Are stock buybacks too high?

Edward Luce writes in The Financial Times:

According to William Lazonick, a scholar at the University of Massachusetts Lowell, seven of the top 10 largest share repurchasers spent more on buybacks and dividends than their entire net income between 2003 and 2012. In the case of Hewlett-Packard, which spent $73bn, it was almost double its profits. For ExxonMobil, which came top with $287bn in buybacks and dividends, it amounted to 83 per cent of net income. Others, such as Microsoft (125 per cent), Cisco (121 per cent) and Intel (109 per cent) were even more extravagant. In total, the top 449 companies in the S&P 500 spent $2.4tn – or more than half their profits – on buybacks in those years. They spent almost the same again in dividend payouts. Taken together, they came to 91 per cent of net income.

There is more here.  I would read the data this way: the rents earned by those companies stem from their preexisting intellectual property, rather than from their current managerial talents.


This has been said before. Also the corporations are drawing down their stock so they can water it again with options for employees, as is well known. Most public corporations are rip-offs of shareholders, especially the Asian ones (China, Japan, Korea in that order).

I thought that too, happy to see that somebody else shares this view. Actually econ college convinced me for a short while that one should buy emerging market stocks 'cause capital is best used in China. I then lost money on some Asia ETF. The econ professors' idea may be right but it doesn't take into account that the most sophisticated scammers can often be found at the stock exchange.

I always thought of buybacks as a way of retaking control over the company (by clawing back shares) while paying off shareholders in the process. It's helpful down the line if you have to make difficult decisions or decide to defer paying out dividends versus reinvesting earnings back into the firm. Now is especially a good time to do that, since borrowing money is so incredibly cheap.

They aren't borrowing for 30-years. If interest rates go up, the debt used to buyback shares will cut into earnings.

There's nothing inherently wrong with buybacks (they're generally a good thing) or using debt to buy stock. But the time to do it is in 2008, not 2014. Now is the time to be issuing stock, as those Asian tycoons understand. Sell high, buy back low. American managers do the exact opposite.

Yeah, but if you issue new stock you need to know something good to do with the money. That's the big problem.

What's Microsoft going to make? Another Windows version?

Yea, i think thats the real message here. Companies cant think of where else to put their money, so they do buy backs. There are worse decisions to make.

Or, God forbid, they could pay dividends to their actual owners.

They do buybacks as a way of compensating their most loyal shareholders in a more tax efficient manner than dividends.

@asdf -- that story makes a lot of sense. Do buy-backers ever state this explicitly (e.g., in their annual reports)?

I don't know, I try to avoid reading annual reports! But it is pretty obvious that if you were going to reinvest the dividends, stock buybacks are far more tax efficient.

There are certainly some big companies borrowing long-term.

And long-term rates were actually quite a bit higher in 2008. They bottomed out in 2012, rose last year, and have declined again this year. All in all, not a bad time to borrow long.

Agree completely. The market is overpriced right now. It's the time to sell stock, not buy it.

But the time to do it is in 2008, not 2014.

That is why i prefer steady growing dividends to stock buy backs even though stock buy backs are better from for taxes. Management sometimes buys back at the wrong time..


'the rents earned by those companies stem from their preexisting intellectual property'

Yep, ExxonMobil is all about intellectual property.

Pre-existing real property? Pre-existing contracts? Pre-existing assets? Pre-existing pollution rights? Pre-existing fully depreciation paid off plants?

In any case, running a refinery or an oil rig is not all that easy. Not everything is captured by patents. There's a lot of internal informal know how.

ExxonMobil is about oil, of course. And this excerpt might explain the stock buybacks too -

'Exxon Mobil also benefited from higher oil prices in the quarter, both in the U.S. and abroad. In the U.S., Exxon Mobil sold oil for an average of $98.55 per barrel, up from $93.18 per barrel in last year's second quarter. Outside of the U.S., oil sold for $103.72, up from $101.54 last year.

But the asset sale and higher oil prices masked a continuing decline in oil and gas production at Exxon Mobil. Production fell to 3.84 million barrels of oil and gas per day from 4.15 million barrels last year. The decline was driven by the expiration of rights to a field in Abu Dhabi, low natural gas demand in Europe, and natural field declines.

