One justification made by proponents of stock buybacks is that the practice is an effective way for funds to flow from companies that do not “need” the cash out to shareholders, who will then invest it in companies that are issuing new shares to finance firm activity. Does this explanation show up in the data?1 For non-financial corporations, in all but one of the last 15 years, it does not.
There has been a decline in the total net issuances of publicly traded companies over the past 20 years, and net issuances by non-financial corporations have been negative for most years since 2002. This means that more corporate funds are flowing out to shareholders than are flowing back in through the issuance of new equity.
Net issuances can be calculated by subtracting how much a firm spends on repurchasing its own shares from the amount the firm raises when conducting new share issuances. Firms first issue new shares in order to raise funds. This primarily occurs during the initial public offering (IPO) stage, but it can also occur for mergers and acquisitions. Firms then repurchase their own shares in order to benefit their shareholders. Repurchasing shares increases the firm’s earnings per share (EPS), an important variable in the value of a stock, and therefore can increase the price of the stock. The rise in the share price is taxed at the capital gains rate, whereas dividend payments are taxed at the income tax rate. Overall, this has become increasingly attractive amongst top firms in our economy, as a large amount of executive compensation is stock based.
In Figure 1, the yearly totals are separated by whether the firm was in the financial sector or not. Firms in the financial sector tend issue new shares at a much higher rate as they participate in mergers and acquisitions more frequently. There was a spike in net issuances following the 2008 financial crisis, as failing firms were “bailed out” by the federal government by issuing new shares that were then purchased.
In Table 2, the data is broken down over the past two decades and grouped by North American Industry Classification System (NAICS) sectors. Manufacturing, Retail Trade, Information, and Accommodation and Food Services have the largest negative change in net issuances. This is explained by the increasing use of repurchasing shares in order to pay their shareholders.
The data show that, no matter how useful the theory deployed by economists and business leaders who support stock buybacks, among publicly traded corporations—which are the bedrock of the American economy—shareholders are extracting wealth, and that wealth is not flowing back into U.S. companies with publicly traded stock.
1. All data from the S&P Compustat database; author’s analysis.↩