Senators Chuck Schumer of New York and Bernie Sanders of Vermont want to penalize “self-indulgent” corporations that buy back their own stock. In a recent article in the New York Times, they argued that when companies repurchase shares, not only do the vast majority of Americans not benefit, but income inequality is exacerbated since only wealthy shareholders and corporate management profit.
Despite decades of extraordinary success that the United States has enjoyed and that we enjoy today, Schumer and Sanders believe that something sinister is taking place in the corporate world. They call buybacks a form of “corporate self-indulgence.” Why? Because
corporate boardrooms have become obsessed with maximizing only shareholder earnings to the detriment of workers and the long-term strength of their companies. . . . Companies, rather than investing in ways to make their businesses more resilient or their workers more productive, have been dedicating ever larger shares of their profits to dividends and corporate repurchases.
Now even some Republicans are getting on board. Florida senator Marco Rubio has suggested changes in the tax law to discourage buybacks because he says they “inflate” the prices of stock “at the expense of future productivity & job creation.”
These senators don’t seem to fully understand that the purpose of a business is to allocate resources in a way that maximizes per share results over the long run. To think that this can be achieved at the expense of workers, at the expense of investing in research, at the expense of developing new and better products, at the expense of investing in equipment to both lower the cost and increase the quality of production, etc. is sophomoric. This underscores their lack of knowledge about investing and financial markets.
Companies have several options with regard to the use of excess cash. They can (1) retain the funds in the company, (2) invest in the capital needed to grow the company, (3) make acquisitions, (4) pay out the excess cash in the form of dividends, or (5) repurchase shares from existing shareholders.
These senators see little value in share buybacks, but they should listen to Warren Buffett, who is unequivocally a long-term investor. His financial success is a result of making exceptional long-term investments in resilient companies. Unlike Schumer and Sanders, Buffett is an enthusiastic proponent of utilizing excess cash to repurchase shares when conditions are favorable (or opportune).
Here is what he said in his 1984 annual report: “The companies in which we have our largest investments are all engaged in significant share repurchases at the times when a wide discrepancy exists between price and value.” He has made this point repeatedly throughout the years. These companies repurchase shares and continue to grow, continue to invest in research, in capital that will improve the quality and lower the cost of products. He has even bought back $1 billion of shares of his own company, Berkshire Hathaway, not because he is “self-indulgent” but because he thinks the firm is undervalued.
Schumer and Sanders—and in some cases they are joined by Rubio—provide two main reasons we are in a stock buyback “crisis”:
First, stock buybacks don’t benefit the vast majority of Americans.
Second, when corporations direct resources to buy back shares on this scale, they restrain their capacity to reinvest profits more meaningfully in the company in terms of R&D, equipment, higher wages, paid medical leave, retirement benefits and worker retraining.
The first point is utter nonsense. More than 100 million average Americans own stock. Americans invest in mutual funds and index funds and buy and sell stock every day. Tens of millions more have 401K plans, and most union pension funds have hundreds of billions of dollars invested in stocks.
The second point is equally absurd. A corporate board of directors is elected by shareholders, the owners of the company. When a board makes the decision to repurchase shares, it is a sign of confidence in the firm’s long-term profitability. It raises share values, which obviously benefits shareholders and puts firms in better financial shape — which also benefits the employees. Essentially, Schumer and Sanders believe, and Rubio seems to believe, that they have the right to tell the owners of a corporation the best way to allocate their profits.
Studies show that firms that buy back their own shares have strong long-term growth.
Consider Apple. It has become the most valuable company in the world. This exceptional success was achieved because of the enormous investments they made to develop revolutionary products. Companies cannot develop revolutionary products by underpaying talented workers or without investing billions of dollars in research, factories, and equipment. Not incidentally, Apple has repurchased billions of dollars of its own stock.
The hyper-competitiveness and efficiency of U.S. companies is a major reason that unemployment is at a near 50-year low. Today, no company can survive if its workers are treated poorly. Walmart, which Schumer and Sanders attacked in their article, and many other companies recently raised their wage rates substantially, starting with entry-level positions.
What is most disturbing about Schumer and Sanders’s proposal is their hubris in believing that they know how every company should handle its excess cash better than the CEOs, the boards of directors, and shareholders do. That is a rather all-encompassing statement. One would be hard-pressed to find a more vivid example of what Friedrich Hayek called “the fatal conceit,” the distorted notion that one knows more than is knowable. Would Buffett invest in a company if Schumer and Sanders were in charge of allocating its resources?
We doubt it. Who in their right mind would?
If approved, what Schumer and Sanders propose would not only hurt U.S. companies. It would harm the entire U.S. economy and financial system. It would raise the cost of capital for companies. What they advocate would tell domestic and foreign investors that our government is interfering with how companies allocate their resources.
What is the difference between going after a large company with lots of shareholders and a small company with one owner? How long before Senators Schumer and Sanders tell the tire-shop owner that he has not paid his employees enough and that therefore he has withdrawn too much of the profit as an owner distribution?
Every shareholder and business owner in America should rise up in loud protest against what these senators are proposing.
Thomas A. Smith is the president of the Smith Foundation and ran a successful investment company for 40 years. Stephen Moore is a senior fellow at the Heritage Foundation and an economic consultant with FreedomWorks.