Exxon Mobil's production has been steadily shrinking, and it is a continuing concern for investors.'

Admittedly, if one considers lease rights 'intellectual property,' then ExxonMobil owns considerable IP. But then, so would any resource extraction company.

XOM has lots of IP, mostly in the form of 3D models of potential oil reserves. Trade secret not patent.

Trivial: XOM used to have hq in N. VA before moving to Houston.

No, Exxon had its HQ in NYC before moving to Irving, near Dallas (not Houston).

The Exxon-Mobil merger took place after Exxon had moved to Irving, so XOM has never had an HQ anywhere but Irving.

Pre-merger, Mobil used to be in Fairfax, XOM now uses that property for downstream.

Buybacks are a way to raise the share price. Capital gains generate less tax for shareholders than dividends. Is it a puzzle that buybacks might exceed net income in a given year? I don't think it's that uncommon. When they occur, buybacks tend to be large because fixed transaction costs are high.

Buybacks are a tax efficient way to return surplus capital. But the real question is why is the capital being returned and not invested. The FT article somehow makes out that the cause is rent seeking (or the favorite of leftists - short term thinking) by management. But wouldn't rent seekers want to hold onto capital instead of returning it to the investors?

There is something in Tyler's comment about the companies on this list having earnings being the result more of previous one-off success factors. Microsoft could only invent one dominant operating system for instance. But I don't think it is the case with the other companies on the list, Intel for instance or Exxon Mobil. They have a pipeline of potential future investments. The problem they have is one of inflated expectations for their investors due to their previous successes. So Exxon can't just invest in regular projects that exceed their cost of capital, their investments have to be super-profitable to avoid unflattering comparisons with previous ones, with detrimental. So they finding only a few opportunities that meet their standards compared with their cash flow. Whether or not this is a bad thing is questionable. There is nothing to stop investors taking their returned money and re-investing it into companies that will invest it. Indeed you can argue this is exactly what is happening with the shale industry. Money is being taken out of big oil and invested in smaller independents. Many people are arguing that instead of under-investing the shale companies are over -investing. The truth is that we don't know at this stage, and the good thing is the investors are volunteers so we don't need to interfere.

...'their investments have to be super-profitable to avoid unflattering comparisons with previous ones, with detrimental..."

This is a very good point.
If Cash is high and new Project returns are lower than what the company wants, don't Share buybacks make good sense , even if they are higher than current Profits.The higher EPS, combined with the lower floating stock , probably increases then Capitalisation of the company.
And the market keeps going up , even though the economy and employment are flat.So with the share buyback you are trying to tell the general investing public " Lower your expectations , we don't have anything very attractive to do.." and you end up sending the opposite message with the Market reaching new highs.
C'est la vie, plus ca change.

I think the loudest message in a buyback is "We've more money than we could profitably use"

As an aside, how does it compare to returning said excess money via large dividends?

The message is very similar to the company that hikes dividends, but people ascribe all manner of nefariousness to stock buy backs.

I'm trying to imagine if Tyler thinks a post titled "Are stock dividends too high?" would be received similarly.

"As an aside, how does it compare to returning said excess money via large dividends?

It's similar, but US tax structure makes share buy backs more attractive. An investor doesn't pay taxes on the gain from a share buy back until he wants to, whereas a dividend will be taxed that year.

A buyback is basically a dividend.

Not true for US shareholders. Long term capital gains are essentially subject to the same federal tax rates as qualified dividends. At the margin, that's 20 percent plus any Medicare surcharge. (Short term capital gains are subject to the higher, ordinary, tax rates). It might be true for non-US shareholders (subject generally to 15 percent US withholding tax on dividends, plus possible home country tax) but I doubt that is what is driving the decision.

Ray Lopez, the first commenter, got it essentially right, but his chronology may be confusing. Stock repurchases increase the share price. Dividends reduce it. Those employees with *existing* (not future) stock options benefit from share buybacks much more than dividend payouts. But, when stock options are exercised, a company must issue shares to the person exercising it. Those shares can consist of newly issued shares or shares purchased on the open market. In order to figure out what, exactly, is going on, one needs to look not merely at share repurchases, but *net repurchases* to account for this activity. That said, in general, I would say, somewhat contrary to Cowen, that share buybacks are a reflection of very adept corporate management---management at increasing returns for themselves and their employees.

