Stop share buybacks! This makes no sense... Kroger example - Thank you Mr Reich.

Robert Reich, a noted public figure who was former Labor Secretary under Clinton, is a frequent commentator on various media outlets, and currently professor at UC Berkeley, highlighted the following story:

Normally I am a bit skeptical with many of Mr Reich's views on policy and the role of government rules/regulations and capitalism in the various ills that plague the US, but on this one I couldn't agree more. This is his take on the situation:

"Friends, stock buybacks don’t create more or better jobs. They don’t build a company. They don’t grow the American economy. Stock buybacks serve one purpose: enriching shareholders and executives. Kroger made billions thanks to the hard work of its frontline employees, and instead of rewarding them, it's rewarding the executives who got to safely work from home. Remember: Stock buybacks were illegal until the Reagan administration legalized them in 1982 — around the same time most Americans' wages started to become stagnant. Congress should make buybacks illegal again, and pass the PRO Act so giant corporations like Kroger can't keep exploiting their workers in the name of share value."

For those that don't follow how corporate America operates, here is a simplified recap of the situation. Companies try to make money by selling goods and services. If they achieve that goal, they normally have 3 options on how to deploy those profits:

1. Share Buybacks
2. Dividends
3. Re-investment in the business (including acquisitions)

I often ask my students in class to rank order how they believe corporations redeploy their profits. Where do you think the majority of the income goes? I'll give you a few seconds to think about that. While you do this, let me tell you that my students tend to think that  option 3 leads the pack, with an equal distribution between 1 and 2 for the remaining votes.  You?

Well according to the Harvard Business Review, this is how it goes: "The 465 companies in the S&P 500 Index in January 2019 that were publicly listed between 2009 and 2018 spent, over that decade, $4.3 trillion on buybacks, equal to 52% of net income, and another $3.3 trillion on dividends, an additional 39% of net income." So option 1 takes in more than 1/2 of the profits, and re-investment in the business rakes in less than 10% of the net income! Crazy no?

Although I would tend to think that company management should know best as to how to spend their net income, and after all is is the money that their companies generated so they should be free to operate according to their own free will (in the bounds of legality of course), in this case, the capital allocation decision of corporations affect taxpayers like you and me. 

Let's take the recent example of the catastrophic economic consequences brought on by the Covid pandemic and shutdowns. Many corporations received bailouts as their business opportunities plummeted to zero. Let's take the example of airlines. According to Forbes: "In 2019, American Airlines spent $1.1 billion on buybacks, at an average cost of $32.09, according to company disclosures. In fact, from July 2014 to December 2019, American Airlines spent $12.4 billion on stock buybacks at an average weighted cost per share of $39.76, according to disclosures." 

Although it's hard to know exactly how much money has been disbursed to airlines in the various stimulus packages passed by the Trump and Biden Administrations, what is clear is that $25 billion was allocated in the spring of 2020, another $15-25 bil in December 2020 and possibly more this year. Of course it's not fair to blame the lack of business on the airlines themselves, but what can be pinned on them is the fact that their cash positions were depleted to such an extend primarily due to the fact that they had spend so much on share repurchases. Had they not done so, they very well might have ended up spending the money elsewhere, but they also may have kept it in treasury. That would have allowed them to survive the shock without asking for government bailouts. Companies such as Apple, Microsoft, Google and others sit on large cash balances as they reap in enormous profits and do not go out and spend it all on acquisitions or share repurchases (or dividends).

After the 2008 financial crisis, financial institutions were required to maintain larger reserves than before then. A similar requirement can be had for corporates and how much cash they might need to maintain on their balance sheets relative to how much they spend on share repurchases. I will leave the political argument to brighter minds such as Robert Reich, but seriously think that he is onto something here...

Go get them Robert!