Quite a few government officials have decided that a crisis of public health and economics is the perfect time to move against — stock buybacks.
Sen. Elizabeth Warren, D-Mass., thinks that companies that get relief money should be permanently banned from buying back their stock. Asked about whether companies should be forbidden to use relief money for buybacks, President Donald Trump said that "conditions like that would be OK with me." The Senate stimulus package agreed to Wednesday reportedly contains language to that effect.
The case against buybacks has never made much sense, and the coronavirus epidemic isn’t strengthening it. A buyback is one way for a company to reward the investors who own it.
It buys outstanding shares and thus raises the value of the remaining ones.
In transferring cash from a company’s balance sheet to equity holders, a buyback is very like the payment of dividends. Without the prospect of such payments, there would be much less reason to invest in the first place.
Until recently, the major criticism of buybacks has been that companies should give their employees raises, or invest more in research and development or new plants, rather than send money to shareholders. The epidemic and consequent economic shutdown has changed the prevailing critique: Now the complaint is that companies should have kept the money as a cushion, so they wouldn’t need "bailouts." (We’ll leave aside whether bailout is the right word for what is happening, and for that matter whether it would have been prudent for companies to have planned to be able to bear a pandemic.)
If any of these complaints about buybacks are valid, they are just as valid about dividends. Warren takes partial account of this point by also banning the payment of dividends while companies are receiving federal funds.
But that doesn’t solve the problem. In the long run, Warren’s policy would leave some companies unable to repurchase stock but able to accomplish the same result by paying dividends. If she were instead to ban dividends permanently, too, then investors would have less incentive to buy stocks in those companies.
Shareholders would have much less incentive, in turn, to exercise any pressure on the company to be well managed.
OK then, you might think: Why not have a temporary ban on both dividends and buybacks, for example until a company has paid back any funds it got to the government? Wouldn’t that keep the federal help from becoming a windfall for shareholders?
It might not hurt, but it would also have limited effectiveness. The government support would presumably buoy the share price, and a company could just accumulate cash to give to its shareholders after the ban ended.
That temporary ban would have the merit of preventing a company from using a government loan to reward its shareholders and then going under before paying it back.
But it wouldn’t do anything to keep a company from rewarding bondholders that way. What we want is to secure the government’s loan.
The government could use the same tools that other lenders do, from collateral to required cash balances. Lenders sometimes impose restrictions on distributions to shareholders, but there’s no reason to focus just on them — let alone to focus even more narrowly on buybacks.
Let’s take a step back and ask what we want from giving aid to companies in the first place. We want them to continue, as far as possible, to pay their employees, so that those employees can pay their own bills. And we want them to be viable concerns after the economy has resumed (something closer to) normal functioning.
We don’t, on the other hand, have any particular interest in the welfare of the companies’ shareholders or bondholders. (We don’t wish them ill, that is, but we shouldn’t be going through this exercise for their sake.)
If we want to avoid rewarding a company’s current shareholders while making sure that its future ones can still gain rewards by investing in them (and prudently exercising control over them), then we have a number of options.
Re-organizing the company’s assets through bankruptcy is one. Another would be for the government to get an equity stake in return for assistance, with its shares to be sold to the public after the crisis passes. Current shareholders in that case would see their ownership diluted.
Restricting buybacks has become a good way to win bipartisan applause. But it's not an effective way to improve corporate governance or protect taxpayers’ interests.
Ramesh Ponnuru is a Bloomberg View columnist. He is a senior editor of National Review and the author of "The Party of Death: The Democrats, the Media, the Courts, and the Disregard for Human Life." To read more of his reports — Click Here Now.
© Copyright 2020 Bloomberg News. All rights reserved.