The controversial ethics of Stock Buybacks [Finance Fridays]
One of the biggest hopt-topics in the industry today
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What are stock buybacks? Why do companies perform stock buybacks? And why these buybacks so controversial? And why do the same companies that did massive stock buybacks also conduct massive layoffs?
Get ready, because today we will be some very spicy topics🌶🌶
If you give companies the rights of the person and the responsibility to make as much money as possible for their investors, then you have effectively created an institutional psychopath.
- A quote I came across recently. It will be very relevant for many of the posts to come.
The Economics of Stock Buybacks
What are stock buybacks- Stock buybacks are a very simple concept to understand. Imagine your company has a 100 shares in circulations. The company has made a lot of money and you would like to give yourself a bonus. But directly giving yourself money would increase your tax-bill. So, your company buys some stock from the public market and then makes them go away. This helps you in two ways- it increases the stock prices and it reduces the number of shares in circulation. The latter increases the value of each individual stock⬆⬆💹💹. Talk about a double whammy!!! Stock buybacks are becoming increasingly common over their alternative - dividens- because they are not taxed.
Who normally does stock buybacks- Stock buybacks only make sense for certain kinds of companies. Typically older, more established companies conduct buybacks. If a company has complete market dominance, and doesn’t have the resources to make any meaningful investments, then it will resort to buybacks as a way of rewarding their investors.
Why Stock buybacks necessary- Buybacks are good for several reasons, they are a show of strength and thus boost investor confidence. There is another reason that companies conduct buybacks. Many employees are given stock options as a part of their compensation (the so-called Golden Handcuffs). These shares are invented out of thin-air, reducing the value of existing shares (think of it like inflation for stocks). Buybacks are a way of combating this.
How management gets paid from buy backs- Typically CEOs, Upper Level Management and Senior Employees make more money from stock options than they from their base salaries. This might seem meaningless at first, but this changes the dynamic in one fundamental way- the incentives of these employees aligns closer with investors than it does with the normal employees of their firms. This is normally fine, but when times get tough, this difference becomes stark. 2-3 weeks ago, we covered how the CEO of Salesforce actually made money when he laid off over 7,000 employees from his firm. This is more common than you’d realize. A CEO/Upper Level manager is more likely to sign off on layoffs, cutting benefits, and other cost-cutting measures, because their compensation is largely untouched. The press might even increase the value of their shares.
Buybacks and Layoffs- The above point becomes even more apparent when we consider the recent situation. We have seen many profitable companies layoff thousands of employees. The excuse given has been overexpansion. Managers talk about how the recession has made cutting costs necessary. But here is something to consider- many of these companies also boughtback a lot of stock. Salesforce bought 1B worth of stock just before November, 2022, a 2 months before their layoffs.
Why commies hate stock buybacks- As should come as a surpise to noone, stock buybacks are controversial amongst certain segments of the population. It’s easy to dismiss them as Capitalist haters. But companies like Delta airlines spent 11 Billion USD on stock buybacks. This is fine by itself, but when the pandemic hit, Delta had no cash reserves to survive, and took billions of dollars in bail out money from the government. They were not the only ones. Many big companies use all their profit in buying their shares, and then use the government to bail them out when times are tough. The execs at these companies profit during the good times, and the negative consequences at faced by the ordinary employees like us.
Many people have called for a ban of stock buybacks. They say that excess profits should also be shared amongst the employees, since they created the value in the first place. My personal opinion- I don’t think that buybacks themselves are inherently evil. Investors do take a risk when they invest, so I’m not against compensating them. However, buybacks are currently abused by companies that are ‘too big to fail’ and this needs to be fixed. And obviously, a company using some of the excess profits as a safety net for it and it’s employees would be a welcome change. What do you think about stock buybacks? Let me know.
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