So I got that goin’ for me

Dry a subject as you’d imagine they would be, buybacks have become a topic every bit as polarizing as some of our political discussions. No matter how nuanced your view, it will be auto-tuned to some extreme by the obedience collar-wielding ideologues on one end of the spectrum or the dog whistle-wielding ideologues on the other.

Even now, someone is preparing a “stop with the bothsideism – it’s just math” response without reading any further.


It’s not about the math.

Sure, in nearly all cases where companies buy back stock, in the narrowest interpretation of that specific action of buying back stock, is management acting ethically and in the interest of shareholders”? Almost universally yes, because math. In a nearly universal range of circumstances, stock buybacks evaluated independent of other considerations are a really good, really efficient way to return capital to shareholders to deploy as they desire. In a very real sense, it can represent a company delivering on its most fundamental duty to the people who trusted it with capital: returning it to them with greater value.

So why isn’t it about the math?

Because the questions being asked about buybacks go beyond “in the narrowest interpretation, is management acting ethically and in the interest of shareholders.”

Because what buybacks (and any form of return of capital) tell us in general about corporate opportunities and American willingness to take business risk to produce returns at a macro scale matters.

Because what that tells us about how central banks and other policymakers are artificially influencing the relative attractiveness of those investment opportunities matters.

Because the way in which stock-based compensation structures may be exploiting the general (and appropriate) approbation of stock buy-backs among investors in order to mask the appearance of higher tax-advantaged compensation matters.

Because the way in which financialization in general is squeezing margins higher and making markets as measured on a P/E basis less expensive-looking matters.

Because even if you don’t think these things are nearly as bad as buybacks are good (and they are good), if you don’t realize that Wall Street is losing this meta-game, you aren’t paying attention.

So when you read this article in the Atlantic today, I suspect you will probably respond (or already responded) like I did:

You will cringe at the predictable framing of the issue around Michael Milken for some damned reason.

You’ll have ammunition ready to dispute the conclusions, robustness and analytical quality of the Fortuna study.

You’ll wince at the loaded word choices. “Draining capital.” “Corrupts the underpinnings of capitalism itself.” Really?

You will be ready to highlight how comparison of buybacks to corporate salaries without applying the same logic to dividends, debt reduction or any other effective return of capital is cherry-picking bias meant to inflame a certain kind of reader.

You will read the closing paragraph, chuckle at its sheer cheek, and find your brethren in the break room, colleagues at other shops and followers on social media to laugh about its bias and absurdity.

And you’d be in the right to do so. It is. It’s biased. It’s absurd.

And yet, it is also worth remembering our oft-told tale of coyotes and raccoons.

You see, you and me? We’re the coyotes. We’re wise enough to understand that those jars of pennies the Wilton retiree is shaking at us won’t actually hurt us. We know we’re right about the math of this efficient return of capital that is buybacks, and we’re going to shout down all this terrible analysis until everyone realizes we’re right. We are too clever by half.

Those guys in boardrooms figuring out ways to take advantage of our charitable passion for this issue to immunize their non-cash comp? They’re the raccoons. And they will continue to succeed in skimming the cream off their artificial EPS beats as long as we’re so focused on arguing with the Gell-Mann Amnesia-ridden readership of the Atlantic about the obvious damn math of buybacks.

It’s. Not. About. The. Math.

If we care about maintaining the flexibility of corporate management teams to deploy and return capital flexibly and with the least interference by regulators and politicians – and we should – every moment that we spend as an industry debating and analyzing the math of buybacks instead of actively seeking out and rooting out raccoonish boards and management teams is an utter waste of time. The right to return capital in a very sensible way will be legislated out of existence (again) while we thump our chests about whether the data-set used in some dumb article properly accounted for survivorship bias.

This topic is firmly in narrative land now, folks, and if you’re playing this as a single debate to be won instead of the metagame it now is, you’ll lose. But at least you’ll be right. So you got that going for you, which is nice.

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  1. Brilliant writing and analysis Rusty. Hard to believe that you are raising your already incredibly high bar. Best explanation of the meta game around buybacks I’ve read - well done.

  2. Plus 1…even I understood Rusty’s explanation and I’m the slowest of the pack members.

  3. Correct me if I’m wrong but buybacks sole purpose seem to be to return capital while avoiding taxes(unlike dividends). Unless I misunderstand (please tell me how, I probably am), this doesn’t seem like just a meta game fail, but just a loosing argument.

  4. Hmmm, I believe the record shows that, on average, corporate management buys back shares at the highs and issues shares at the lows.
    Rusty, I get you point and do desire freedom vs regulatory control but help me understand why this isn’t corporate malfeasance?

  5. Avatar for CMG CMG says:

    So the million-dollar question – how do we root out the raccoon boards/management?

    Attempting to invest based on governance gets you into ESG territory (which has all of the charm noted in Demonetized’s Kobayashi Maru note).

