The Virtues of Stock Buybacks

They’re good for just about everyone, including employees and shareholders as well as overpaid CEOs

By Jesse M. Fried and Charles C.Y. Wang. Mr. Fried is a professor at Harvard Law School. Mr. Wang is an associate professor at Harvard Business School. Excerpts:

"The critics argue that buybacks are driven by greedy executives and starve firms of capital for investment."

"These critics ignore equity issuances to shareholders, which move cash in the other direction. Across the market, firms recover from shareholders, directly or indirectly, most of the capital distributed by repurchases. Taking into account equity issuances, net shareholder payouts in public firms during 2012-21 were only about $4.4 trillion. By our calculations, this left public companies with approximately $10 trillion for investment, not counting proceeds from debt financing. 

Much of this money, our research shows, is in fact plowed into investment. Overall investment levels, as measured by capital expenditures and R&D, reached historical record highs in six of the last 10 years, totaling $12 trillion during 2012-21. Investment intensity at these firms, measured by the ratio of investment to revenue, has also been rising over the past 10 years and is now near two-decade highs.

At the same time, firms are piling up cash. During 2012-21, cash balances rose by 78%, reaching around $8 trillion and thus leaving firms with ample resources for additional expenditure. There is no evidence that dividends and repurchases are starving firms of capital. If anything, public companies are sitting on too much cash.

A tax on buybacks will harm shareholders. It creates an incentive for managers to hoard cash, leading to even more corporate bloat and underused stockholder capital. Because CEO pay is tied closely to a firm’s size, this bloating will drive up executive compensation, further hurting investors.

Buyback critics may argue that companies could simply switch from repurchases to dividends. But executives will be reluctant to make this switch, partly because dividends (unlike repurchases) reduce the value of their stock options. When buybacks are taxed, overall shareholder payouts will decline."

"most repurchased shares either go to employees, who later sell to investors, or are acquired to reduce equity dilution after employees have sold stock. This repurchase-issuance cycle moves cash to employees and is cash-neutral for shareholders. Our research shows that 85% of this value flows to employees below the top executive level. Increasing the tax burden will tend to lower equity pay, to the detriment of workers."

"The cash from shareholder payouts by public companies often flows to private ones, such as those backed by venture capital or private equity. These private firms account for half of nonresidential fixed investment, employ almost 70% of U.S. workers, are responsible for nearly half of business profit, and have been important generators of innovation and job growth."