From Peter Radford What isn’t said is often more telling than what is. The silence denotes either a disrespect for thorough analysis or an ignorance of issues beyond the ken of the speaker. Then, of course, a third option arises: that those issues are an embarrassment to the point being made and are thus best left unmentioned. For some reason stock buybacks appear to fall into such a zone of silence. There is some controversy currently about the topic because of the recent proposal to impose a very modest tax on stock buybacks here in the U.S. The usual arguments have been put forward to defend buybacks. Michael Mauboussin, who is head of something called consilient research in an arm of Morgan Stanley, recently wrote this in an op-ed for the Financial Times: “An essential role of
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from Peter Radford
What isn’t said is often more telling than what is. The silence denotes either a disrespect for thorough analysis or an ignorance of issues beyond the ken of the speaker. Then, of course, a third option arises: that those issues are an embarrassment to the point being made and are thus best left unmentioned.
For some reason stock buybacks appear to fall into such a zone of silence. There is some controversy currently about the topic because of the recent proposal to impose a very modest tax on stock buybacks here in the U.S.
The usual arguments have been put forward to defend buybacks.
Michael Mauboussin, who is head of something called consilient research in an arm of Morgan Stanley, recently wrote this in an op-ed for the Financial Times:
“An essential role of an efficient economic system is the reallocation of capital away from businesses with limited prospects to those with more potential. Buybacks facilitate this process, and nearly all of the proceeds are reinvested in the shares of other companies.”
All you need to know about the oddity of the topic is contained within these two sentences.
The first is a bland statement about the pros and cons of financial markets. Capital allocation is the central purpose of the activities of the myriad of actors collectively known as the financial system. We can argue about the success and failure of such a system, especially with the financial crash of 2008 still in our recent memories. Clearly the system is subject to major failures. Misallocation can occur with alarming frequency and force. Keeping what turned out to be a rotten and self-serving system afloat cost us all dearly. Its manifest flaws have never been addressed, and it is back to such self-congratulatory opinion as the Mauboussin piece. Self-awareness is not a strength on Wall Street.
With this said, it is the second sentence that ought to give us pause.
Buybacks, we are told, facilitate the process of capital allocation by withdrawing capital from businesses with “limited potential” and re-allocating it to other companies. Presumably these other companies have greater potential.
But that is not what happens.
The re-allocated capital goes back to shareholders very few, if any, of whom invested in the business now viewed as having limited potential. They bought their shares in a secondary market. They are very unlikely ever to have handed over capital to the business in question. They simply own shares. And shares do not, after their original issue, represent investable cash for a business. So the cash that is returned to a shareholder by way of a stock buyback scheme does not necessarily flow into the capital accounts of another business. It is far more likely to flow into purchases of shares of a business adjudged to produce a higher market rate of return for the lucky shareholder. The capital re-allocation that actually takes place is simply a re-balancing of stock portfolios, it is not the movement of capital from one business balance sheet to another.
The re-allocation argument is thus fatuous.
That deals with what was said.
Now to deal, once again, with what is left unsaid.
And here I am repeating myself, but the point has to be made.
It is the use of the word “return” that ought raise our suspicions.
Here is an example, taken from the same op-ed piece:
“While buybacks provoke rancour, dividends are viewed much more favourably. In both cases the company is returning cash to shareholders. But buybacks differ because of sorting, taxes and attitude.”
When, exactly, was this cash given to the business? To return something implies an earlier gift, donation, or transfer. But there has been no such gift. None. As I mentioned above, the shareholders who benefit from the buyback, are highly unlikely ever to have provided capital to the business. So there is no question of a “return”. This is simply financial-world jargon for the sequestering of capital on behalf a privileged group whose claim to ownership of that capital is based, not on a prior gift to the business, but on the basis of having bought in a secondary market a claim against the business. There is no return. There is simply a claim.
And that claim is based on the shaky and erroneous footing that, somehow, shareholders “own” the business. They do not. An incorporated business — the sort that might indulge in gifting capital to its shareholders — owns itself. This is a matter of logic. The business is incorporated. It then secures funding. The provision of capital comes, sequentially, after the formation of the business. Thus the business pre-exists the capital and is not owned by the capital providers. That this error has been sidelined by the law and financial practice through the years does not invalidate the logic.
People who have provided financing to a business are well within their rights, in our current system, to secure certain privileges in return for their cash gift. For instance, they can secure a claim against the cashflow of the business. That this, somehow implies ownership is a fiction that has become a fatal fact. That it transforms a gift from the business to sundry shareholders into a “return” of capital is an insult to everyone else involved in the livelihood of the business.
And this is the critical part left unsaid.
The deformation of thought that results from this fictional perspective on the excess cash within a business hides from view alternative uses for that excess.
The singular channel that the fiction imposes on the financiers means that they ignore the possibility of lower prices of the business products. This would “return” some of the excess to the people who keep the business afloat by buying its wares. Surely the consumers have a justifiable claim against the excess. Most economic theory would certainly support such a gesture.
Alternatively, some of the excess could be returned to the business’s workforce who, presumably, have contributed to its accumulation by forgoing higher wages. Their generosity surely deserves recognition as much as, if not more than, any shareholders whose commitment to the business is likely to be wafer thin and proven so by their keenness to take advantage of the gift of cash represented by a stock buyback.
It is no great revelation that the theory defending stock buybacks is part of a greater whole designed to provide capital owners with a privileged position in the pantheon of the activity we call business. This has become a pernicious problem and one in need of proper debate. If we are to tolerate private ownership of businesses, and I err in favor of such a thing, then we need to be honest about the implications and not hide the power and privilege such ownership can bestow behind false theories. We ought to measure it carefully and put severe limits on it to prevent distortions in capital allocation becoming endemic. Pretending that stock buybacks are a return of something — something never given in the first place — is preventing us surfacing that honesty.
It is thus upsetting that the op-ed I have been mentioning ends with this:
“Bashing buybacks may have political appeal, but financial literacy demands that their role, backed by substantial empirical research, be better understood.”
That ought to be more broadly based than a narrow and contrived peon to power and privilege. Ought it not?