The controversy around share buybacks

This is an audio transcript of the Behind the Money podcast episode: ‘The controversy around share buybacks’

Michela Tindera
There’s a certain topic in financial circles that no matter who you are, everyone seems to have an opinion on it.

Brooke Masters
Share buybacks are one of the single most controversial issues in corporate governance.

Michela Tindera
That’s Brooke Masters. She’s the FT’s US financial editor, and she’s talking about the practice of what’s called share or stock buybacks. They’re a way for companies to return excess cash to their shareholders. And in recent years, they’ve exploded in popularity.

Brooke Masters
To give you a sense of this trend that in 2012 there were $463bn of share buybacks globally. That’s all companies around the world. Last year that had gone to 1.3tn. So it really is just about tripled in a decade.

Michela Tindera
And as they’ve grown more popular, the argument around how beneficial they are has grown too.

Brooke Masters
The main debate over share buybacks is whether they are a good use of corporate money because they get the money back to the investors who ultimately own it. Or are they robbing future growth in order to feed greedy investors now?

Michela Tindera
It’s a debate between investors who are focused on the long term versus investors focused on short-term gains, which opens that discussion to something even bigger.

Brooke Masters
I mean, it is the debate over the nature of capitalism. Like, what is the point of a company? Is the company’s point to get as much cash to the people who own it now, or is it to help grow society? And is it in the interest of the company’s investors to actually do that?

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Michela Tindera
I’m Michela Tindera from the Financial Times. Share buybacks are a growing practice among publicly traded corporations. On today’s episode of Behind the Money, we’re looking at how they’ve become so controversial and whether that’s ever going to change.

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Hi, Brooke. Welcome to the show.

Brooke Masters
Thanks for having me.

Michela Tindera
So before we get too in-the-weeds here with our discussion, I want to make sure everyone understands what it means when a company buys back its shares. Can you explain how it works?

Brooke Masters
Basically, what happens is a company has a certain amount of shares that are out in the public market owned by people. If the company has extra cash, it can buy its own shares. And the idea is by reducing the overall share count, each share ends up owning a little bit more of the company, so it’s worth a little bit more. So it ought to boost the share price. And so that’s good for investors.

Michela Tindera
So what’s the history of share buybacks? Where do they come from?

Brooke Masters
Share buybacks have been around for a very long time and they have been used for decades as a way of getting money back to investors. To put this in context, pre-1990s, when buybacks first started and before they really took off, companies tended to go out and buy in other companies and you’d see the creation of conglomerates where, you know, companies would say, oh, well, we make cars, but let’s also make something else. We’ll make aeroplanes too.

Michela Tindera
And candy bars.

Brooke Masters
Yeah. And that was because companies didn’t know what to do with their cash. So they went and bought more stuff. These days, there’s not a lot of interest in conglomerates because the theory is, unless you’re Warren Buffett, most people who are good at, you know, running a car company are probably not great at running a television company. And so there is an interest in give us the money back. So you can see the push towards buybacks as partly investors saying we want the power to select who we invest in rather than letting you, corporate manager, go out and pick what company you can get your hands on.

Michela Tindera
Yeah. So you’re saying buybacks have come out of a sort of reaction to that conglomerate era of business. But buybacks haven’t been the only way to return company’s excess cash to shareholders over the years, right?

Brooke Masters
Share buybacks are fundamentally an alternative to dividends. They’re kind of two ways you can return money to your investors. Historically, most companies tended to prefer to use dividends because that’s really simple. You, you know, you have extra cash, you hand over the cash to the investors and it provides a steady stream of income.

Michela Tindera
So then what made buybacks so popular recently? As you said, this trend has just absolutely shot up over the last decade.

Brooke Masters
While interest rates were low, it made buybacks especially attractive because companies could borrow money by selling bonds and use that cash to pay for buybacks and know that their interest rate costs were gonna be really quite low. And another thing is the rise of activist investors who take a stake in a company and demand changes that they think will boost the share price. For them, buybacks are a quick solution because they are intended to boost the share price and they happen quite quickly so they can get returns quite fast.

Michela Tindera
Mmm. So essentially, some companies were using debt to buy their own shares when interest rates were low and debt was cheap. And then there’s been the activist investors demanding quick changes. So why else have buybacks become so much more prevalent?

Brooke Masters
The other thing that’s happened over the last 10 years is there have been a number of hugely profitable, particularly tech companies, Big Tech, that generate enormous amounts of cash flow, and many of them have more cash than they really know what to do with. And so that has led to them looking for ways to get money back to their investors. There were especially large jumps in 2021 and 2022 because lots of companies, as we came out of that first Covid, you know, decrease, suddenly had more revenue than they were expecting. They had all hunkered down, expecting horrifying things to happen. And suddenly the economy was not as bad as they thought it was. So a lot of them turned to share buybacks.

