Stock Buybacks, Corporate Executive Cashouts, and the End of the ‘Safe Harbor’ Rule?

Monday’s bold speech by Robert Jackson Jr., Commissioner at the Securities and Exchange Commission (SEC), will hopefully mark the beginning of the end for the stock buyback “safe harbor,” known formally as SEC Rule 10b-18. With an economy marked by record-high corporate profits but stagnant wages for most workers, it’s long past time for Congress and the SEC to take a hard look at these rules. In today’s political environment, an overhaul before 2021 is unlikely. Commissioner Jackson has, however, taken an important first step, declaring that the rules governing stock buybacks can and must be changed.

Commissioner Jackson’s office conducted new research that empirically demonstrates that corporate executives are authorizing buyback programs to inflate share prices and then turning around and selling their own shares for profit. They found that in the first eight days after a buyback announcement, insiders sell their own personal holdings at twice as many companies as usual. Most notably, executives are selling an average of $500,000 worth of stock per day—a five-fold increase as compared to the normal daily average of $100,000.

This has resulted in personal profit to insiders of $75.1 million in 2017 and the first three months of 2018—a figure that would be much higher if examined across all public companies in the U.S. (they limited their investigation to roughly 350 firms).

This is remarkable, because, in theory, companies are authorizing buyback programs because they believe their shares are undervalued. But rather than hold onto their company’s shares because buybacks will cause share prices to rise over time, executives take advantage of the quick bump in share price and sell for their own gain. As Commissioner Jackson noted in his speech, this weakens the rationale for paying executives in stock in the first place, a strategy intended to encourage them to care about—and invest in—the long-term health of the company.

What can be done? Most notably, Commissioner Jackson wants to open a comment period for Rule 10b-18, the ineffective and inefficient rule that purports to govern stock buybacks but instead gives companies free reign to conduct this extractive practice without fear of liability. This rule is out of step with other advanced economies, which place clear limitations around buyback activity and disallow insiders from selling their own personal shares in the time period around such activity. He specifically called to deny the safe harbor to companies in which executives cash out during a buyback program.

In the European Union, the U.K., and Japan, insiders are simply not allowed to sell their own shares within a certain period of time after buyback activity. Coupled with bright-line restrictions on how much money a company can spend on buybacks and mandatory, immediate disclosure of buyback activity (rather than a few months down the road), Commissioner Jackson’s proposed measures would go a long way towards reducing the billions spent on buybacks in America today—a sky-high trend driving our high-profit, low-wage economy.

Commissioner Jackson also called on corporate boards to reexamine the link between performance and pay. Boards should be required to approve the sale of shares and should have to disclose to shareholders why this activity is in the company’s long-term interest. If enforced, this too would go a long way towards reducing corporate behavior that prioritizes profits for executives over investments that serve the economic well-being of the company, all of its stakeholders, and our economy overall.

Meanwhile, if insiders (corporate executives and members of the board of directors) are lining their own pockets, what is happening to workers? Plenty of corporate boards and executives authorize billions of dollars in stock buybacks while claiming that they “can’t afford” to pay workers living wages.[1] Stock buybacks represent an opportunity cost for corporate profits (i.e., in theory, the funds spent on buybacks could have been used to lift worker pay instead).

We show that while buybacks have skyrocketed, real wages for non-supervisory and production workers have stayed flat. Below, we present data comparing the growth of net stock buybacks (stock buybacks minus new equity issuances, i.e., when companies issue new stock) versus the growth of real wages for the non-financial corporate sector for the years 2000-2017. We find that while stock buybacks totaled $3.6 trillion between 2000-2017 (in 2017 dollars), workers’ purchasing power stayed relatively flat. In 15 out of 18 years, real net buybacks were positive, and in all years but one from 2004 on, real net buybacks exceeded $100 billion dollars.

Meanwhile, real hourly wages for non-production and supervisory workers rose just $2—from $20.25 an hour in 2000 to $22.31 an hour in 2017 (in 2017 dollars). This comparison demonstrates the opportunity cost for working families when corporations choose to spend the majority of their profits on shareholder payouts—they can claim they have nothing left to reward workers who invest through their labor and create profits for the firm.

