For years, companies have been engaging in a practice of repurchasing their shares
in order to drive up stock prices and buoy demand.
While largely an American phenomenon, buyback activity in Japan has been at record highs,
while the trend is also on an uptick in Europe, China and emerging markets.
As markets get volatile and rescue plans are needed to save these companies,
the practice of stock buybacks is receiving scrutiny.
So what are buybacks, and why do they cause such mixed reactions?
Let’s say a company has made 100 lots of its shares available in the open market
which are then bought by retail investors
and professional traders.
A stock buyback happens when a company uses
the excess cash it has on hand
to buy back some of these shares in the marketplace
in order to drive up the price of its stock
and increase overall demand.
While stock buybacks happen across major bourses worldwide, American companies have been
leading the way, with almost $1 trillion worth of such deals in 2018.
That was driven partly by President Trump’s tax reform,
which lowered the corporate tax rate from 35% to 21%.
Flush with that extra cash, some companies chose to spend it on buybacks
to enhance shareholder value, instead of reinvesting it in creating jobs or on their employees.
Apart from Japan, buyback activity outside the U.S. has been limited
mainly because of investor appetite for dividends, legal restrictions,
and the focus on reducing debt levels.
Across the Atlantic, European companies spent around $150 billion on buybacks in 2018
or about 6% of their cash, compared to 25% - 30% in the U.S.
In Japan, $52.5 billion of buybacks were recorded in the same year,
encouraged by investors and sluggish performance of Japanese stocks.
But why is this contentious when most big companies, including BP,
Royal Dutch Shell, and Aviva engage in some form of buyback activity?
When a company has excess cash, it usually invests the money back into its own business,
pay dividends directly to shareholders, or it can buy back its own stock.
Critics of buybacks say that companies are inflating their stock prices artificially.
The practice is usually seen as diverting the use of cash from other important investments
such as higher employee wages,
building more factories,
creating more jobs, and innovation.
Company executives who are compensated
in stock ownership also stand to gain from buybacks.
Low interest rates have also encouraged buybacks fuelled not by cash,
but debt, which makes it precarious
for companies during a recession.
However, buyback supporters argue that
money gained by shareholders is usually reinvested
in other companies and spurring growth in the economy.
Proponents of the laissez-faire approach
also argue that investing that excess cash internally,
such as higher wages for existing employees,
may affect a company’s competitiveness,
especially for older companies with high cost structures.
This may eventually cause companies to shrink and prevent the creation of new jobs.
Nowhere is the practice of stock buybacks more evident than in the airline sector
as the pandemic casts a long shadow over the economy.
In the past five years, five of the largest U.S. carriers doled out $45 billion to investors
mostly in the form of stock buybacks.
Europe’s largest budget airline Ryanair has also halted its share buybacks
while Australia's flag carrier Qantas has shelved similar plans.
With much of the global economy coming to a standstill,
governments are coming to the rescue
in the form of bailouts and subsidies.
However, there are caveats.
The European Banking Authority has demanded that with their pay-out assistance,
all EU banks should stop dividends and share buybacks.
Eiopa, the European Union’s insurance regulator, has also called
for insurance companies to halt dividends and share buybacks.
This will affect a few big companies like Allianz and AXA
both of which have share buyback programs.
In Washington, lawmakers are also demanding tougher conditions
for companies seeking federal aid, with U.S. President Donald Trump chiming in too.
Will you guarantee that the money, the billions, the tens of billions of dollars,
hundreds of billions of dollars even, that’s going to go these industries,
will not go to executives’ bonuses, or to more stock buybacks?
Well, we don’t want that.
In fact, some companies as you know, did stock buybacks, and I was never happy with that.
Under pressure from regulators and politicians, some companies are taking heed of the backlash.
Major corporations such as Royal Dutch Shell, Ryanair, HSBC and Barclays
are scrapping their plans for buybacks and dividend pay-outs
as stockpiling cash takes precedence.
Notably, Japan’s SoftBank Group, which has seen its share price plummet
amid the market selloff following the coronavirus pandemic, is bucking the trend.
SoftBank, which has stakes in numerous unicorns like Slack and Uber
plans to embark on an ambitious stock buyback.
With unemployment numbers surging worldwide, the focus is on reversing that trend.
In the first quarter of 2020, China’s official unemployment rate hit 5.9%, or 26 million people
while unemployment in the United States rose to 4.4% in March.
According to the International Labour Organization, the pandemic may claim as many as 24.7 million jobs.
While the practice of stock buybacks isn’t likely to go away anytime soon,
many companies are hitting the pause button.
As the pandemic rattles the global economy, lawmakers worldwide are calling for bailouts
to come with strings attached
meaning it’s likely that buybacks will continue to remain under scrutiny for a while.
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