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Michela Tindera
OK. So there are a lot of reasons that companies have wanted to issue share buybacks recently. What with low interest rates for a long time, and as you said, the proliferation of these massive tech giants who’ve had all this extra cash to blow. But as you also said, this practice is pretty controversial. So what are the key arguments from critics about why share buybacks are not a good idea?

Brooke Masters
The basic argument is that that’s a bad use of the money, that a company should be using its extra cash to invest in its people, in its products, in its capital stock, in order to fund future growth and, you know, keep the company healthy. And there’s also concern when companies take on debt or they spend down all of their cash on share buybacks, that they have no resilience.

Michela Tindera
Mmm. And what do you mean by that?

Brooke Masters
A bunch of companies got into huge criticism in 2020 when at the beginning of Covid, all the travel companies in particular were in deep trouble. You know, their business went to hell. And they all asked for government rescues and they needed help. And people pointed out, like, Hilton, Boeing, Southwest Airlines had all done massive share buybacks in the last six months. So there was not a lot of sympathy for these companies. Like, you spent the cash that you should have kept as a rainy-day fund. And that’s clearly not thoughtful or responsible management.

Michela Tindera
Yeah, I definitely remember those companies getting all that flak a few years ago. But what about this idea around funding these share buybacks with debt? I mean, can that get a bit risky?

Brooke Masters
General Electric is famous for having used enormous amounts of buybacks and actually gotten itself into trouble doing that. GE, between 2012 and 2017, spent like $32bn to buy back shares, which made them look great for a while. But it also meant that they had, of course, taken on debt in order to do this. So, you know, they were taking advantage of the low interest rates. But then when things turned, they had to pay back that debt. And they also probably didn’t invest very effectively in growth. And so they got into a huge hole. And a lot of people blame share buybacks for one of the reasons GE is no longer the great, enormous company it once was.

Michela Tindera
Yeah. So something to think about with these examples you’ve mentioned. There’s the travel companies and General Electric. There’s sort of two sides here, right? I mean, investors focused on short-term gains versus the ones who are focused on the long-term gains.

Brooke Masters
There’s a huge number of shareholders who are in it for the long term. You know, they’re an index fund. They are, you know, small investors who buy a company and want to stay in it and they want it to grow. And for them, buybacks sort of tinker with the price in the short term. What they want is growth in five years and those people don’t get a lot out of share buybacks. Activist investors and hedge funds have an interest in short-term growth. You know, they buy into a company and they need to show results quickly. And so for them, a buyback is great. And so it is fundamentally, I think the debate over share buybacks is partly how much of the profits of a company should be going to investors versus to its workers and to its community. And people who think that not enough of corporate profits are going to workers hate share buybacks because that’s a clear, straight cash out the door that could be used for people and for, you know, investing in more jobs and communities.

Michela Tindera
Right. Because often the workers are not necessarily the shareholders.

Brooke Masters
Right. Exactly. You know, the workers aren’t necessarily the shareholders. And also, you know, if a company is spending every last dime on buybacks, it just has a lot less room to offer better benefits and to offer better pay. And there’s certainly a point of view, and I have some real sympathy for this, that a happy workforce is a better workforce and the company is in the long term going to prosper if you pay people properly. And so, you know, that last dollar spent on buybacks might better be used at paying staff more.

Michela Tindera
So is there ever a time where you think buybacks would be a smart decision?

Brooke Masters
You know, if you’re Apple and you are sitting on the world’s largest cash pile, giving some of it back to your investors makes a lot of sense because you are also investing in the next iPhone and you are investing in AI and you’re investing in fabulous new services and streaming. So like Apple, it’s really hard to say Apple shouldn’t do share buybacks. They pay their people pretty well. They do great products. They clearly have a future.

Michela Tindera
Is there any data out there for whether buybacks are smart decisions or not? What have you found in your reporting on that?

Brooke Masters
There’s a ton of studies which have entirely contradictory results where people find what they want to find. I think probably that’s because in the right situations, buybacks make sense. And in the wrong situations, they’re a terrible idea. And so the truth is, it’s one of those things, like, all things in moderation. In terms of specific studies, there was a study a while back of American companies that found that, like, a third of the companies that were doing buybacks, if they had not done the buyback, they would have missed their earnings per share guidance, which would have sent the share price down. You know, there’s a sense that, like, there’s a group of them who are using share buybacks to hit targets as opposed to you’re supposed to hit earnings per share targets by growing profits. And that’s not what they did. The UK did a study relatively recently as well and did not find that link. And maybe that’s because UK companies are better. Maybe the study just wasn’t very good. It’s unclear. I mean, as I say, the evidence is very conflicted, I think, because this issue is not a black-and-white issue.

Michela Tindera
So more recently in the US, there’s been some new laws and proposed changes to regulations around share buybacks. What happened there?

