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John Engle
John Engle
Articles (257) 

Sanders and Schumer Declare War on Stock Buybacks, Pt. 2

Their weapon of choice is completely ineffectual

February 08, 2019 | About:

Senator Bernie Sanders of Vermont and Senator Charles Schumer of New York recently proposed legislation that would restrict stock buybacks by companies. We discussed their proposal in a recent research note, laying out their goals as well as explaining why their arguments are faulty in their own right.

But that is not the end of the issue. The push to block or restrict share buybacks is fundamentally flawed on economic grounds, as well inevitably ineffectual.

The virtue of buybacks

It is important to understand that businesses reinvest capital when there is potential to see a return on that investment. If a company cannot find a good place to invest its profits, the best decision is usually to return it to shareholders, as former Goldman Sachs (NYSE:GS) CEO Lloyd Blankfein pointed out in a recent tweet:

“A company used to be encouraged to return money to shareholders when it couldn't reinvest in itself for a good return. The money doesn't vanish, it gets reinvested in higher growth businesses that boost the economy and jobs. Is that bad?”

Decisions to use extra cash to buy back stock or to issue dividends are based on companies’ acknowledgment they do not need the cash to fund their operations or growth aims. That does not mean companies never commit to unsustainable payouts. But those that do so inevitably face financial pressure, which tends to hurt the corporate executives and shareholders who are the supposed beneficiaries of such overly generous payouts. It is a self-correcting mechanism.

Hence, one of the key points of the Sanders-Schumer proposal, that buybacks were stifling useful reinvestment, falls flat on its face.

Would it even work?

It does not take long to recognize the proposed restrictions, even if written into law and rigorously enforced, would be totally ineffectual. That is because corporations have another way of achieving essentially the same outcome: dividends.

While gallons of ink have been spilled over the past couple decades debating the relative merits of buybacks and dividends, the focus is generally on how it impacts investors - and even then it tends to be an argument only over benefits at the margins. From the corporation’s standpoint, however, spending cash on reducing the share count or distributing cash directly to shareholders is, functionally speaking, the same thing.

Thus, if Sanders and Schumer get their way, nothing will stop the companies currently engaged in share buyback programs to switch to dividend payouts. The flow of capital is unchanged; cash goes from company to shareholders, just in a more uniform distribution pattern.

Reach exceeds grasp

Sanders and Schumer are not quite so ignorant of the workings of financial markets as to be unaware of the existence of dividends. In their op-ed, they note dividends could be used to circumvent their policy. In response, they suggest the policy could one day be expanded to encompass dividends as well.

One might well ask why they would not simply include dividends in their current policy proposal now. The answer is simple: While federal laws govern buybacks, dividends are under the auspices of state law and are thus beyond the power of the senators to influence at present.

The looming threat

Of course, the federal government has taken various powers previously reserved to the states many times in the past, so it is not beyond the pale to consider the possibility that Sanders and Schumer might one day make good on their threat to bring dividends under the sway of their notional legislation.

Thankfully, the prospect of such a tectonic shift in the regulatory framework of U.S. capital markets is a distant longshot. Still, the possibility - however improbable - is frightening. It could have far-reaching - and potentially devastating - impacts on capital markets and the broader economy.

Looking ahead

Investors should watch policymakers very closely in the months ahead. Their actions could prove the primary drivers of capital markets in these volatile times.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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Comments

batbeer2
Batbeer2 premium member - 1 week ago

Hi John,

By simply doing some cold objective analysis of the efects of these proposals, you might actually get some investment ideas out of your effort. Some might agree with Schumer and Sanders and some might not. There are other forums for that. Here's were I hope to find investment ideas.

So here goes....

If this legislation is passed ( I wouldn't hold my breath) it will be a bit of a problem for companies like Walmart and a big problem for say... Dillards. But not Microsoft, Apple and Costco. Amazon will have to adjust a bit but given the high revenue per employee and their ongoing initiatives to automate simple tasks, I suspect they will be able to adjust.

So in the grand scheme of things you end up with a policy that is a tailwind for companies like Costco and Amazon relative to companies like Walmart and Dillards. You'll notice I'm staying in the retail space here but we could take this discussion to any labor-intensive industry. E.g. wages of workers at Fedex will more closely resemble wages at the USPS. That could have some interesting effects. etc. etc.

You may or may not agree with the policy but it is more accurate to say Schumer and Sanders are attacking low wages (a policy which is a major driver of innovation) than whatever it is you are suggesting in this article.

just some thoughts.

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

There is no chance this legislation will pass. The reason is simple: There is no legal, practical or technical difference between investing in a company's own stock and making any other form of investment with the same proceeds. Yes, there are specific rules governing stock buybacks but the principle that management can decide whether, when and how much to invest will not be altered by political winds.

batbeer2
Batbeer2 premium member - 1 week ago

@Stephenbaker

You say: There is no legal, practical or technical difference between investing in a company's own stock and making any other form of investment with the same proceeds.

In my view the basic principle of investing is that you do not spend your cash but put it to work in a way that will generate more cash for you in future. Buying back stock is management returning cash to the owners of a business because they are unable or unwilling to put it to work.

In short, it is more accurate to say buying back stock is the opposite of investing than to say it is the same. Both can be rational decisions though, depending on price.

But I agree that this legislation is unlikely to pass.

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

Batbeer, I disagree; not sure how investing in your own company can be the opposite of investing. Allocating funds toward the highest risk adjusted return for the benefit of company shareholders within the premise of a company's operations is the mandate of management. Whether such allocation is to outside investment, R&D, new divisions, bolt on acquisitions, dividends or company stock is up to management - not the legislature.

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