We hear a lot of opinions stating how stock repurchases are a problem, yet no detailed explanation of why they are a problem. In tandem with low interest rates, both pose major issues for the US economy leading to the diversion of wealth to the top. In other words, wealth inequality.
One of the biggest reasons stock repurchases are a problem is because when companies spend their liquid assets to buy back their own stock, those funds do not go to infrastructure, capital improvements or employee wages. In fact, much of the time employee wages suffer for the sake of diverting money to buying back stock.
Why do companies focus so much on stock value, when it has little or no correlation to profit margin? Mostly because for many years corporate executives have received stock packages as part of their compensation. Sometimes the stock packages can actually exceed their wages. Stock packages as compensation are not taxed when disbursed to the recipient. They are not taxed until the stock is sold. As a result, corporate executives are more than willing to sacrifice profits, employee wages/benefits, capital maintenance, improvement and repair in order to artificially increase stock value. If the stock value increases, so does their wealth.
Now, you may think that this is fine because they will have to pay taxes on any accumulated wealth when they sell the stock. That’s not exactly true, either. As a general rule, what they are likely to do is buy other investments immediately, once again deferring taxation. Even if they cash out stock entirely, it is taxed at the capital gains rate, which maxes out at 20%.
The damage and denial to employees via denial of wage increases, increasing employee cost of insurance or complete cancellation or raiding of employee benefit programs is something which is never recovered for the many working for a company that engages in such behavior, which has become extremely common. If employees fall short on wages or benefits, the result is often debt to meet an emergency. Debt which can take years to pay off and can set off a chain of debt which they may never escape.
In addition to corporate executives, major stockholders demand making dividends and forced increase of stock values. This often leads to layoffs, wage reductions and loss of employee benefits as well. If they get what they want, this is why CEO’s of failed companies are given massive bonuses voted in by corporate boards, even as the company declares bankruptcy.
Low interest rates have been contentious for many for several years now. This is considered by many, including myself, to be a form of continuous quantitative easing. What it means is that financial institutions can borrow money from central banks at very low rates, all the way down to 0%. In some cases, the financial institutions are the stockholders. In other cases they can then loan money to corporations at extremely low rates to fund stock repurchases.
This leads into a cycle where the corporation borrows money to repurchase stock, increasing stock price. Now they have a debt to pay. Company profits are then used to pay the debt, rather than used for wages, improvements, etc, same as mentioned above. The company may state a certain profit but not mention that that profit is before making payments on outstanding loans. Of course, the loan allows them to maintain a certain level of cash on hand, obscuring the fact that the company may be deep in debt. Long as the stock price looks good and continues to rise.
Just this week, stock prices have been climbing after falling for a month. Not enough to overcome the losses, so the stock market has still lost nearly 1700 pts in only one month. The reason for the rise was the Federal Reserve Bank stating they may decrease interest rates soon.
At the same time that stocks are rising again, so are precious metals. Historically, stocks and precious metals are on a negative feedback mechanism, where if one rises the other falls. This alone is a clear indication that stocks are rising via stock repurchasing. Outside investors are diverting their funds to precious metals, which are far more secure. Generally if investors do not invest in stocks, they move to bonds, which are more mobile than metals. This is an indication that investors are now setting in for a long decline in the stock market and business climate. They do not see stocks or bonds as safe or profitable.
Until the early 80’s under Ronald Reagan, companies buying back their own stock was illegal for exactly the reasons detailed above. Because allowing them to do so allowed them to manipulate stock price at the expense of the actual business, employees and even outside investors. The thing which limited the practice organically for many years was the balance of using available cash versus taking on debt with loans. Since 2008, the debt from taking on loans and paying interest on those loans has been nearly nonexistent.
If liquidity runs dry, companies have one of two options. Sell off stock, driving stock value down. Of course, the first to sell off the stock while it is at peak will be corporate executives. Any punishments fail to ever equate to the profits made. Or the company can declare bankruptcy. Not because the business is not profitable but because of losses in stock value.
The result for outside investors, employees, contractors and debtors is the same- they lose. Mass layoffs and loss of benefits. While executives walk away richer than ever.