Warren Buffett has written often about share repurchases. He says that two conditions must exist to justify them: 1) stock is trading at below its intrinsic value (insiders know better than the market?); and 2) the company has adequate cash and can borrow easily. Low interest rates may explain some of this. But, more recently, he's stated that too many are done merely to drive up the stock price in the short term and, as usual, he's likely right.

I would add to the above that share buybacks may be tax efficient for *some* shareholders but not for the *average* shareholder. The tax advantage of share repurchases might be that they allow shareholders to choose, by either selling or holding, whether to incur that tax currently. But, as stated above, it is not an issue of tax rates.

The qualified dividend is treated as if the investor had a basis of zero. An investor who returns to the pre-buyback ownership rate only pays taxes on the gain.

Yes, but I don't think that this is a good way to look at it. The better way to evaluate it is that if the effect of $1 share buyback is to increase the share price by $1 (ratably), then that increases the capital gain or reduces the capital loss (depending on individual basis) by $1 (losses are also deductible, against gains and then up to $3,000 against ordinary income, the rest carried forward). It is true that by increasing the share price rather than giving everyone a dividend, individual shareholders have more *individual* choice in tax planning (i.e. timing gains and losses); but, that was covered by my comment earlier.

A small point- there is value in being able to defer tax incidence and enjoy "inside build up" via stock buybacks as compared with dividend payments, even under uniform tax rates.

Compare two 10-year investments in stocks that earns 8% per year. If 2% is distributed in dividends annually that are reinvested, post-tax assets after 10 years are 1.7% lower than if no dividends are paid and the stock is sold at the end of 10 years, assuming both dividends and capital gains are taxed at 20%.

Over 30 years, the difference in post-tax assets is 51%.

Yes, that's true. It is part of the value of allowing shareholders to time their own taxation events by deciding when to sell. It has nothing to do with rates, per se. This is particularly true if one is able to be wedded to those shares until death ("until death do us part"). No income tax at all.

That said, I doubt that it has much, if any, bearing at all on a company's decision to buyback shares or pay dividends.

But stock buybacks may be tax-efficient for the company.

If the company issues long-term debt and uses the cash raised to buy-back shares, they get a tax deduction for the interest expense going forward.

This is in addition to any price pop in the short-term, and the lower dilution of EPS in the longer-term.

Modigliani and Miller says that companies should be maximally levered so long as debt is tax-advantaged.

There is also the broader issue of supply and demand of equities as an investment vehicle. Stock repurchases reduce the supply of equities in the capital market. We know from econ 101 that given normal supply and demand curves this will increase the price of equities generally (not just the price of the particular stock that was repurchased). Stock repurchases are bullish.

Stock repurchases might be bullish (because insiders think their stock is undervalued, maybe); but, I'm trying to get my head around your supply and demand argument. Based on the logic presented here, it seems that if every company on the market did a reverse 1 for 2 stock split, that would be extremely bullish. Less supply! Equal or greater demand for fewer shares! Supply would be halved overnight! And, doing a two-for-one split would be very bearish. "Supply" would be doubled overnight!.

Suppose a company bought back one-half of their stock and then did a 3 for 1 stock split. Would that be bullish or bearish from your Econ 101 supply/demand analysis?

Let's assume that all of a company's shares are traded on a public market and there are 100 of those shares. The company buys back 50 of those shares. Sure, there are now 50 shares publicly traded *but, the entire supply of the company's shares representing all the ownership of that company remains on the market*. Nothing in that respect has changed except those fewer shares are (perhaps) in fewer hands. I'm not convinced that the effect (if any) on the overall market is a supply/demand issue rather than a sentiment issue.

With your examples of splits - you're not changing the supply at price - ie market cap. With buybacks you are. There's a big difference. Scott H is spot on here for this bit - and this is reflected in higher EPS results after buybacks. This is all assuming that management doesn't issue a bunch of new stock to exes - which is why I'm so skeptical of buybacks.

You can make various arguments about the accessibility of shares after splits - see AAPL for example - but that's a different beast.

