2/17/2021 Bailouts Might Bring Bans on Stock Buybacks. Here’s What It Means.

| Barron's

INVESTING

Bailouts Might Bring Bans on Stock

Buybacks. Here’s What It Means.
By Evie Liu March 20, 2020 7:10 pm ET

Stock buybacks are expected to

decline this year as American
companies hit hard by the
coronavirus outbreak seek to
conserve cash. Government
bailouts could limit the total further.

Already, the nation’s eight major

banks have said they will suspend
Photograph by Pepi Stojanovski
their stock-repurchase programs
through the second quarter in an effort to support “customers, clients, and the
nation’’ amid the pandemic. The move could be followed by other industries,
especially those with deeply disrupted businesses such as energy and travel
companies.

Companies’ need for cash and the possibility that federal bailouts could include
temporary buyback bans have renewed the focus on repurchases–a key driver of
the bull market over the past decade.

Here is a Barron’s guide to buybacks and why they are controversial.

What are buybacks?

Buybacks happen when a company buys back its own stock from the open market,
which reduces the number of outstanding shares available. The share price can go
up as the supply goes down.

Why do companies buy back their own shares?

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2/17/2021 Bailouts Might Bring Bans on Stock Buybacks. Here’s What It Means. | Barron's

There are lots of reasons. Sometimes companies repurchase their own shares as a
form of investment. This happens when management sees its own stock as
undervalued and believes that prices will go up in the future. Sometimes a
company wants to demonstrate that it has plenty of cash, boosting investors’
confidence and the valuation of the stock.

Companies also use buybacks to increase earnings per share and buttress the
value of the shares. By reducing the number of existing shares, buybacks make
each one worth a greater percentage of the company, so a higher proportion of
earnings are allocated to each share. If the market maintains the same price-to-
earnings ratio for a stock as prior to a buyback, share prices will go up, rewarding
shareholders.

Share buybacks can also prevent investors from taking a controlling stake in the
company, or give management stock options to distribute as compensation.

How much stock did American corporations repurchase last year? How does
that compare to history?

Stock buybacks within the S&P 500 index totaled an estimated $729 billion in
2019, down from a record $806 billion in 2018, but still much higher than 2017’s
total of $519 billion.

On relative terms, the S&P 500 companies’ 2019 buybacks accounted for about 3%
of the index’s total market value, slightly higher than the 15-year average of 2%.

Why are buybacks controversial?

There are a few main areas of concern.

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2/17/2021 Bailouts Might Bring Bans on Stock Buybacks. Here’s What It Means. | Barron's

• Buybacks represent short-term thinking, critics say, as they use up cash that
companies should be spending on innovation, investment, or emergency
preparation.

• Buybacks artificially lift stock prices and earnings per share, while adding no real
value to the business. Shareholders and management benefit, using money that
could improve product offerings, hold down prices, or augment employees’
benefits.

• Companies don’t necessarily buy back their own stock at cheap prices,
especially as the stock market kept climbing higher over the past decade.
Buybacks may not be the best use of capital.

• Some companies have been drawing down their cash balances or even taking
on debt to fund stock buybacks. That can be risky, especially if the economy
runs into trouble.

• Some company executives have their bonuses tied to the stock price or earnings
per share. Buybacks can be used to inflate those numbers artificially, boosting
their pay.

What is the link between buybacks and bailouts?

A number of industries have been hit hard by coronavirus-triggered disruptions.

Struggling companies–including airlines, hotels, and oil producers–are asking the
federal government for help. But many are facing criticism for spending too much
cash repurchasing their own shares in recent years, which has depleted corporate
capital and left the company ill-prepared for a crisis like this.

Some lawmakers in Congress have been pushing for protections to ensure that the
government bailout money doesn’t go toward executive bonuses or more stock
buybacks, but to benefit workers and the broader economy. During a press briefing
on Thursday, President Donald Trump said he is open to imposing conditions on
companies that receive federal aid in the coronavirus crisis, including a ban on
stock buybacks.

The president said some companies have been buying back stocks over the course
of years at higher prices, and that he will view those businesses differently than
those that built plants all over the country. The federal fiscal stimulus package–
expected to top $1 trillion in spending–is still under negotiation.

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2/17/2021 Bailouts Might Bring Bans on Stock Buybacks. Here’s What It Means. | Barron's

Trump has been criticized for a record-setting buyback spree that followed his
2017 corporate-income tax cut, which prompted the repatriation of billions of
dollars previously parked overseas. Critics say most of the cash wasn’t used to
build factories, reward employees, or for other capital spending, but to repurchase
companies’ own shares.

On Thursday, Trump said he was “never happy” with stock buybacks, but that the
practice was difficult to prevent.

Write to Evie Liu at evie.liu@barrons.com

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