeholder-based system is how to effectively weigh the varying interests of individual stakeholders. Indeed, societal benefits beyond stakeholders are seldom discussed under this system. Instead of focusing on and comparing individual stakeholders, a dynamic approach allows a full examination of potential societal beneficiaries.

Benefit for Employees

Understanding how repurchases benefit both shareholders and the broader economy is important in discussions about prohibiting or restricting its use. However, what is seldom discussed is its positive impact on workers.

Restricting repurchases may have unintended consequences for workers with equity compensation and pension plans. Traditionally thought of as a perk for executives, equity compensation plans are becoming more common. It is also well established that repurchases have become an effective way to offset dilution of both employee compensation and pension plans. Therefore, prohibiting or restricting repurchases may unintentionally harm the very workers many policymakers are hoping to help.

In addition, according to research by Professors Fried and Wang, almost “50% of total equity issuances are to firms’ own employees, with the vast majority (85%) of those shares going to nonexecutive employees.” These findings stand in stark contrast to the claims that executives predominantly gain from repurchases at the expense of workers. Excess capital that is reinvested in non-S&P 500 companies can be of a significant benefit to the 80% of the workforce that is employed at these other companies.

“50% of total equity issuances are to firms’ own employees, with the vast majority (85%) of those shares going to nonexecutive employees.”
Professors Jesse Fried and Charles Wang

In addition to the economic benefits that accrue to 80% of workers at non-S&P 500 companies, a 2018 Gallup Poll found that “50% of Americans are invested in the stock market, and 4 in 10 dollars invested in the stock market are held in retirement funds.” Those with defined contribution retirement accounts, such as 401(k)s, are not the only ones who benefit—workers’ pension plans benefit as well. This last point is worth stressing, given that many workers who are not invested in the market come to rely on their pension plan’s solvency at retirement.

Efficient Use of Capital

Many academics and economists consider repurchases to be an efficient and effective use of capital. Before enactment of the 1982 safe harbor provisions, excess capital was not always used efficaciously. As Professor Alex Edmans of the London Business School stated in opposing restrictions on repurchases, in the 1970s “CEOs simply wasted free cash on building empires … rather than paying it out.” Further, in reviewing academic research, the SEC staff found that repurchases can “alleviate concerns that managers will spend [excess] cash in sub-optimal ways.” The U.S. Chamber of Commerce recently cited substantial evidence that “some managers would use surplus cash for projects or acquisitions that were not in the best economic interest of the company.” As Warren Buffett, the longtime CEO of Berkshire Hathaway, has repeatedly stated, “Buybacks are better than most acquisitions” when done for the right reasons. In short, companies should not overspend or spend inefficiently on investments. Understanding the best use of excess capital is vital to effectively managing growth and long-term value for companies.

Capital For Other Investments

Repurchases also have a rather unique quality of facilitating business growth throughout the economy. Excess capital that goes to repurchases is disbursed to companies that need an infusion of capital.76 Understandably, much of the criticism of repurchases focuses on the implications to companies included in the S&P 500. However, those listed companies represent only 20% of the workforce and 50% of the profits. As Professors Jesse Fried and Charles Wang argue, to properly assess how repurchases by S&P 500 companies affect the broader economy, one must also factor how repurchases affect all companies. They say that criticisms focusing solely on the “payouts” of S&P 500 companies misunderstand capital flows between companies and their shareholders, and they also exaggerate the S&P 500’s role in the nation’s economy. In examining capital flows to non-S&P 500 companies, Fried and Wang found that those companies were “net importers of equity capital” and that they accounted for more than 10%, or more than $407 billion over 10 years, of excess capital from S&P 500 companies. Capital flows to smaller companies are not only important because of the high percentage of workers they support, but also because so much innovation happens in these types of companies. In addition to the innovation, these smaller companies account for the vast majority of jobs created and grow at a faster rate than larger companies.  Repurchases result in shareholders using the capital “to invest in smaller public and private firms, supporting innovation and job growth throughout the economy.”

Repurchases result in shareholders using the capital “to invest in smaller public and private firms, supporting innovation and job growth throughout the economy.”
Professors Jesse Fried and Charles Wang

In addition to supporting smaller companies, capital from repurchases was “reinvested in firms raising capital through IPOs and in nonpublic businesses backed by venture capital and private equity.” These companies are responsible for 70% of the U.S. workforce and almost 50% of profits; they also are leaders in job growth and critical innovation, including important discoveries in pharmaceuticals and information technology.

Furthermore, the influx of cash from sold shares after a repurchase allows investors to use those funds for goods and services in the broader economy. Moreover, the reinvested capital may well have a greater value than investment opportunities at the companies. According to Professor Craig Lewis’s findings, “The reallocation of capital into consumption and other investments potentially redirects it to activities that have higher value than incremental investments available to firms.” Further, using repurchases does not divert money away from community investments because “investors in general tend to invest in local companies.” As former Goldman Sachs CEO Lloyd Blankfein tweeted, the capital from the repurchases “gets reinvested in higher growth businesses that boost the economy and jobs.” Blankefein expressed frustration at the claims that repurchases divert money from investments. Companies, he said, used to be encouraged to redeploy excess capital in that way. As policymakers debate various proposals to prohibit or restrict repurchases, the positive effects of repurchases on a full set of beneficiaries should be an important part of that discussion.

VI. Conclusion

One of the biggest concerns in the increased use of repurchases is the impact on employees. It is understandable that policymakers focus on the perceived inequality, given that stock buybacks are seen in static terms as a vehicle that benefits only shareholders. However, employees also benefit from repurchases through the increased value of their retirement accounts, equity-based compensation plans, and a growing job market in other companies that use increased capital to expand. Beyond employees, repurchases provide multiple benefits to shareholders, including sustained increased share value, tax benefits, and protection against dilution.

The broader economy and society also benefit from repurchases through an influx of capital to smaller companies, which leads to job creation and facilitates innovation. Through this dynamic analysis, repurchases can have a positive impact on an individual beneficiary’s savings, investments, purchasing power, and job opportunities. The effects of capital redeployment can ultimately help numerous members of society, including employees, shareholders, retirees, local communities, and other growing businesses.

Although share repurchases may not always be the best option for an individual company, understanding their broader impact is vitally important. Unfortunately, when policymakers debate which stakeholders are more deserving of excess capital, they undermine the duty of management and boards to effectively operate their companies. Instead of focusing on individual stakeholders and the benefits they receive, policymakers should craft policies that recognize the importance of repurchases to society at large.