"...this is reflected in higher EPS results after buybacks".

That has nothing to do with "supply".

Sure it does - I could have put in the "all things being equal" caveat - but didn't think it was needed.

If you reduce the amount of shares (the supply) and earnings are higher, steady or even slightly lower, the EPS is higher than under the prior share issuance. Basic math and a great way to show EPS growth even when revenues are flat. This is part of the attraction of buybacks.


1. The assertion was made that stock buybacks increase the prices of *all stocks*, not just those that are the subject of the buyback and the former because of reduced "supply";

2. The reason the price goes up on the stock that is the subject of the buyback is not due to reduced "supply"; it is due to the increased EPS per share. The latter is an altogether different story. This is demonstrated by my reverse split example (many companies actually do this in the belief that increasing the "supply" of shares will *increase* company value because it will make those shares more accessible.) Simply reducing the number of shares does not, *in and of itself*, increase the valuation of a company's shares in the aggregate, much less that of the entire stock market.


1 - "generally" - and yes - I would agree with Scott's assertion. Fewer shares of stocks = less supply for those wishing to own.

2 - for EPS purposes, stock splits are generally considered binary events - and thus EPS' are changed to reflect the nature of the beast. Stock buybacks however, are different animals due to their ongoing nature and reduction of shares at price. Fewer shares, AEBE, = higher eps = higher value/prices.

Thanks cheesetrader. At the risk of screwing up the reply I'm going to add a bit more. So, Vivian, think of it this way. First, total market value available is not the same concept as supply. Supply is availability at a certain price. Supply is definitely changing here, and it's changing beyond just the price implied by increased EPS -- especially in environments that contain high quantities of stock repurchases. The price of a stock can fluctuate based on increased EPS or it can increase based on an increased P/E ratio. The P/E ratio of the market portfolio of stocks is determined by demand for stocks versus supply of stocks. When companies like Apple repurchase $100B of stock (for example) they are increasing the demand for Apple stocks and all stocks. Once that repurchase demand is met there is decreased supply, ceteris paribus, for all other subsequent stock demand.

Just imagine any normal market. Take a large quantity of cash and purchase that market's assets. What's going to happen? Stock repurchases aren't just increasing EPS here. They are also changing the overall demand for stocks.

This drives me especially crazy in my own industry (pharma research). For a business that depends so much (or should) on R&D, share buybacks seem to take money that could be used to do more research and give it to the shareholders instead. I might be happier as a shareholder myself to think that the company I'm invested in has enough ideas to keep itself occupied, but I seem to be in a minority. More here:

I'd rather know that the company I'm invested in has run out of ideas (perhaps temporarily) than think it has enough ideas when it really does not.

More realistically, they haven't run out of ideas but have more cash on hand than ideas worth pumping it into.

They are getting money in the hands of consumers to stimulate the economy. Its what good corporate citizens do when there is inadequate AD.

Yes, it is quite funny that I remember a story in the FT a year or so ago comparing Google, Apple, etc. to Scrooge ("hoarders") for sitting on all this cash and not investing it or using it to pay off investors. I wonder how much buybacks are related to the buildup in cash holdings that were idling and the companies just gave up on finding something good to invest it in.

First, firms don't "spend" capital on buybacks and dividends; they *return* capital. Second, Modigliani-Miller says that dividend policy (and buyback policy) don't matter in the absence of taxes. Wouldn't that suggest that to understand dividends and buybacks, we should first try to understand the impact of tax laws, changes in tax laws, and potential future changes in tax laws? The last paragraph of the cited article mentions that Apple bought back shares and issued debt, i.e., shifted from equity to debt financing. Is that consistent or inconsistent with high corporate tax rates and low interest rates?

I would modify Tyler's last sentence to recognize that "managerial talents" includes financial engineering talent.

Just to expound: operational decisions, like managing and deciding what projects to invest in, are separate from financial decisions, deciding how to carve up projects' cash flows to accomodate investors' timing and risk preferences. Dividends, buybacks, issuing equity, and issuing and retiring debt are all financial decisions. Modigliani-Miller implies that, under ideal conditions, firms never need to consider financial factors (investors' timing and risk preferences) because investors can accomodate those themselves by trading in financial markets. When those ideal conditions don't hold, then firms may have to consider financial factors, but it doesn't (necessarily) mean that firms' *financial* decisions reflect *operational* factors.

