What does a BIDEN Presidency look like?

[Threviel]

If the company had a particularly good year they would be wise to share the rewards with the employees. So they don't have to deal with those employees taking their skills elsewhere, if nothing else. But we might well be talking about different things here.

Bonus?

[The Minsky Moment]

So you are a leader of a corporation with excess cash that you don't have a useful way to reinvest.

Unless the company is a dying cash cow, how could it be that there are no useful investment options for a profitable company?

$100 spent on buybacks will result in stock appreciation of $100.

What is the mechanism that ensures that result?  If the company spends $100 on a buyback, it acquires stock worth $100 but loses cash worth $100.  It's a wash - EPS may tick up but it is offset by the loss of cash or increased leverage.  The selling shareholder(s) gets the $100 but what do the remaining shareholders get?  The transaction makes sense if and only if the company stock is undervalued by the market, and if there are no other better investment opportunities in the world.

The reason why stock prices tend to go up on a buyback is that buybacks are often interpreted as a signal from management (insiders) of their confidence in the company.  But sometimes it is perceived as a gambit and there is little or no effect.

Of course there are reasons as CEO you may prefer buybacks: your stock options become more valuable with a buyback, but less valuable with a dividend.

Now you've got your finger on the issue.  And that is why a left populist like Warren sees a target.

[alfred russel]

Unless the company is a dying cash cow, how could it be that there are no useful investment options for a profitable company?

There aren't any that exceed the working average cost of capital. Seems like a common occurrence...

$100 spent on buybacks will result in stock appreciation of $100.

What is the mechanism that ensures that result?  If the company spends $100 on a buyback, it acquires stock worth $100 but loses cash worth $100.  It's a wash - EPS may tick up but it is offset by the loss of cash or increased leverage.  The selling shareholder(s) gets the $100 but what do the remaining shareholders get?  The transaction makes sense if and only if the company stock is undervalued by the market, and if there are no other better investment opportunities in the world.

The reason why stock prices tend to go up on a buyback is that buybacks are often interpreted as a signal from management (insiders) of their confidence in the company.  But sometimes it is perceived as a gambit and there is little or no effect.

[/quote]

Theoretically the benefit of either a dividend or a stock buyback is getting cash that is unable to invested effectively by management out of the entity and to shareholders who can reinvest appropriately.

As a shareholder, I invest in a corporation making paperboard with expected equity returns of 10%. It has cash that is unable to be invested to generate sufficient returns to provide that return. It can hold the cash in money market accounts -- which is inefficient because they aren't a cash management company and that isn't what I want to be invested in (I invested in a paperboard company) --  maybe it could also invest in computer software, but I think we can all agree a computer software company might have better expertise to do that.

[alfred russel]

I think the IMF has estimated that about a third of US stock buy-backs are funded by bonds, so it's not always just cash-rich companies making this decision. Given that a significant proportion is being funded by debt I'm not sure that it's companies lacking a way to usefully re-invest as much as a preference for buybacks which have hugely increased in the last 20 years. In addition from studies done by groups like the IMF it is a large drain on corporate treasury.

Also shareholders' reaction would depend on the type of shareholder - shareholders that are holding as long-term investment (often included as part of employee schemes) benefit more from dividends than a buyback. Shareholders that are looking to or able to sell (pension funds, institutional investors, senior leadership/management) benefit from buybacks more than dividends.

But all of those benefit (some) shareholders of the company which is fine for the company to care about, from a regulatory/government perspective though I think it should be looking at what is the benefit to the economy. It's not clear there is one - so banning might be a bit strong - but I'd certainly look at tax incentives to make buybacks very unattractive compared to dividends or re-investment.

Debt is super cheap and readily available. I don't think it takes an Ivy League MBA to see that companies are going to want to shift their debt / equity ratio in this environment toward debt.

[crazy canuck]

While share bybacks might theoretically benefit a shareholder, if management does it like Buffett does - only use it as an option when he makes an assessment that the market value has undervalued the the share price.  A problematic proposition for those who believe the market is always right, but I digress.  In those limited circumstances shareholders are not harmed.  But of course the reality is that it is mainly used as a tool by the executives controlling the public corp to maximize their pay packages which have been designed to incentivize short term thinking, amply demonstrated by AF's example of it actually being a virtue to use cash for this purpose.  As Buffett has famously observed, corporate America shows an embarrassing record of doing exactly the opposite of what he does in their approach to bybacks.

[The Brain]

If the owners want short term thinking and even put bonus systems in place to achieve it, then why deny them this pleasure?

[The Minsky Moment]

Theoretically the benefit of either a dividend or a stock buyback is getting cash that is unable to invested effectively by management out of the entity and to shareholders who can reinvest appropriately.

Correct, but in the case of stock buybacks only the selling shareholders get the benefit of the cash.  The loyal shareholders who remain get nothing.

As a shareholder, I invest in a corporation making paperboard with expected equity returns of 10%.

I'm not familiar with the manufacturing process but is there no possible way to make the process more efficient?  No way to improve distribution or product quality?  Has paperboard manufacturing remained exactly the same for a century?

It's possible that the answers to some or all of those questions are yes but is that uniformly true for all companies that buyback shares?

In recent years, the companies with the largest buyback programs in terms of dollars were Apple and Microsoft.  Part of the reason is that they are such big companies that if they do a buyback it will look big.   But are these companies that really have absolutely no other investment possibilities?

[alfred russel]

Correct, but in the case of stock buybacks only the selling shareholders get the benefit of the cash.  The loyal shareholders who remain get nothing.

That isn't true. Imagine there are two groups of shareowners: call them A and B. Both expect 10% returns on their investment (the risk adjusted market rate for an entity such as this). The ownership is divided evenly between the two groups.