Forthcoming research will explore the broader relationship between stock buybacks and the impact on employees.[2]

Making the Case: Why Arguments for Stock Buybacks Don’t Hold Up

As stock buybacks skyrocket—Apple repurchased $22.8 billion worth of stock in the first three months of 2018 alone—the arguments made in support of this practice do not address the misaligned incentives for executives. Instead, they focus on a conventional model of capital markets, in which buybacks are simply a mechanism to shift money to firms that “really need it”. Here, we debunk some of the most popular arguments for why buybacks are a productive use of firm cash and present evidence that shows why they are actually a problematic feature of today’s high-profit, low-wage economy. It is worth examining the multiple arguments concerning buybacks because they will surely come up in the debate about reforming Rule 10b-18. Here, we address one of the most frequent claims: that buybacks serve to reallocate capital towards its best use. As we show below, the volume of stock buybacks has been much higher than stock issuances for most of the last 18 years, showing that funds are pulled out of the stock market rather than circulating within it, the latter of which proponents of buybacks inaccurately claim.

Proponents of buybacks make the misguided argument that stock buybacks are a mechanism by which companies that have no useful investment opportunities return money to shareholders, who in turn will use it to invest in new opportunities. For example, JPMorgan Chase CEO Jamie Dimon said last week that “when a company cannot use its capital, it gives it back to shareholders, who then redeploy it to a higher and better use.” Economist Justin Wolfers has also argued that “[s]hareholders will be eager to use their newly-returned funds to finance those companies with the most profitable projects. In this happy version, the buybacks channel money from firms with few profitable investment opportunities to those with better prospects. Investment rises and the economy grows more rapidly. And financial economist John Cochrane argues that critics of buybacks miss the notion that cash returning to shareholders and not spent on investment or wages inside one company gets recycled into investment in another company. That, they argue, is the whole point of capital markets.[3]

But these arguments do not stand up to the data: Proponents’ arguments rest on an assumption that companies are issuing new equity for shareholders to buy. If shareholders are simply trading equity among themselves on the secondary markets, those funds do not make their way back companies to be used productively. When we examine stock buybacks compared to issuances of equity, the data shows a different story: For all non-financial public corporations, cash is flowing out at a much higher volume than companies are issuing equity.

The chart above makes clear that the scale of shareholder payouts dwarfs equity issuances—in other words, shareholders are not simply taking the profits from stock buybacks and turning around and reinvesting those funds in public companies. This analysis is generated off publicly traded businesses, so it misses young, private companies. It could be argued that funding is going towards new startups, however, we see a declining rate of business startups in our economy today: Instead of increasing, the share of investment coming from new and small companies is actually declining. Further research will develop the question of whether buybacks are translating into increased investment in private companies.

Other work from Roosevelt has shown that this is not a story of funds from older firms being directed towards newer technology firms. Over the past 15 years, the share of investment from tech companies has steadily declined. Instead, tech industries have increasingly become sources of funds for the financial system. Payouts in dividends and buybacks from tech industries have actually increased more quickly than payouts from publicly traded firms in general.

Conclusion

The effects of buybacks on the American workforce are profound and will increase as the volume of buybacks increase. Proposed legislation, including Senator Tammy Baldwin’s (D-WI) “Reward Work Act” and Senator Cory Booker’s (D-NJ) “Worker Dividend Act,” would go a long way towards rebalancing our economy. However, these proposals are unlikely to move forward in the next few years. In the meantime, the SEC should heed Commissioner Jackson, take the initiative to reform Rule 10b-18, and replace it with a commonsense framework that would curb extractive buybacks that are used to line executives’ pockets and instead encourage long-term, shared prosperity.

^{[1] There is plenty of rigorous analysis that shows the divergence between worker productivity and compensation over the last several decades. See, for example, Economic Policy Institute’s Productivity Pay Gap analysis.}

^{[2] For a specific discussion on the impact of buybacks on Walmart workers, see Making the Case: How Ending Walmart’s Stock Buyback Program Would Help to Fix our High-Profit, Low-Wage Economy.}

^{[3] Professor Alex Edmans also makes this argument: “The idea that buybacks (or, for that matter, dividends) stifle investment is ‘partial thinking.’ It considers investment only in the company in question and ignores the fact that shareholders can reinvest the cash returned elsewhere… A restriction on repurchases could take us back to the 1970s, where CEOs simply wasted free cash on building empires—RJR Nabisco being a prime example—rather than paying it out to be allocated elsewhere. Repurchases allow shareholders to reallocate funds to young, high-growth firms that are screaming out for a cash injection.”}