For example, when Apple buys back shares and issues debt, Apple is increasing shareholders' leverage out of an apparent belief that Apple can more efficiently increase leverage than individual shareholders can in their own portfolios. That's not a reflection of operational factors like how much rent Apple earns from pre-existing intellectual property vs. new projects. Operational factors may be reflected in firms' decisions to change total D+E, but not in the mix of D relative to E. Looking at dividends and buybacks in isolation, which decrease E, doesn't tell us what is happening to D+E, and it's especially uninformative to compare to previous period's earnings. When firms can access financial markets, retained earnings are not the only source of financing so the case of E growing with earnings (retaining all earnings) is not a particularly important baseline.

So, if we are trying to understand firms' financial decisions, it would seem like financial factors are the natural place to start.

For those who think that share buybacks are driven by the fact (in fact, generally, the fallacy) that capital gains are taxed more favorably than qualified dividends, consider this:

Prior to 2003 this was certainly true. Ordinary dividends paid by US companies were taxed at ordinary tax rates (marginal tax rate on dividends was almost 40 percent prior to that date). In contrast, the marginal tax rate for long-term capital gains was a maximum of 20 percent. That's a differential of nearly 20 percent in favor of capital gains! It would seem to have been a relative no-brainer prior to 2003 to strongly prefer, for tax reasons, stock buybacks to dividend payments.

After 2003, the maximum rate on dividends and capital gains was generally equalized (both at 15 percent and then 20 percent). You would think that this would reduce the attractiveness of stock buybacks relative to dividend payments. But, look at the chart here:

What do you see? Basically the opposite. How do you explain that?

Vivian, see my comment above, although it's mostly relevant to long-term buy-and-hold investors.

As a long-term investor, I prefer buybacks to dividends, all else equal.

I'm the opposite - I want divvies. Tangible cash in hand allows me to invest back into the company, invest elsewhere or leave the cash parked. Since I don't know when the buybacks are occurring - just that they are - I get a different financial read AND have to sell shares in order to generate cash return for myself.

More divvies, please!

A buyback is a tax free dividend reinvestment.

Yes, this is very interesting. I recall that Jean Tirole's excellent textbook on corporate finance that it talks about how the literature on this question of why share buybacks occur in lieu of dividend payments (or differ from them in some way at all) is a bit inconclusive. The tax policy seems like it should be the main differentiation, but it doesn't seem to explain it. Buybacks tend to be lumpier, happening every so often; dividends tend to be smoother. I also vaguely recall him talking about how the price of a company's stock increases when buybacks are announced and how this might reflect superior insider knowledge being communicated to outside investors.

Isn't it part of the stock buyback tactic to increase the price of unissued shares, the options for which will become management bonuses?

Yes, it's amazing how little this has come up in this discussion. Taxes are secondary. Executive managers (who drive the decision) who hold options have a HUGE preference for buybacks over dividends. If you dividend out cash, it goes to the existing shareholders (option holders get nothing) and it's gone (and the value of the company's shares actually decrease except possibly with a slight offset to the extent people might expect future dividends). To take the extreme, if Apple dividended out all of its cash in one big dividend, option holders (e.g. management) would be screwed - the exercise price of their existing options would stay the same, but a huge asset just went out the door. So do you expect them to push for that? On the other hand, buybacks reduce the number of shares outstanding, which is good for EPS calculations (and many managers have bonuses based on that) - and, at least if by luck they are at a cheap price (which admittedly, they tend not to be), it helps option holders in that way, and in any case, they reduce shareholder political pressure on the dilution caused by option plans.

Interesting comment, but perhaps less nefarious than you suggest.

Expected dividends are built in to option prices. So, a company with high historical dividends would sell out of the money options for cheaper than an identical company that did not pay dividends historically.

The expectation is that more of the earnings will be expressed via dividends rather than a rising stock price.

Suppose the no dividend company had superior earnings than expected. If they decide to pay out a large dividend, option buyers might feel a bit double-crossed, although I would say their expectations were merely upset.