    The voices on either side of the debate are louder and have far more Twitter followers than most of us will ever have, so a publicity push seems hard.

    The math does work, and in the case of executive X using buybacks to “beat” estimates and increase share price, other shareholders benefit, making the broad-based shareholder pushback difficult.

    How do we fight the raccoons without using the Fatcat Executive, Ban Buybacks narrative?

  6. It certainly doesn’t make the argument more compelling, However, if the buy-backs were at least sourced from productive activities, you could argue that there is some broader societal benefit at play (R&D, better/cheaper stuff, employment, something). When it’s just an empty game…the argument is as you point out awful.

  7. I’ve seen datasets and analyses which, depending on assumptions, horizons, etc. show very different outcomes for buyers-back. But let’s accept your premise as a given. Even so, bad decisions alone aren’t malfeasance. And outside of compensated related maybe-kinda-sorta malfeasance, there isn’t an appreciable monetary difference between buybacks and dividends, so what we’re really talking about here is separate from what they are - it’s how they’re able to be used. They have the appearance of something more sinister, aided by the reality of their use in immunizing non-cash comp, and that’s what’s got regulators’ hackles up.

  8. I’m not 100% sure that I follow you, Michal. What is the losing argument you’re referring to, and on whose part?

  9. Thanks, Mark!

  10. Totally fair question. What do you think?

  11. It IS awful! But it’s not awful because of the buybacks per se, but because of the financialization impulse that underlies their particular use in this way. Financialization would still thrive without them. Root out the source, I say, not the method of conveyance du jour.

  12. Really, It seems the only way is to avoid investing in companies run by raccoons. That’s far from perfect, either on the identification or effectiveness front, but I’m at a loss for ways to sort this out short of a consistent record of efficient and shareholder friendly capital allocation

  13. You wrote about the Math argument. i.e. “It’s. Not. About. The. Math.” This implies to me that there is a rational mathematical argument for NOT banning buybacks. (The argument against banning them that seems to convince me personally is not mathematical but rather the liberty argument). So I’d like to understand it better. I’m a mathematician(not finance) by training so it’s interesting me.

    Well the strongest form of the math argument as best as I understand it,

    1. buybacks are the same as dividends.
    2. buybacks offer tax advantages.

    If one were to accept this:
    The first is a loosing argument(as in it won’t convince many people) because it shows that we literally don’t need buy backs, as they serve no purpose. We already have dividends.

    The second is an argument against buybacks, because it will get reworded as investors(i.e. “the rich”) use them to avoid taxes.

    So it seems to me that not only is the math argument a narrative failure, but can be used to reach the opposite conclusion.

    So, the conclusion I seem to come to is that either, I understand the math argument, and those who argue from that angle, don’t understand much of anything really, or I’m missing part of the math argument.

  14. My 2 cents, for whatever they are worth.

    It sounds like you are looking for a perfect rule. I find these types of questions easier to answer if there are specifics. E.g. Buffets investment in coke(and how they recently spent lavishly on management). I don’t pretend to know the whole story, so substitute in another company if it helps. Would you invest in Coke? Under what circumstances? Could management do something that would change your mind? You won’t get a perfect top down rule, but after repeating the process you might come to some conclusions.

  15. I see what you are saying now, thanks!

    The math argument is not, however, that ‘buybacks are the same as dividends’, but that they are effectively the same from the perspective of calculating ‘how much capital is being returned to shareholders.’ There are meaningful non-mathematical differences, even beyond any tax considerations. Most important of those differences (at least in my opinion) is that management teams are rightfully concerned that return of capital characterized/structured as a dividend tends to impact value based on the common knowledge expectation of their consistency and continuation. This is a common tenet of a variety of investment strategies, so their belief is not at all unfounded. It is narrative management, but not necessarily perniciously so, or any more than any other million techniques available to management to present its results in a way that tells a particular story.

    More importantly, I think, the fact that two methods of returning capital largely achieve the same mathematical ends doesn’t produce the conclusion that we ought to ban one. It is just as easy, for example, to make the argument that there are entire sub-asset classes of equities which effectively and over long periods of time finance dividend payments in the debt markets, and that there are financialization-related distortions embedded there, too. Shall we ban dividends because many companies make objectively bad capital allocation decisions in order to keep the dividend-oriented narrative stable among portions of their investor base?

    There ARE non-cash compensation abuse issues that are somewhat unique to buybacks in a tangible sense, and plenty of narrative management issues (as highlighted in the article). The latter is a call for clear eyes. The former? Well, I make my point expressing concern with that the concluding point of the brief above. I simply think that banning buybacks because they’re sometimes used for these more nefarious purposes is like banning VPNs or cryptocurrency because they are methods/venues often used in illicit trades: a coercive, freedom-reducing decision by the state that would be better directed toward curbing the bad activity directly.

