Testimony before the House Financial Services Committee Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets
October 15, 2019
By Lenore Palladino
Thank you, Chairwoman Maloney and Ranking Member Huizenga, for inviting me to speak today. It is an honor to be here. My name is Lenore Palladino, and I am Assistant Professor of Economics & Public Policy at the University of Massachusetts Amherst, a Fellow at the Roosevelt Institute, and Research Associate at the Political Economy Research Institute.
I join you today to discuss the causes and consequences of the rise of stock buybacks. Stock buybacks may sound like a technical matter of corporate finance: Why should it matter whether or not corporations repurchase their own stock? When a company executes a stock buyback, they raise the price of that company’s shares for a period of time, but the funds spent on buybacks are then unavailable to be spent on the types of corporate activities that could make the company more productive over the long term: investments in future productivity and in the workforce. Stock buybacks are one of the drivers of our imbalanced economy, in which corporate profits and shareholder payments continue to grow while wages for typical workers stay flat.
Stock buybacks are virtually unregulated, even though Congress has recognized their potential for market manipulation. Importantly, there are currently no meaningful limits to stop executives from using corporate money on stock buybacks to raise share prices for their own short-term gain. Executives are not required to disclose that they have conducted a buyback until the next quarter’s filing; meanwhile, there are no substantive limits to stop them from selling their own personal shares in the same quarter as they are conducting buybacks.
Stock buybacks have reached record volume: Corporations spent roughly $900 billion on them in 2018, and projections for 2019 predict an even higher scale. To put this into perspective, that is nearly a third of our national spending on health care. The volume of stock buybacks explains why more money has flowed out of our public capital markets than has flowed back in, for the nonfinancial sector, in almost all of the last 20 years. Their magnitude explains why even many on Wall Street are ringing warning bells, saying that executives are prioritizing stock price highs over the kinds of true investment that will lead to long-term prosperity.
Congress and the Securities Exchange Commission (SEC) recognized decades ago that this kind of practice could manipulate the stock market, and before 1982, open-market stock buybacks were functionally impermissible. Rule 10b-18, the stock buyback “safe harbor,” was a sharp departure from the proposals made by the SEC in the 1970s that clearly recognized that a large volume of stock buybacks would manipulate the market. Rule 10b-18 leaves stock buybacks virtually unregulated, allowing companies to spend billions a year with no oversight or accountability. This is out of step with the spirit of our securities laws, which is to “insure the maintenance of fair and honest markets.”
Some have argued that stock buybacks serve the stock market by moving capital from companies that have no use for it to companies with a higher need for new funds. This begs the question: Could it really be the case that so few American corporations have innovative ideas, could build up their cash reserves or pay down debt, or invest in their workforce? Or could there be another motivation for the high volume of stock buybacks? Additionally, more money has been flowing out of our public capital markets from stock buybacks than has been flowing back in through new equity issuances (for nonfinancial corporations). Rather than argue about how stock buybacks could recirculate funds around the public markets in theory, it is better to look at who stands to gain the most from their use in practice and what tools of public policy we can use to mitigate the focus inside corporate boardrooms on short-term stock returns at the expense of long-term productivity and prosperity.
This committee is well aware of the long-term stagnation of wages for typical workers, widening wealth gaps, and the continual rise of executive compensation. To give some context to who benefits from stock buybacks: According to the Federal Reserve’s Distributional Financial Accounts, in the first quarter of 2019, the richest 10 percent of households owns 86.8 percent of corporate equities; while the bottom 50 percent owns just 0.8—less than 1 percent of the total value of the stock market. Meanwhile, companies spending billions on buybacks claim that they cannot afford to pay family-supporting wages to their employees, who largely create the value that allows businesses to conduct stock buybacks in the first place.
Companies are conducting stock buybacks in the midst of layoffs, calls by their workforce for an end to poverty wages, and clear productive uses for corporate funds. According to economist William Lazonick, Boeing spent $43.1 billion on stock buybacks from 2013 to 2019, raising the company’s stock price to a record high just 10 days before the second crash of its 737 MAX. Boeing CEO Muilenburg collects most of his pay through stock or compensation based on financial metrics. Yet the company reportedly avoided spending the estimated $7 billion it would have needed to engineer a safer plane. Less than 10 years after a public sector bailout, GM has spent $10.6 billion on stock buybacks, while engaging in layoffs and plant closures. That amounts to $221,308 for each of the 47,897 active UAW members currently on strike at GM. Walmart spent $9.2 billion on stock buybacks from August 2018 to July 2019, which, by my calculations, could have been used to give a raise of roughly $5/ hour to each of its 1 million
hourly workers instead.
It is the lack of meaningful regulation of stock buybacks that has permitted their rise. SEC Rule 10b-18, the stock buyback safe harbor, gives companies the go-ahead to spend up to 25 percent of their average daily trading volume on buybacks without liability for market manipulation, but it also states that there is no assumption of liability for companies spending above that limit. Furthermore, the SEC does not collect the kind of information necessary to even determine if companies are staying within the safe harbor limit.
I recommend that Congress ban stock buybacks, or in the alternative, place bright-line limits on their use. At minimum, corporate insiders should not be able to personally benefit from the practice, and buybacks should be disclosed immediately.