Wall Street is countering Senate liberals Charles Schumer and Bernie Sanders after the two proposed legislation that would prevent companies from buying back their own shares until they raise their minimum wages to $15 per hour.
“True, wage growth remains soft by historic standards and secular trends that do not favor low-skill workers remain in force. However, we are not convinced that restricting buybacks is a sensible solution,” AB Bernstein’s chief U.S. equity strategist, Noah Weisberger, wrote in a note to clients. “Good companies buy back their shares.”
Household names including Apple, Walmart and Johnson & Johnson are the many that have announced multibillion-dollar share repurchase agreement over the last several years. Eighteen percent of corporate America reduced their outstanding share counts by at least 4 percent in the third quarter, which boosted their earnings per share, according to S&P Dow Jones Indices.
Such buybacks swelled to a record $1.04 trillion in 2018 between a historic bull market and a one-time tax boost from President Donald Trump’s landmark legislation.
It’s that surge in share repurchases that exacerbates inequality among Americans, Schumer and Sanders argued in their New York Times op-ed. Their reasoning follows that the owners of capital have seen their portfolios swell in value in recent years as corporate suites opt for short-term, self-serving buybacks while middle management and the working class toil through meager-to-flat wage increases.
Taking these claims in order, the senators hold that share buybacks don’t benefit the vast majority of Americans.
When a stock buyback occurs, a company chooses to use its excess cash to repurchase a predeteremined amount of its own stock. Repurchased shares are absorbed by the company, and the number of outstanding shares on the market is reduced. That has the effect of enriching those who’d then own a relatively larger slice of a company by making each share more valuable.
Even armed with statistics from Goldman Sachs it’s not difficult to see how this could widen the income gap between the nation’s richest and poorest households.
Source: Congressional Budget Office
“It is indeed true that stock ownership has become more concentrated,” Goldman’s chief economist, Jan Hatzius, wrote last month. The wealthiest 0.1 percent and 1 percent of households now own about 17 percent and 50 percent of total household equities, respectively, up significantly from 13 percent and 39 percent in the late 1980s.
“Over the past several decades, corporate boardrooms have become obsessed with maximizing only shareholder earnings to the detriment of workers and the long-term strength of their companies, helping to create the worst level of income inequality in decades,” the senators wrote.
According to the most recent Census data, the bottom 20 percent of households earned 3.5 percent of the nation’s income while the richest 5 percent kept 21.8 percent of the pie, down from 22.8 percent in 2016. Households in the lowest quintile had incomes of $24,638 or less in 2017, while the top 5 percent of households in the income distribution had incomes of $237,035 or more.
Others, such as Stanford Law Professor Laurie Hodrick, challenge that opinion and argue that the more socially prosperous thing to do is to return residual monies to investors in the form of buybacks and dividends. Such a move would ensure the healthiest companies have access to the capital they need to grow their business and maximize employment, she said.
“The irony is that the thing to boost economic well-being in the long term would be to channel the capital to where it will contribute most to long-term prosperity,” Hodrick said Tuesday. “If you really want a long-term, robust economy that will hire and pay workers, the best way to do that is reallocate cash to investors.”
Corporations have been on a hiring binge lately with robust nonfarm payroll gains in the past 12 months. The unemployment rate ticked higher to 4 percent in January and more Americans re-enter the workforce. On a year-over-year basis average hourly earnings rose 3.2 percent, consistent with the past few months and around the highest levels of the recovery.
The second claim made by Schumer and Sanders is that buybacks infringe on a company’s ability to reinvest in itself.
“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,” their column states.
Research and development spending as a percentage of GDP has remained largely constant in the United States over the past several years even with the surge in buybacks. Spending at businesses, government and higher education has hovered between 2.5 and 2.82 percent since 2005, according to the World Bank.
As of June 30, 2018, the top five cash holders of U.S. nonfinancial companies were Apple, Microsoft, Alphabet, Cisco and Oracle, five enormous technology companies renowned for their reinvestment and innovation.
At that time, capital expenditures — funds used by a company to acquire, upgrade, and maintain property, industrial buildings, or equipment — consumed the largest portion of cash flow from operations. Capital spending totaled $830 billion for the 12 months ended June 30, up 9 percent from calendar 2017.
“Buyback activity is, if anything, a complement to other corporate activities that are more long-term in nature,” Bernstein’s Weisberger added.
“When looking across stocks in the S&P 500, a company’s buyback yield tends to be positively correlated with R&D spending and employment growth. While the correlations are modest, at the very least, buybacks are not coming at the expense of these other activities in a systematic way,” he wrote.
Originally published at CNBC