‘Share buybacks don’t create or destroy a lot of wealth,’ professor says

Wed, Apr 26, 2023, 8:28 AM

Cornell University Assistant Professor Nick Guest joins Yahoo Finance Live to discuss the stock buyback landscape, whether or not buybacks benefit companies in the long term, and the effects of increasing taxes on dividends.

Video Transcript

- Buyback announcements reached a new record of $1.22 trillion last year. They're already on pace to top that high in 2023. That's according to data by EPFR TrimTabs. Among the most recent companies to make such announcements is tech giant Alphabet. We just talked about it looking at a $70 billion stock buyback authorization.

However, with companies pouring in on repurchasing shares comes a split view between buyback critics and supporters. Here to discuss is Cornell University Assistant Professor Nick Guest. And here, we're not talking about opinion on buybacks. We're talking about data that you looked at, Nick, as to whether buybacks benefit companies over the longer term. What did you find?

NICK GUEST: So, of course, there are several criticisms of buybacks, including that they're due to companies trying to manipulate their share price upwards. Some people argue that they're associated with excessive executive compensation and that companies that buy back don't have as much cash available to take advantage of investment opportunities, thereby sacrificing growth and sacrificing, ultimately, profitability. But our evidence comparing both companies that repurchased and companies that don't repurchase shares didn't find any large scale, on average, evidence of any of those things.

Of course, there are rare instances of companies abusing buybacks. But whether a company repurchases a large or small amount, whether they repurchase frequently or infrequently, we didn't find short-term price bumps followed by poor long-term performance. We didn't find excessive executive education, no sacrificing of investment opportunities. So the firms that repurchase, they tend to be profitable and invest steadily. So that's our main takeaway that, of course, conflicts with the major criticisms for the majority of firms.

- On the flip side, did you find any sort of long-term benefit from doing the buybacks?

NICK GUEST: There isn't much evidence of that, either. So our main takeaway is that share buybacks don't create or destroy a lot of wealth. So then you might wonder, well, then, why do-- why are companies repurchasing, as you just showed, more than-- on track for more than $1 trillion this year. And the benefits seem to be an opportunity for management to signal that they believe the stock is undervalued. Your previous guest Chris brought that one up.

Of course, repurchases have more flexibility than dividends. They're easier to temporarily cut during a downtime. Repurchasing shares reduces the amount of cash that could be misused on management's pet projects. And finally, the managers and others-- the board, for example-- can use the repurchased shares to compensate employees. So those seem to be the benefits as opposed to improving long-term profitability or creating additional investment opportunities or anything like that.

- Interesting. That's really interesting and sort of counter to the conventional wisdom, it would seem, around buybacks. One of the reasons that they've been under more scrutiny recently is, of course, that the Biden administration has proposed an increase in taxes on dividends to 4%. Do we have any sense of what kind of effect that could have?

NICK GUEST: Well, and this is where we get more into conjecture because we haven't had a long enough time period to collect data or see the effects of the current 1%, even. And then, of course, the 4% proposal is a hypothetical. So because it's just 1% and those benefits of buybacks seem so strong for so many firms, that 1% tax that we have currently we don't think is likely to dissuade most firms from buying back their shares, nor is it likely to raise a significant amount of revenue for the government.

However, if the disincentives increase-- for example, if we get this 4% tax or other limits on what managers can do in terms of selling their own shares after the company has bought back shares, and other potential restrictions-- then some firms might decide to retain the cash instead or switch to dividends, which both could have negative consequences. For example, dividends, as we know, are taxed at income tax. They're taxed as income, whereas repurchases typically generate a capital gain. So that could create some additional costs for shareholders.

Of course, if the firms decide to retain the cash, then that's more available for the executives to misuse on pet projects or value-destroying mergers and acquisitions. And things like a value-destroying merger and acquisition could hurt employees who often get laid off or misallocated in such transactions. So currently, it doesn't seem like the 1% will have much of an effect, but increasing taxes or restrictions definitely could cause some changing behavior at companies.

- Yeah, unintended consequences, but the 4% doesn't seem like it's getting much traction at the moment. We'll talk to you again if it changes. Thanks so much, Cornell University Assistant Professor Nick Guest. Appreciate it.

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‘Share buybacks don’t create or destroy a lot of wealth,’ professor says

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