I saw this work of art on Twitter today, referring to Dropbox management using stock buybacks to sterilize their outrageous stock-based comp, and it made my day.
The Epsilon Theory notes I wrote about stock buybacks in 2019 are the most controversial thing we have ever published. They generated more anger, more arguments and more cold shoulders from the mainstream finance community than anything else we’ve done. Here’s my position:
When stock buybacks are used to sterilize stock-based comp (i.e., a company gives managers stock with one hand and buys it back from them with the other hand), no money is “returned to shareholders”. This is true whether or not management actually sells its shares into the buyback program.
Stock buybacks only “return cash to shareholders” to the degree that the buyback program reduces the sharecount. To the degree the buyback program does not reduce the sharecount, but simply sterilizes new issuance to management, it is purely a transfer of wealth from shareholders to management.
As the kids would say, it’s just math.
I think you would be AMAZED at the proportion of stock buyback programs that go towards sterilizing stock-based comp. I certainly was. I think it’s the greatest transfer of wealth in human history.
Not to founders. Not to entrepreneurs. Not to risk-takers.
Nope … to managers. To asset-gatherers. To fee-takers. To rent-seekers. To rakes.
Yep, Jamie Dimon is the rake. But then so is every S&P 500 management team. So is every Wall Street management team. That I’m aware of, at least. It’s the water in which we swim.
“Yay, Stock Buybacks!”
It’s amazing how many people get very angry at me when I say this.
Anyhoo … in addition to The Rake, here are the notes that started all the fuss.
— Ben Hunt | June 15, 2021 | 4:04 pm
Suppose everyone got to choose how much of their income was subject to withholding tax etc and how much would be subject to both potential tax advantages and their option with regard to the timing of stock sales. Even if it were taxable and even if it had to be in 10b51 plan most people would choose a significant amount in stock. Big institutional shareholders let it happen but they’re going to play hardball on ESG.
There is a commentator that used to post to Seeking Alpha but now sticks solely to his own site (heisenbergreport.com). He would periodically post a chart (from Goldman Sachs and Federal Reserve) which showed net demand for equities by category (ETFs, Mutual Funds, Pension Funds, Households, Foreigners, and Corporations [buybacks]). The amazing thing is that almost all categories were typically negative except corporations.
Perhaps stock buybacks should be banned unless management does NOT receive stock based compensation. If their management skills are so good and their stock is such a good deal then they can buy the stock on the open market.
Brian Reynolds, of Reynolds Strategy, has been highlighting this dynamic for years. Of those major fund flows ALL are outflows from US Stocks post- GFC (Pensions, Mutual Funds, Foreign, and Individuals). Not every year in every category, but a cumulative line of flows is OUT from 2009-2020. How is that possible? Share repurchase and M&A has meant the Corporate flow has been the ONLY driver. It explains ALL of the net flow into Equities.
It is a procyclical behavior. While credit is available and spreads are tight the financial engineering happens. When credit markets close ('08/'09, '15 for Energy, 3/20) it stops dead and the market or sector crashes. The Fed finally caught on with the foray to backstop corporates and high yield during the Pandemic.
Wall Street convinced CFO’s the first time the Fed cut rates near zero that the hurdle rate to buy stock was no longer the WACC. The bar used to be a low double digit return (8 or 9 P/E to shrink the float). Once the primary exercise was to sterilize option grants starting in the late '90’s, as long as the repurchase was accretive (pennies per share earned were greater than interest income not earned on cash, or interest expense paid to finance) it was okay. This meant stock buybacks at 40 and even 50+ P/E’s!
At this point, the stock market only corrects when this flow dries up. When it seizes up, markets crash.
Do we think with the new 1% share buyback tax in the “Inflation Reduction Act” is going to change or impact company actions regarding buybacks in the future?
I work as a financial advisor at a large investment bank and last year the bank (management) increased the portion of our compensation in stock significantly. When I was younger and needed the cash this was very frustrating but as I get older having a significant portion of my compensation deferred is more palatable from a tax perspective. However, I don’t really have a vote on this and the company has figured out that since the age of their average advisor has increased over time the company can get away with this action without much pushback. The research about buybacks detailed in the post makes me feel like a pawn.
Continue the discussion at the Epsilon Theory Forum