Regulating stock buybacks: the $6.3 trillion question

ABSTRACT

Corporate resource allocation decisions shape business investment, income distribution, and productivity growth. Stock buybacks––a term denoting when a corporation repurchases its own shares on the open market––manipulate stock prices and enrich senior corporate executives and hedge fund managers. We argue that the growing distribution of corporate funds to share-sellers via stock buybacks is a source of productivity fragility in the US economy. This article presents new data on the use of stock buybacks by US corporations in 2010–2019. We show the widespread and growing use of stock buybacks across industries and sectors and describe policies that will curb the excessive use of corporate funds on stock buybacks.

KEYWORDS:

• Stock buybacks
• shareholder primacy
• securities and exchange commission
• corporate finance
• corporate governance

JEL CLASSIFICATION:

• D2
• G1
• G3
• G28
• G35
• G38
• O3

Acknowledgements

The authors would like to thank Chirag Lala and Ken Jacobson for excellent research assistance and feedback.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Profits, or net income, are defined in corporate SEC 10-K statements as Total Revenue less (costs of goods sold + operating expenses + other gains or losses + other expenses + depreciation + interest expense + taxes).

2. Since 2004, SEC disclosure regulations have required corporations to report the repurchasing of their shares on their Form 10-Q quarterly reports by stating the number of shares repurchased and the average purchase price per share. Companies are not required to disaggregate shares purchased on the open market that are (nominally) regulated by Rule 10b-18 and in other repurchase transactions. More details on data availability are found in Appendix B.

3. It is important to differentiate between two types of distributions made to shareholders: dividends and stock buybacks (we use the term “distributions” rather than “returns to shareholders”, as the vast majority of shareholders today purchase shares on the secondary markets, and thus have never contributed financial assets to the company in the first place). Although the volume of funds spent on dividends and stock buybacks can be similar, stock buybacks create harms that dividends do not. Dividends do not directly bid up the stock price, and they do not encourage insiders to strategically time the sale of their own shares. While dividends have historically risen steadily, boards do not want to create expectations of perennially unsustainable dividend levels. Dividend increases accrue to all shareholders (with the same class of stock), while stock buybacks directly benefit only shareholders who sell strategically around the buyback.

4. A letter to the SEC from an executive at Investors Exchange LCC stated: “As the global head of trading at a large asset manager put it: When it comes to handling the corporate buyback, what’s painfully obvious to us is that the corporate buyback is probably the most gameable order in the marketplace. If you pursue liquidity in a corporate buyback algorithm, other participants can easily sense how the algorithm is going to react and try to trade in front of it”. (Ramsay 2018).

5. We use S&P Compustat, a data vendor available through Wharton Research Data Services, to aggregate individual corporate 10-Q and 10-K filings.

6. Lazonick and Hopkins (2020) detail the complete history of the shift in prioritization from innovation toward shareholder value maximization in the companies responsible for producing ventilators for the US national stockpile.

7. The SEC issued Proposed Rule SR for public comment on December 15, 2021. As of this writing, the public comment period is still open. The proposal does include some of the recommendations made herein. See “Share Repurchase Disclosure Modernization”, Release Nos. 34–93783, https://www.sec.gov/rules/proposed/2021/34–93783.pdf.

8. Under the Securities and Exchange Act of 1934, which governs secondary trading in the financial markets, companies are subject to anti-fraud and anti-manipulation rules in their trading activity. Capital is a stock, not a flow, and secondary trading relates to financial flows, not investment in an asset (i.e. a stock).

9. Williams Act, Pub. L. No. 90–439, 82 Stat. 455 (1968).

10. The initial proposal to limit buybacks to 15% of average daily trading volume was based on a single article published in 1965, based on share repurchases conducted by large companies in that year for the purposes of employee compensation, not stock-price manipulation (Guthart 1965; Lazonick and Jacobson 2022).

11. Purchases of Certain Equity Securities by the Issuer and Others, 45 Fed. Reg. at 70891.

12. Specifically, the Rule reads: “(1) The total volume of Rule 10b-18 purchases effected on any single day does not exceed the lesser of 25% of the security‘s four-week ADTV or the issuer‘s average daily Rule 10b-18 purchases during the three full calendar months preceding the date of the announcement of such transaction”.

13. Private repurchase transactions and “tender offers” are direct offers to shareholders made publicly by companies to repurchase their shares at a particular price, and do not involve the same potential for market manipulation because they are disclosed in advance and do not take place in the open market. Also see footnote 3, above.

14. This was first proposed by Senator Tammy Baldwin (D-WI) in the “Reward Work Act”.

15. In the United States, Congress passes legislation, which independent regulatory agencies, like the Securities and Exchange Commission, carry out through promulgating rules, which must be within the scope of what has been passed legislatively. In this case, only Congress could ban stock buybacks substantively, but the SEC has the authority to revise rules of corporate conduct (subject to the Administrative Procedures Act.) For a theoretical treatment of the difference between legislation and regulation, see (Kosti, Levi-Faur, and Mor 2020).

16. Phillip Brzenk and Aye M. Soe, “Digging Deeper into the U.S. Preferred Market”, S&P Dow Jones Indices, October 2015, https://www.spglobal.com/spdji/en/documents/research/research-digging-deeper-into-the-us-preferred-market.pdf.

17. See Matt Hopkins and William Lazonick, “The Mismeasure of Mammon: Uses and Abuses of Executive Pay Data”, Institute for New Economic Thinking Working Paper No. 49, August 29, 2016, https://www.ineteconomics.org/research/research-papers/the-mismeasure-of-mammon-uses-and-abuses-of-executive-pay-data.

Additional information

Funding

William Lazonick acknowledges funding for his research on stock buybacks from the Institute for New Thinking.