Raising the Stock Buyback Tax

Investment Analysis Clubs Macro Economic Trends and Risks
1

Yes this is a proposed increase. But there is an existing tax imposed last year.
The president proposed an increase to 4% in his SOTU speech.

There are two issues that I can see.
First-Should our nation’s government be involved in how corporations utilize their profits? Or stated another way–Should there even be a buyback tax.

A corporation buys back shares when it sees no profitable investment opportunities alternatives. Proponents of stock buybacks that a share repurchase is simply returning money to shareholders—just like paying a dividend, but more tax efficient.

Those opposed to stock buybacks believe buybacks are largely utilized to boost CEO’s renumeration. Yes stock holders benefit. But couldn’t stockholders benefit if profits were utilized to increase employee paychecks who then spend more on consumption which flows to the corporate bottom line.

Harvard claims stock buybacks are dangerous to our economy:

That debt has resulted in zombie corporations.

Second-According to DW article below they make up 16% of US firms according to one Morgan Stanley calculation.
Will the buyback tax end these zombie corporations? In bankrupting the zombies, will that money will flow to profitable ventures? Will the FED interest rates accomplish the ridding of zombie corporation more effectively?

How exactly a company earns ‘zombie’ status is ill-defined. Generally, the name refers to firms that roll over their debt with continued access to credit markets, without being able to pay off their debt interest.

These firms stumble along, just covering operating expenses but soulless as far as profitability and productivity are concerned.

America is not alone in its corporate rot. Zombies account for more than 20% of Europe’s companies.

Among their ranks are many firms once synonymous with luxuriant American capitalism: Macy’s, Boeing, Delta and American Airlines.

What seemed like a routine—former Facebook executive and venture capitalist interviews on CNBC—devolved into an uncomfortable and tense conversation that shed light on one of the biggest subversions of capitalism.

Chamath Palihapitiya—said executive and venture capitalist—spoke with CNBC’s Scott Wapner last Thursday and questioned the practice of propping up “zombie companies.”

Wapner, appearing agitated, asked Palihapitiy in an incredulous manner, “Are you suggesting that airlines should fail?” Paligapitiya calmly answered, “Yes.”

Palihapitiy pointed out, “On Main Street today, people are getting wiped out. Right now, rich CEOs are not, boards that have horrible governance are not. People are.” He added, “What we’ve done is disproportionately prop up poor-performing CEOs and boards, and you have to wash these people out.”

He explained to Wapner that it’s not the average person who is hurt when a company files for bankruptcy. Most of the investors are big-money institutions, hedge fund guys and wealth people.

3 Likes
2

Trickle down economics requires that those funds be invested in something productive. Companies that can’t identify opportunities probably need better managers.

2 Likes
3

There was a time when stock buy backs were considered stock manipulation and were not done. I still feel that is true.

Boeing spent enough money on stock-buy-backs that they could have done a clean-sheet redesign of the 737 Max. But they decided to buy back stock and short-change the redesign. Boeing absolutely could have found productive use for its money. Instead it decided to enrich the C-Suite. We know what happened.

Here is another argument against the buy backs. Paul says the companies need better manages if they cannot find opportunities worth spending their bucks on. True! But they could also lower prices, undercut their competitors, if they have more money than they can put to good use.

3 Likes
4

But that is never how it works out. The narrative says “make the rich richer, and you will benefit”? So, forty years later, unions broken, pay stagnant, much productive work moved offshore. But the rich are richer.

The author of this book was on Amanpour last night. He talked about how capitalism has slid toward “extraction”, where profits are made by taking away from others, rather than doing anything productive, and increased concentration of economic power is sliding toward authoritarianism.

8 Likes
5

Would that definition then make the USA a “zombie country”?

6

If taxing corporations is deemed appropriate, then I see no reason why taxing them based on their activity (whether that be pollution, products, or how they chose to spend profits), is any less appropriate.

That being said, I see nothing inherently wrong with a company doing a buyback (and sometimes it is preferred to the alternative of issuing new stock - resulting in dilution). If you are giving employees shares of stock as part of their compensation, then it can only come one of two ways, from the market via a buyback or from further dilution of the company. If I am a stock holder of the company, I would MUCH rather you do a buyback than issue new shares.

Additionally, why are we blaming the company for such behavior instead of blaming the debt holders for financing such? If these are indeed zombie companies, then shouldn’t bond investors be disinclined to finance such?

1 Like
7

Sometimes you reach the top and there’s no place more to go without risking a lot of money on something inappropriate. I’m not sure I would tell Warren Buffett he needs a better manager, given his reputation as one of the best capital allocator in recent memory - and he’s been doing buybacks for a couple years.

Apple is doing buybacks - but exploring other things which they’re not ready to throw money at. Do they need better managers?

Sure you can find lots of examples where buybacks were a mistake (or worse), especially when the corporation is doing them but issuing even more shares to management (a practice I would support legislating out of existence) but it’s a tricky area. Some good, some bad. That’s what makes it hard to make such sweeping generalizations.

