Buyback Critics Are Not Letting the COVID-19 Crisis Go to Waste

Jesse Fried is the Dane Professor of Law at Harvard Law School and Charles C.Y. Wang is the Glenn and Mary Jane Creamer Associate Professor of Business Administration. This post was authored by Professor Fried and Professor Wang. Related research from the Program on Corporate Governance includes Short-Termism and Shareholder Payouts: Getting Corporate Capital Flows Right by Jesse Fried and Charles Wang (discussed on the Forum here)

Critics of stock buybacks, heeding Rahm Emanuel, are not letting a serious crisis go to waste. They found a way to blame repurchases for COVID-19’s economic fallout, and are exploiting COVID-19 to try to curb their use. But critics’ claims are faulty, and proposed buyback restrictions may well exacerbate COVID-19’s ill effects.

Buyback critics have long asserted that repurchases starve firms of cash, with little supporting evidence. But COVID-19 seems to provide a perfect poster child for the anti-buyback cause: bailout-seeking airlines. Citing a Bloomberg analysis that 96% of airlines’ total free cash flow over the last decade was spent on repurchases, critics blamed buybacks for the firms’ desperate plight. But this 96% figure is misleading. It does not take into account equity and debt issuances by airlines, which largely offset the cash paid out in buybacks. “Unfunded” payouts to shareholders were much lower.

During the last decade, for example, repurchases by the big four—American, Delta, Southwest, and United—totaled $43.9 billion. But our analysis shows that $37.5 billion of the $43.9 billion in buybacks was offset by equity and debt issuances. The remaining “unfunded” portion of buybacks was $6.4 billion, about 15% of total free cash flows. Dividends, which also return capital to investors—but oddly do not provoke the same ire as buybacks—were $6.8 billion. That left plenty for investment. CAPEX intensity—the proportion of revenues used for capital expenditures—doubled over the decade. Meanwhile, cash balances for the last five years fluctuated between $15 and $20 billion. These balances appeared adequate for reasonably foreseeable scenarios, even if not for a black-swan event like COVID-19.

Airline executives should be praised for returning cash to investors, not blamed. From a public-policy perspective, executives should not hoard cash for every conceivable disaster, no matter how remote. The expectation of future cash distributions is the only reason investors supply capital to firms, which in turn enables hiring, investment, and innovation.  If firms retained most free cash flow to be able to fully absorb blows from improbable events like once-in-a-century pandemics, enterprises would find it harder to raise capital from investors.

Moreover, the capital returned by public firms like the big four airlines can be—and often is—invested in private firms that hire workers and undertake investment. After all, private firms employ 70% of non-government workers and account for more than 50% of nonresidential fixed investment in the economy. If capital does not flow from public firms, there is less capital available for private firms. Japan is a good example of how pervasive cash hoarding by public firms leads to poor resource allocation and persistent macroeconomic stagnation.

To be clear, we are not defending an airline bailout—generally, taxpayer funds should not be used to cushion investor losses. And we believe that any government loan to a bailed-out firm should be conditioned on a suspension of repurchases and dividends until after loan repayment, as required by the recently-signed Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). Otherwise, the risk to taxpayers would be too high. But there seems to be little wrong with the level of airlines’ pre-bailout buybacks and dividends, which—apart from those funded by debt and equity issuances—approximated only 30% of total free cash flows.

Besides providing a pretext for bashing buybacks, COVID-19 has created fresh opportunities to seek limits on their use. Senator Elizabeth Warren, who co-sponsored a 2018 bill to ban all buybacks, tried to use the CARES Act to achieve a piecemeal implementation of such a ban. She demanded—unsuccessfully—that any bailed-out firm be barred from ever repurchasing stock, even after any government loan was repaid in full and taxpayers were no longer at risk. And presumptive Democratic presidential nominee Joe Biden recently called on every CEO in America to publicly commit to refrain from buybacks over the next year, out of responsibility toward employees. But if every public-company CEO were to make such a commitment, and not circumvent it by switching to special dividends, the result would be disastrous. At the end of 2019, public companies sat on approximately $5 trillion of cash, with some firms holding more than $100 billion each. If cash-rich firms were to refrain from distributing cash to investors, there would be less capital available to finance cash-strapped private firms that can hire workers, at a time when unemployment is skyrocketing.

The COVID-19 crisis is on track to become one of the nation’s worse public-health disasters and economic catastrophes. We must focus all of our energy and efforts on mitigating its terrible impact. We should not be distracted by misleading claims about buybacks, and reject ill-conceived proposals that would only make it harder for our economy to recover.

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