    But banning IS where we’re headed, and it’s our own metagame when talking about it that we have the most control over.

  16. Not to be fatalistic (and it sounds like we’d agree on this), but I wouldn’t expect it to be any more successful than most ESG initiatives have. Because the idea is to avoid state intervention, the most promising idea I can come up with is the pressing of proxy voting services and large asset managers to more aggressively promote (1) expanded restriction windows on post-buyback sales of stock by management and (2) elimination of all per share metric-driven compensation structures for executives.

    But I AM fatalistic. Our industry could offer this olive branch, but there are too many strident defenders of ‘the math’ to think it even makes sense to consider these things as part of a metagame to maintain depth of options for corporate return of capital.

  17. Avatar for CMG CMG says:

    I’d agree with two things mentioned so far: voting with dollars and proxies.

    Michal’s idea of attempting to sort out a decision-making framework to see if patterns emerge around what constitutes raccoon management is interesting. The challenge, as noted, is finding a “rule” through the noise. Take egregious comp, for example – nobody needs $30MM to pay the electric bill, but if s/he is a good steward of the business, is comp the hill to die on? Though maybe this is a case of, as Justice Stewart said, “I know it when I see it.”

    Secondly, in an ideal scenario, proxies would drive behavior. But I, like Rusty, am fatalistic about the potential here (I tend to say “realistic,” but let’s call a spade a spade). The math works in asset managers’ favor, and if it ain’t broke, don’t fix it.

    The Maths vs. The Fatcats is the heavyweight battle we’re all going to be unfortunate to watch. In the meantime, I’ll vote with my investment dollars and keep working with the Pack to find a better way.

  18. Great discussion. However, there’s an implicit bet here being made that regulators and public institutions even would consider wading into the topic with clear eyes. The last time this circus came to town were we left with solutions or more problems? And since then, have these institutions and regulators become more or less corrupt/partisan/politicized? And this isn’t new, it goes all the way back to post Great Depression deposit insurance protections having been slowly eroded since the 30’s, with a steroid cycle of additional moral hazard post GFC.

    Could we have some version of state intervention explicitly limiting buybacks through x,y,z mechanism? Sure, of course. But it’s not going to be because someone did the math right or did the math wrong, or heard a really compelling argument from governance authority, or any of that. It would be pure politicking.

    The army of raccoons in boards has been insulated by QE forever and moral hazard which led to financialization and higher share prices, passive asset management gathering gobbling up active management.

    I like Rusty’s potential solutions, but proxy voting advisors are typically inept at their jobs, and if you don’t think politics plays into it at ISS and Glass Lewis then you’re the sucker. And I see the other suggestions as the output of a rigged roulette game. They are possible, and of desirable, but without knowing who is loading the roulette wheel, we can’t predict the outcome.

  19. I hate to disagree, math matters. A great example is Encana’s growth strategy in Q2, 2010. New drilling, fracing & seismic technologies were revolutionizing the hydro carbon industry. They had great properties that could support years of volume growth. They announced that they would spend more than annual cash flow (run up debt on the balance sheet) to increase volumes of an undifferentiated product (natural gas) and deliver it into a market that was already capacity constrained: the same technology was opening non-conventional gas in the Marcellus Shales. Transportation differential pushed Cdn gas out of the largest Cdn gas market, Ontario.

    AECO gas has periodically gone negative: no exit capacity. Encana’s view (as I recall) was they were the low cost producer, they’d push other producers out of the market. They were low cost in their basin, but their basin was not low cost. The butchers bill is measured in the billions (lost track of the total at around $7 billion) of shareholder value destroyed, the damage to employees and their families is much worse.

    In the case of Encana, growth for growth’s sake was a tragic management decision. Using term capital (debt) rather than internally generated cash flow magnified the damage of management’s growth initiatives.

    If growth cannot be supported by demand growth, return capital to shareholders.

  20. Avatar for CMG CMG says:

    I can’t read the indentations to tell if you’re responding to another comment. In either case, this is a great example in support of Rusty’s point. Buybacks can be a great (in this case, mathematical) solution to return capital to shareholders, which seems to be the prudent step Encana should’ve taken. The unfortunate part is that raccoon management teams will use buybacks to enrich themselves, manipulate shares outstanding to hit EPS targets, etc. This abuse of buybacks needs to be reduced/eliminated in order to weaken the populist narrative-based arguments against buybacks, allowing them to continue as a useful tool for the return of capital.

  21. Yep!

  22. I don’t disagree with anything you’re saying, Sandy. There are lots of reasons that I think we are creating incentives for management teams to return cash even when that ISN’T going to be optimal for shareholders. I think you are pointing out a good one. The point isn’t that the math of ROI doesn’t matter. It’s that the math of whether buybacks are meaningfully different or not from dividends or other methods of returning capital that is a waste of our time in the face of important issues like the one you raise.

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