To me, the nefarious behavior would be for a company to cut its dividend rather than expose option holders to a lower price in the future. Is that what's going on here? Doesn't seem like it.

I agree that there may be some principal/agent issues here if management owns lots of options and makes the "dividend vs. buyback" decision, but this falls under the heading of "executive compensation governance", not "corporate finance".

It may be less "nefarious" than Rusty suggests, but it may also be more of a problem then you are admitting, regardless of within which category you want to place it.

Of course, per the Black/Scholes model, *expected dividends* are part of the option pricing formula. But, that expectation is applied at the time the options are purchased (or, in the case of executive compensation, when those options are granted because expectations are imbedded) and the financial hit to earnings for the latter is normally based on that model. What is the average duration of an option traded on a public market? Six months? Executive stock options typically have an exercise period of 10 years. That gives quite a bit of time for those expectations to be disrupted. It is precisely when management makes a "dividend versus buyback" decision that the problem comes to fore. Whenever that decision is made, there are likely quite a few executive stock options out there granted over the prior 10-year period that are subject to this "disruption" problem.

Companies try to take a certain amount of disruption out of *publicly traded options* by announcing in advance their stock repurchase programs and those programs are often delayed for some time beyond the announcement. The amount of disruption therefore for an option that is outstanding for six months is considerably less than options that are outstanding for 10 years.

This is a real principal/agent problem or, to state it more nefariously, a conflict of interest problem.

Good comment. My point stands, however. Some dividend policy is embedded in the pricing of long-term executive options for company X. If these dividends were "raided" to buyback stock and boost the value of executive options, that's a problem.

It's a governance problem for current shareholders, though. And just like the rest of these governance problems, if I don't hold Company X stock, I don't really care.

Do you see this whole thing (dividends vs. buybacks) as anything more than a "executive compensation/ shareholders' rights" issue?

And, going up one level, the whole "returning money to shareholders versus investing in the business" thing seems like a straightforward corporate finance decision. I'm skeptical that Internet commentators have greater insight on this decision than company managers. If you can lock in borrowed money cheaply, maybe a bit more corporate leverage is called for.


I'm not trying to overstate the case---or understate it. As with most other economic phenomena, there are a variety of factors at play. The principal/agent issue is one that is squarely in the mix, I'm pretty sure. I'm much more skeptical about tax considerations for reasons that are stated elsewhere here. One reason for this is that a few extra million dollar payoff to the folks that make these decisions carries a lot more weight in the process, I'm pretty sure, than a few million bucks to the large collective of shareholders. Those folks are likely pretty good at fooling even themselves at what their real motives are (this is why we have the concept of "the appearance of a conflict of interest rather than merely a real conflict of interest). But, I also think other stuff is at play. Low interest rates may be one significant factor in the current environment. Perceived lack of investment opportunity likely is another.

"Do you see this whole thing (dividends vs. buybacks) as anything more than a “executive compensation/ shareholders’ rights” issue?"

Not really, and I guess that's kind of the point. The point being that if it were strictly a corporate finance issue, in many instances different decisions would be made. Returning money to shareholders is clearly strictly a finance decision. How that is done, not entirely so. This doesn't imply a "yes" or "no" to buybacks, but there's a lot of leeway in scale and distribution in between those two extremes.

The topic is too involved to discuss here, but I think the problems could be alleviated by basing executive incentive comp more on long-term total returns (dividends included) rather than just share price.

Corporations use profits (or even borrowed money) to buy back stock, raising the price per share and then options are exercised by management who then sell the shares at the higher price. Nothing too complicated about that. Management is using the shareholder's money, or borrowing it in their name, to reward themselves at shareholder expense. Sure, the shareholders themselves are receiving a higher, manipulated price but instead of the company investing in r & d and capital expansion it's buying homes in Greenwich, CT and paying for trips to Aspen.

Do you have any proof of this actually happening without the board (stockholders) immediately removing the CEO's and executives who implement your "scheme" versus the much simpler and more likely tax reasons for buybacks over dividends?