Brooke Masters
Progressive Democrats have long thought share buybacks have gone too far and that companies were using them to funnel cash to short-term investors at the expense particularly of workers. And they, as part of the Inflation Reduction Act, got a provision that basically puts a 1 per cent tax on all the money you spend on share buybacks. It’s not really enough to stop anyone from doing share buybacks, but it makes them slightly less attractive. The other thing that’s happened, which I think is really interesting, is the Securities and Exchange Commission, which is on a very activist tear and regulating lots of things, they just passed — over the objections of the US Chamber of Commerce, the big business lobby group, and lots of other people — a bunch of new rules about buybacks.

Michela Tindera
What do those say?

Brooke Masters
Basically, what they say is US companies are gonna have to disclose a lot more information about share buybacks. Specifically, they will every quarter have to say not just that we did a bunch of buybacks, but we paid this amount on this day for this many shares, every day, retrospectively. They will also have to say, why are we doing this? There will be a narrative required like we did these share buybacks because we didn’t have anything else to spend the money on. And so they will be on the record saying we are unable to find anything to invest in, which will again give shareholders a chance to critique the decision. And the third thing they’re gonna do is require insiders, people who work for the company, who buy and sell shares, right before a buyback is announced. It’s gonna require them to disclose that they did it.

Michela Tindera
OK. And why do that?

Brooke Masters
Because there is a conspiracy theory, which may in fact have some truth to it, that corporate executives buy shares right before a buyback is announced so that they get the pop. Because when you announce a buyback, usually the share price goes up. So if, say, the shares are trading at $100 and you announce we’re gonna do a buyback, they might rise to 105. So if you’re a corporate executive and you know, you know you’re about to announce this, you could, in theory, ride that little, get that little bump.

Michela Tindera
And when does this go into effect?

Brooke Masters
It takes effect October 1, which means we’ll start seeing the data with fourth-quarter results, which get announced in early January.

Michela Tindera
What do you think of these new regulations?

Brooke Masters
Look, I’m always in favour of disclosure if it’s not gonna hurt anybody. And I know the companies claim it’s gonna be really expensive, but they have to track this stuff anyway. It’s not that hard to fill out a form. So I’m in favour of the disclosure. I think it will allow us perhaps to answer the debate by letting people zero in on which companies are doing a good job of share buybacks and which ones aren’t. And if there’s more data, it’s gonna be a lot easier to figure out who’s in what camp and why.

Michela Tindera
So very recently, just as of this latest quarter, it seems like there have been less share buybacks happening. So can you tell me what’s happened in the latest earnings season? What have we seen and what does that mean?

Brooke Masters
Intriguingly, in the last quarter, net share repurchases, which is total buybacks, have dropped 36 per cent year on year. So (inaudible) that’s a big chunky drop and that’s just in one quarter. And planned announced buybacks, which for the rest of the year are down about 15 per cent. And there are a couple of reasons for why there’s suddenly been a plunge. One is that oil prices are no longer rising, so the energy companies no longer have enormous amounts of extra cash. So that was, that’s one clear reason. Rising interest rates means that you could no longer take out loans to do buybacks and then not have to pay interest on it. You know, if you’re paying 5 per cent on a loan, it no longer seems like such a great deal to your investors if you’re borrowing money to give share buybacks. So that has definitely cut down on companies doing it. And the third thing is that the whole ChatGPT AI revolution means that the tech companies, which had more cash than they knew what to do with, suddenly have something real to invest in. And so lots of companies are investing more money in future products. And it makes sense. I mean, the whole point of share buybacks is you give money back to investors when you don’t have a better use for it. If you have a better use for it, you should be investing it, assuming you want your company to live into the next, you know, generation.

Michela Tindera
So do you think people will ever stop bickering over share buybacks?

Brooke Masters
Probably not. I mean, there is a fundamental disagreement in corporate culture and in the way people look at what companies should be doing. Whether it’s always shareholder primacy, like the most important thing you should do is give cash to your shareholders whenever possible, or whether companies are better off investing in their people, in their communities and in long-term growth. And I mean that debate, that’s the nature of capitalism. My view is you can’t just say generically share buybacks are good or bad. Some companies do them for the right reasons and some companies do them for the wrong reasons, and some companies do them well and some companies do them badly.

Michela Tindera
Well, Brooke, thanks for coming on the show.

Brooke Masters
Thanks for having me.

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Michela Tindera
Thanks for listening. If you want to read more from the FT on what we talked about during this week’s episode, the articles linked in our show notes are free to read right now. And a quick correction: Last week we ran an episode about the UAE and the global oil trade. In the intro, we said that the city of Fujairah is roughly an hour’s drive west from Dubai. But that was incorrect. Fujairah is located east of Dubai, not west.

Behind the Money is hosted by me, Michela Tindera. Saffeya Ahmed is our producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. See you next week.

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