The company's value (absent excess cash) is $100. The company has excess cash of $100 - the returns of which are negligible.

The company's equity is worth $200. Each shareholder group thus has stock with a market value of $100.

If the Company keeps operating as it is, without a dividend or buyback, it will produce returns of 5% -- below market and neither investor will be happy.

If the Company buys back the stock of shareholder group B for $100, they then get the market value for their investment which they can reinvest to get a market rate of return.

Shareholder group A is left with a company with a value of $100 - and that will be the value of its equity (unchanged). But the company without excess cash should be able to produce the 10% returns that are expected by shareholders and in line with market rates.

Both groups of shareholders are made better off by the buyback.

[The Minsky Moment]

There was a recent story about how TSMC of Taiwan is spending $24 billion on a new chip fabrication plant in Taiwan.  That is no happening in the US.  There are fabrications plants in the US - TSMC built or is building two of them and the other major player is US registered company that is actually owned by Abu Dhabi.  I'm not saying that a US company *must* be involved in building such plants in the US but they do have strategic value in an era of heightened conflict with China and there isn't any good reason why US companies shouldn't be involved in this kind of investment.  The money though substantial is no real obstacle - Apple alone spent more than three times that amount in share buybacks in 2019.

[alfred russel]

I'm not familiar with the manufacturing process but is there no possible way to make the process more efficient?  No way to improve distribution or product quality?  Has paperboard manufacturing remained exactly the same for a century?

It's possible that the answers to some or all of those questions are yes but is that uniformly true for all companies that buyback shares?

In recent years, the companies with the largest buyback programs in terms of dollars were Apple and Microsoft.  Part of the reason is that they are such big companies that if they do a buyback it will look big.   But are these companies that really have absolutely no other investment possibilities?

Absolutely there are ways to improve paperboard process and generate better returns for shareholders!!!

But there are diminishing returns to the investments that can be made, and at a certain point they will fall below the cost of capital. At that point it is counterproductive to continue investing, which results in excess cash being generated.

In my career, I've never seen a major investment initiative without accompanying projections of the effect on future cash flows and whether the benefits exceed the estimated cost of capital. I've probably seen hundreds of them. I'm sure that Apple and Microsoft are doing these analyses as well.

[The Minsky Moment]

Shareholder group A is left with a company with a value of $100 - and that will be the value of its equity (unchanged). But the company without excess cash should be able to produce the 10% returns that are expected by shareholders and in line with market rates.

You've just described the theoretical benefits to ROI of greater vs lesser leverage and not any specific benefit to share buybacks as a mechanism.  You could get the same result from a leveraged recap or an old fashioned MBO/LBO.

If Modigliani-Miller holds, changing the capital structure should not change value. In your example, EPS should go up as it typically does in a share buyback but there is greater risk because if the company experiences an adverse event - e.g. an unplanned global pandemic - it has no reserves and could be forced to liquidate assets.

[alfred russel]

You've just described the theoretical benefits to ROI of greater vs lesser leverage and not any specific benefit to share buybacks as a mechanism.  You could get the same result from a leveraged recap or an old fashioned MBO/LBO.

I didn't explain why a share buyback is a better mechanism for some corporations than a leveraged recap or an old fashioned MBO/LBO because I think that is obvious.

Companies sitting on cash that can't be invested in an efficient way need a way to return that to shareholders. I don't think we want a legal structure where companies are like, "well we've accumulated a ton of excess cash that we can't efficiently reinvest, time to find someone to do a leveraged buyout of our company!"

If Modigliani-Miller holds, changing the capital structure should not change value. In your example, EPS should go up as it typically does in a share buyback but there is greater risk because if the company experiences an adverse event - e.g. an unplanned global pandemic - it has no reserves and could be forced to liquidate assets.

Well no shit. Usually the capital structure of a company balances higher EPS from greater leverage versus higher risks due to greater leverage. But I don't think the way to ensure those decisions are appropriately made is to stop buy backs. If the government is concerned that corporate boards are not able to determine appropriate capital structures, perhaps a better reform is for the government to take control of the boards?

[The Minsky Moment]

and whether the benefits exceed the estimated cost of capital.

Which raises the question of how cost of capital is measured.  The debt component is pretty straightforward - and in recent years has been quite cheap.  But the equity component comes down to what percentage returns the company decides it should (or "needs" to) deliver to shareholders. If on a national basis the economy is run on the assumption that the private sector should do nothing unless the ROI exceeds 15%, you end up with an economy where equity holders earn very fat returns but where a lot of worthwhile investment projects that could return 12% (and employ people and purchase goods and services from other businesses) don't get done.  And that justifiably feeds into the belief of the Elizabeth Warrens of the world that there national economic implications to this kind of thinking.

[The Minsky Moment]

AR I think you just set forth a good arguments why dividends should not be tax disadvantaged as compared to other forms of corporate cash distributions.  Which is my personal position.

[alfred russel]

and whether the benefits exceed the estimated cost of capital.

Which raises the question of how cost of capital is measured.  The debt component is pretty straightforward - and in recent years has been quite cheap.  But the equity component comes down to what percentage returns the company decides it should (or "needs" to) deliver to shareholders. If on a national basis the economy is run on the assumption that the private sector should do nothing unless the ROI exceeds 15%, you end up with an economy where equity holders earn very fat returns but where a lot of worthwhile investment projects that could return 12% (and employ people and purchase goods and services from other businesses) don't get done.  And that justifiably feeds into the belief of the Elizabeth Warrens of the world that there national economic implications to this kind of thinking.

I'm the real world, I've seen wacc rates under 5% in some countries (we use different waccs based on country). Our auditors generally push back that they are too low. The bias is to go low for a long list of reasons.