Take a hypothetical world where 100% of a company's operating cash flow is spent each year on dividends or repurchases (same thing from a corp finance perspective; a cash dividend leaves co in same place as a repurchase + stock split). Any new capital spending must be funded by tapping the capital markets. So the operating cash goes back to investors, who may choose which companies to fund.
Would this be a more efficient world or less efficient than today?
On the one hand, there are frictions to capital raising, particularly when the financial markets are in turmoil.
On the other, if a company can't justify raising capital to fund its projects, should it really be devoting cash on hand to that investment? Is the true cost of capital any less for cash on hand?
I think of this counterfactual whenever someone complains that buybacks/dividends are "short-term" in nature or hinder investment on an economy-wide basis.

For technical companies, the rule (broken by perhaps MS (Windows and Office) and certainly by Apple) is that you only get one idea that really takes off.

And that makes sense. To be successful, and idea has to be good, but it also has to win the lottery of right time, place, phase of moon, etc. (An established company has one advantage, it doesn't have to worry about funding the idea, so the odds go from maybe 1 in 100,000 to one in 10,000).

A well run company shouldn't expect further miracles (even as others are pointing at other lottery winners and say "see, be like them"). Instead sensible management should be keeping whatever cash it needs to fully exploit its original success and give the rest back to the shareholder.

Also, the idea that the stock market properly values share buybacks (keeps the same earnings per share) seems highly dubious to me, given its nature. I'd expect a big bump for a short while until the market "forgets" about it and then a slump. Has anyone shown whether buybacks increase a share price the "expected" amount in the long term, or is the market so noisy that everyone can just pretend it does?

Problem is you are describing what's best for shareholders. Does it align with what's best for the management? Will a mature firm fire all / most of its R&D staff?

Most R&D staff is employed making minor improvements on existing products, not inventing entirely new businesses.

I more or less agree with Tom that really good ideas are rare and hard to manufacture.

I think his last paragraph is hippie crystal-grippin' nonsense, and if he really thinks the market is that predictably irrational he should go start a hedge fund.

Simple, S&P 500 is a bunch of mature companies with low growth prospects for the most part, therefore investors' return will be greater with the capital returned to them. Textbook.

Moreover, for many of these large, mature companies the challenge is not to grow beyond potential, but to hold serve and survive at the top -- which an analysis of composition of the high cap end of the S&P500 or DJI across the decades suggests is far from a foregone conclusion. Can it be that do no harm can be a meaningful basis for (a decent percentage of) management compensation? Rents are not what they used to be.

The owners of their stock want that. They have pension obligations and just want a steady consistent cash flow.

It is also a perfect scenario for them all to have their clocks cleaned by more vigorous and able competitors. Or by someone elsewhere.

Slightly off-topic, but this reminds me of a question I've never gotten an answer to: Who would be the residual claimant if a company bought bck all of its shares? Before you say that can't happen, let me give you three scenarios:
(a) A company issues 1 million shares at $1 per share and then borrows $1 million. They have no projects. They buy back the 1 million shares (each of which has $1 in value) and then somebody on the board gets a bright idea to invest the million that's left (from the loan) which hits and pays off the loan plus another $10 million. Who gets the $10 million?
(b) Two people own a company. They die in a plane crash and each wills their shares to the company. They have no other heirs.
(c) Company A buys up the shares in Company B, whose only asset is the shares of Company A.

If anybody has answers to any of these, let me know.

Equity compensation is deducted from profits. Most share but backs are recycled into equity compensation. Ergo... Tyler is double counting.

Yeah, managers need to look busy sometimes so they play with company money.

Phil Jacoby comes to mind. That guy is a real idiot if I've ever met one.

Jk, Phil. But your Preakness suit makes you look like a broke Colonel Sanders

I wouldn't necessarily have said that this means that the companies' profits come from previous work rather than current management, at least in the sense of an implied critique of the management. These are all very, very large companies. It's hard for them to grow at the same level of profitability as measured by return on equity. All the management skills in the world won't move the needle much on that.

Why "rents"? Why not "profits"? Has Tyler gone over to the dark side where all profits represent nothing more than exploitation and theft?

I don't find Lazonick's argument very convincing. (And in general, people seem to have a very hard time thinking clearly about stock buybacks.)