5 Likes
8

There is no penalty for investing the funds in bonds or T-bills. Or paying it out in dividends? The penalty is for using it to buy back shares. Surely a well managed company can do better than that.

9

Huh? Of course there is! You have a far lower return on those things, often not even beating inflation.

This is nearly identical to buying back stock … you are giving the money to someone else (the investors) to allocate into different investments.

No, it’s just the opposite. Sometimes good management realizes that returning the capital (dividend, buyback) is the better choice. Look at AT&Ts adventures in media, they had a bunch of cash (because the phone service business generates lots of it) and they just had to do something with it, so they bought media companies, a business they were hardly proficient at, and incinerated their investors capital instead of just returning it. Same for Time Warner and AOL, and plenty of other examples.

5 Likes
10

Stock buybacks can be a good investment if the stock price is low. AAPL is trading at $150. If the price dropped to $75 for some reason(s) that isn’t permanent (think the covid crash of 2020) then the company would be doing well to buy, say, $100 billion worth of their stock.

DB2

3 Likes
11

When a question starts out that way, 99.9999% of the time the answer is “no”.

1 Like
12

Time to end this 40 year experiment.

They were illegal until 1982. It is past time to make them illegal again.

5 Likes
13

Why? It does not logically follow that because it was illegal before, that such was the better state.

Think of all the things that have been “legalized” over the last 100 years. Is it also time to make those illegal again or might there be a benefit to legalization?

Hawkwin
Who generally prefers more liberty, not less, even if means regulated liberty.

3 Likes
14

I think the reasoning to make it illegal is that it smacks of stock price manipulation by the company. And while there might be reasons why investors like buybacks, we need to remember they are not the only interested party here. Does the consumer benefit from buybacks, for example? How about employees (especially those who are not high up the ladder). I’m not one who subscribes to the theory that companies exists solely to make money for shareholders.

4 Likes
15

Seems the reasonable position is that “shareholder value” need to be balanced with the long term sustainability of the company. Stock buybacks have turned into stealth liquidations. I was looking at Union Pacific the other day. The railroad makes plenty of money $6-$7B net income/year, but equity has fallen consistently, year after year, from $18B in 2019, to $12B in 2022, while debt has grown from $24B in 2019 to $32B in 2022, and shares issued has fallen from 1.1B to 614M.

Steve

2 Likes
16

Agreed! The classic example of late is Boeing, who spent so much money in stock buybacks that they “could not afford” to do the 737 Max correctly.

17

Don’t know about ‘liquidation’. The operations of the company continue the same, with or without a buyback program. In addition, they give the company more flexibility in the future. IIRC, the stock usually isn’t retired but merely held by the company. If there is a need more more cash down the road then the stock can be sold. Easier than issuing new stock.

Hopefully the company bought back their stock when it was relatively cheap. To quote Warren:
Buffett says stock buybacks aren't 'immoral,' but some are 'stupid'.

DB2

18

Actually, no. In UP’s case, in spite of being comfortably profitable, net debt has gone up $8B, 33%, in only three years. In an economic downturn, a company can stop paying dividends, but the money lenders still want their interest payments. If a company resells the stock it bought back to juice EPS, the reverse happens: the added stock amplifies the drop in EPS. Then there is the “information content” in selling the stock onto the market, that the company is in a financial bind, which will depress the price, on top of the dilution of EPS.

When I was in B-school, a company with negative equity, and negative book value, was bankrupt. These days Shiny business practices say everything is fine, as long as they can service the debt, but the company is performing a high wire act, where the slightest hiccup will bring the facade down.

Steve

5 Likes
19

It is no more manipulation than when a mutual fund decides to take a 5% position. If it is legal for Fidelity to buy up shares, then why should the company be prohibited from doing the same?

Regardless, buying stock worth $40 million or issuing dividends worth $40 million, all else being equal, has the exact same impact on shareholder value and stock price.

And who cares if the consumer benefits? The corporation does not exist for the benefit of the consumer. That is why we have non-profits. You also mention employees - well in shareholder-owned companies, buybacks are a necessity. How else can employees be awarded stock or otherwise purchase such through the company unless the company either does a buyback or issues new shares resulting in dilution and harm to shareholders.

And while I agree with you that the sole reason is not to benefit shareholders, it is certainly the most important reason as it pertains to for-profit corporations. Doesn’t mean everything else is always secondary but it is kind of hard to run a business if the owners are constantly losing money.

1 Like
20

I don’t look at it that way - I don’t sell my shares - i do use my dividends. I would much prefer they pay out extra dividends rather than a stock buyback. Particularly my Roth investments.

It used to be illegal and Glass-Steagall used to be a thing. It was the wisdom of prior generations that enacted those rules based on their experiences. We should not presume we know better and clearly we don’t. Bring back Glass-Steagall, bring back no stock buybacks and probably a half-dozen more recent changes.

3 Likes