Superficially, the answers seem obvious: Corporate America should be the engine that drives the economy. If it distributes a growing share of its profits to shareholders — mostly the rich and upper middle class — it will have a hard time playing this crucial role. Indeed, these stock purchases have been cast as one of the villains of the present economic slump.
Former vice president Joe Biden, the presumptive Democratic nominee for president, has criticized share repurchases and urged that they be curbed. So have some congressional Republicans (prominently, Sen. Marco Rubio of Florida). A new study shows how profits are distributed — and it has some surprising conclusions.
There are two main channels for funneling profits to shareholders: dividends and stock repurchases. From 2000 to 2017, dividends and stock buybacks totaled about $10 trillion, finance professors Kathleen Kahle of the University of Arizona and René M. Stulz of Ohio State University report in a just-released working paper by the National Bureau of Economic Research. That was roughly double the amount ($5 trillion) from 1971 to 1999, a longer period.
The study compared the two periods to see what changes, if any, had occurred. (All figures were adjusted for inflation.)
There were two large shifts: First, total payouts to shareholders — dividends plus share repurchases — rose from 19 percent of operating profits in the 1971-1999 period to 32 percent in 2000-2017; and second, buybacks alone accounted for 55 percent of the distribution in the 2000-2017 period, up from 22 percent in the 1971-1999 period. To emphasize: Stock repurchases soared.
Here is where self-dealing becomes possible and, perhaps, probable. Given the increased importance of stock-based compensation packages for top executives, the bias toward stock repurchases boosts executives’ pay as well as shareholders’ cash balances.
But there’s another possible explanation for the surge in stock repurchases, note Kahle and Stulz: the “lifecycle” theory. When companies are young and growing rapidly, they have an almost-insatiable demand for investment funds to finance their operations. As they age and expand, they begin to generate sizable amounts of profits and cash. At some point, these companies may have more cash than they know how to spend.
Their traditional markets and products are mature. Expanding into new markets is an obvious use for this cash, but doing so is a risky proposition. Just because a firm succeeds at making cornflakes doesn’t mean it can succeed at making computer chips. People who suggest that firms can easily switch to something new usually don’t know what they’re talking about. There’s a good chance that the investment will be wasted.
Not surprisingly, dividends and stock purchases are concentrated among large, successful companies. In 2018, 10 firms accounted for more than 25 percent of dividends and stock purchases. The top five were: Apple, $87 billion; Oracle, $38 billion; Qualcomm, $26 billion; Cisco Systems, $24 billion; and Microsoft, $23 billion.
The crucial questions in this debate are: What happens to the money when it’s returned to shareholders? Do they simply spend it? If so, on what and how much? Do they invest in other firms? Do they put the money back in the stock market or some cautious investment vehicles (bank deposits, U.S. Treasury securities or mutual funds)?
If companies decide to pay more to shareholders, stock repurchases are the most attractive way to do it, says Alice Bonaime, a University of Arizona finance professor not involved in this study. The reason: A dividend cut usually results in a drop in a firm’s stock price — something companies seek to avoid at all costs. By contrast, stock repurchases don’t have that drawback. They can be turned on and off to reflect companies’ present needs without automatically depressing firms’ share prices, says Bonaime.
The irony is that stock repurchases are now being savagely squeezed by the pandemic. Many companies need every cent they can find to avoid bankruptcy. Still, the broader lesson remains: All investment opportunities aren’t the same. They can easily become a source of waste, not wealth. We shouldn’t forget that.
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