First, if the problem is low corporate investment, why not just complain about that directly? At the very least it seems strange to complain about buybacks but not dividends, if your point is that too much cash is being returned to shareholders. Also strange to blame buybacks when there are piles of cash on balance sheets. And to the extent that buybacks are debt financed, they don't reduce cash for investment at all.

Also Lazonick uses a hokey measure where he only uses a subset of the S&P firms that have been listed over the decade. Why not use the full set of firms? Also it seems (?) he is using gross buybacks instead of net. Admittedly, data on buybacks can be difficult to get, but doesn't he have access to Compustat?

I'm skeptical the whole notion that aggregate net buybacks as of 2014 are particularly large. If so, why isn't the S&P500 divisor falling more quickly? It has declined only 0.34% over the year ending Q2 2014.

The most basic economics teaches than investment drives profits to zero. Stock prices in free lunch economic theory is determined by profit, not by invested capital, so investment is contrary to the demand for higher share price - investment must be limited to create the shortages required for monopoly profits.

As high profits ensure customers will be limited in the total they can buy because profits are the amount NOT paid to customers, known as workers, so the only way to boost sales is to buy shares of stock with the profits so former shareholders will buy what is being sold with high profits. Thus the supply of products remains limited compared to the money chasing the scarce goods thus creating high profits.

Of course, if a competitor or substitute appears in the market, paying too much to buy that potential competitor with profits is critical to ensure restricted supply to maintain monopoly profits because if a competitor drives your profits down, then you are bankrupt. No company with a monopoly generating monopoly profits can survive competition forcing them to compete by merely having above market ROIC. Imagine Apple becoming Amazon forced into the constant treadmill of constantly investing every dime into new productive capital assets and constantly chasing more and more revenue any way it can without any brand monopoly to allow extracting monopoly profits, constantly threatened by alibaba....

Then again, alibaba will probably be selling iPhones illegally produced in China using discarded circuit board photoworks and chip shooter robot coding and assembly jigs using former iPhone factory workers. Thankfully, governments will step in and state that 50 million iPhones are not like 50 million toothpicks, a commodity that can be sold for labor cost. Now if only I can get government to declare my toothpicks not a commodity so I can sell mine for $1 each and have the government prevent anyone else from selling toothpicks at labor costs.

"The most basic economics teaches than investment drives profits to zero. "

No, it really doesn't.

Today's blog post from Aswath Damodaran provides a much needed dose of clear thinking on this topic:

+1. I recommend this link to Tyler Cowen and many commenters here.

That was an interesting post. I read it and left a comment. The entire post seems now to have been deleted.

Yes, that's a good link. Tyler's speculation strikes me as a bizarre non-sequitur.

I'll add that we have been hearing for years (including possibly on this blog?) that companies have been holding onto historically large amounts of cash. If a company's net income bears any resemblance to its free cash flow, and if it ever wants to start working down its cash balance by returning cash to shareholders, it will have to pay out more than its net income in dividends and buybacks.

For a variety of reasons (some shareholder-friendly and some management-friendly), companies usually prefer buybacks to a large one-time dividend for this purpose.

As Damodaran says: "As for management compensation, I agree that there is a problem, but buybacks are again a symptom, not a cause of the problem. In my view, it is poor corporate governance practice on the part of boards of directors to grant huge option packages to managers and then vote for buybacks designed to make managers even better off. Again, fixing buybacks does nothing to solve the underlying problem."

I think this quote in the link is the source of skepticism toward buybucks: "As for management compensation, I agree that there is a problem, but buybacks are again a symptom, not a cause of the problem. In my view, it is poor corporate governance practice on the part of boards of directors to grant huge option packages to managers and then vote for buybacks designed to make managers even better off."

People know that it has the potential to reap huge rewards to management that is doing nothing special, and our inclination is to believe the buybacks often being done for the primary purpose of spiking management compensation/options. Diffuse owners feel somewhat helpless when the boards grant huge unwarranted pay packages, and buybacks live in the same mental space as these pay packages. It's notable that many buybacks are necessary to simply offset the dilution of lavish options packages at some companies.

Personally, as an investor I usually don't mind buybacks because many companies do have difficulties deploying capital effectively. I just don't want a disproportionate share going to management for average performance.

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