Companies tend to do one of two things with their cash, either return or reinvest. Reinvesting is all about pumping money into in new plants and jobs, or spending on R&D.
Then there’s returning capital to shareholders via dividends and buybacks. The early 80s saw the growth of the dividend mantra, where the company was expected to distribute cash via dividends to shareholders on a regular basis. Half the companies earnings were being spend on dividends by the early 80s.
Buyback was a negligible component of the cash payout back then, however. But by late 80s, buybacks and dividends accounted for 80% of earnings. Little was left to reinvest for long term growth.
Companies have been allowed to repurchase their shares on the open market with virtually no regulatory limits since 1982, with the only mandate being they have to announce the buyback program to the public.
Companies could now buy large quantities of their stock without the SEC knocking on their doors for price manipulation. One rule is that it can’t be more than 25% of the previous four weeks’ average daily trading volume is the ceiling for a permissible buy back. The SEC requires companies to report total quarterly repurchases but not daily ones, meaning that it cannot determine whether a company has breached the 25% limit without a special investigation.
This all comes full circle with Hillary Clinton’s attack on short termism, which has led to excessive buybacks and dividends. Clinton wants to counter the excessive buybacks by adopting safe guards, such as what the United Kingdom and Hong Kong do, which require companies to disclose buybacks within one day.
In the U.S., companies can go an entire quarter without disclosing buybacks. Along those lines, the plan is to get a handle on using buybacks to boost executive pay. In 2012, the 500 highest-paid executives of U.S. public companies received an average of $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards.
The idea is that the way the U.S. executive compensation is set upcreates an incentive to keep stock prices high in order to maximize compensation. Buybacks play their role — open market purchase creates artificial demand which helps in the short term elevation of the stock price.
Now, with buybacks under attack, the next logical step will be a moratorium on dividends.