Stock Buybacks Should Be Transparent, Not Taxed

Members of Southwest Airlines Pilots Association protest company prioritizing stock buybacks over labor contracts outside the New York Stock Exchange on Dec. 7, 2022. (SWAPA)SWAPA

Commentary

Stock buybacks used to be largely prohibited. Most considered them a form of stock manipulation. If companies wished to return corporate profits to shareholders, they could only do so by paying a dividend. Shareholders who were dissatisfied with a company’s stewardship of its excess cash could always convert the value of those shares to cash simply by selling them.

That ended in 1982, when the Securities and Exchange Commission (SEC) adopted Rule 10b-18, which provided a “safe harbor” for share buybacks if certain specified conditions were met.

Since then, share buybacks have been used extensively to return profits to shareholders. Some companies prefer them to dividends because once a company pays a dividend, shareholders come to expect them to be paid annually. Buybacks allow more selective, nonperiodic distributions.

But one of the big reasons companies prefer them is that they reduce shares outstanding and, often, boost the share price. Since share price is often a measure of executive bonuses, and stock options, the people in the C-suite heavily favor them in their own personal interest, above those of the company.

It’s important to differentiate a tender offer from a buyback.

Tender offers are solicitations by the company (or an acquirer) of its shareholders to buy back its shares by a certain date for a set price. They are sometimes used to consolidate ownership within the company, to effect a takeover, or to take a company private, so that it no longer has to file with the SEC as a public company.

A buyback is effected by the company’s executives buying shares on the open market pursuant to their board’s authorization. They can do so up to a fixed date or the date can be open.

The Problem With Buybacks

While Rule 10b-18 is nominally structured to prevent stock manipulation, it’s fatuous to believe that share buybacks cannot result in stock prices being manipulated. Just as central banks step in to support a run on their currency, so, too, can companies step in to sustain or boost their stock price with a buyback. For example, after fast-casual restaurant Chipotle suffered a widely reported norovirus outbreak in December 2015 that affected scores of students at Boston College, the company’s earnings cratered thereafter. The chain spent more than $1 billion in the following two quarters on stock buybacks. The stock cratered nevertheless in the aftermath of the norovirus outbreak, but there’s no way of knowing if it might have cratered even more without the buybacks.

Another problem with buybacks is that investors cannot correlate a buyback with a stock price movement because the amount of the buyback is not reported until the quarterly SEC report, Form 10Q. But in the UK, the London Stock Exchange requires such buybacks to be reported by 7:30 a.m. of the business day following the calendar day the buyback occurred. The Hang Seng, the Hong Kong stock exchange, has a similar rule that says share buybacks must be reported no later than 30 minutes before the commencement of the preopening trading session on the next business day.

The SEC proposed a similar rule for the United States in the spring of 2023, but it was challenged by the business community, and the rule was withdrawn.

Buybacks are also perceived to be a form of finance capitalism, in which wealth is created by financial transactions, as opposed to industrial capitalism, in which wealth is built by manufacturing. Democrats and some Republican populists tend to be of this belief. The sense is that companies buy back their shares, enriching their executives and shareholders, but at the cost of new investment, training, and wage growth for their workers.

It is fairly common to see headlines in which companies announce stock buybacks while nearly simultaneously announcing employee layoffs. Such headlines caused great consternation in public policy and political circles and resulted in Congress imposing a 1 percent excise tax on stock repurchases as part of the 2022 Inflation Reduction Act. While the revenue effect was minimal, the politics of such a tax were likely intended by the Biden administration to try to win some of the populist base of former President Donald Trump. (President Joe Biden’s 2025 budget proposal would quadruple the excise tax to 4 percent.)

Let’s Get It Right

The Biden administration’s excise tax on buybacks is little more than class-war political posturing and should be rescinded. That said, investors deserve at least the same transparency as the London and Hang Seng stock markets on stock buybacks. So instead of pushing to quadruple the stock repurchase excise tax, the Biden administration—and the Trump campaign—should push for the kind of transparent reporting of buybacks that are routine in those two markets.

As in all things in the securities markets, the more information available to investors—particularly small, retail, investors—the better. For the United States to be less transparent than the UK or Hong Kong is disgraceful.