IMPact SGR - Short-term gains or long-term growth? The buyback dilemma

Stock buybacks, a common method for remunerating shareholders, typically involve companies repurchasing and canceling shares to increase the price of remaining stock. This practice boosts earnings per share (EPS), thus improving the financial profile of the stock. Buybacks are often seen as a more flexible alternative to dividends, offering advantages such as deferral of capital gains taxes. Unlike dividends, which require formal planning and can signal trouble if reduced, share repurchases can be executed opportunistically. Buybacks are like dating, dividends are a marriage.

Before the introduction of the SEC’s Safe Harbor Rule in 1982, which protects companies repurchasing their shares from accusations of stock market manipulation, buybacks were practically nonexistent. Since then, spending on open market repurchases has surged, reaching $6.3 trillion in the 2010s and continuing to grow post-COVID. In 2022 alone the world’s 1,200 largest companies spent a record USD 1.3 trillion on buybacks (Janus Henderson, 2024).

However, the landscape is shifting. In January 2023, the U.S. introduced a 1% excise tax on buybacks through the Inflation Reduction Act. France, Canada, and India quickly followed, proposing or implementing similar measures to curb the practice. Meanwhile, China and the Netherlands have taken the opposite approach, loosening regulations to enhance corporate flexibility. 

In the Netherlands, the government scrapped a planned 15% buyback tax following market backlash and criticism from leading companies like ASML (Bloomberg, 2024). China, facing a slumping market, also eased restrictions to encourage stock repurchases. By allowing companies to repurchase shares during bearish market conditions, they may act as stock price backstop. However, outside of China, most buybacks are announced during market booms, questioning their effectiveness as a counter-cyclical tool.

Globally, though, the tide seems to favor more regulation. Following the U.S. 1% tax, President Biden proposed raising it to 4%. In France, a retroactive 1% tax was suggested in response to record buyback levels and budget deficit pressure. Similarly, the UK’s Liberal Democrats have called for a 4% tax, arguing that the money spent inflating share prices could instead have been used to grow the economy and tackle the climate emergency (Euronews, 2024).

Ironically, the rise in buybacks has also alarmed investors. Money spent on repurchases diverts funds away from long-term investments that could fuel innovation and growth. A fund manager at Federated Hermes even described buybacks as an “environmental hazard,” stating that dividends benefit all investors, while buybacks primarily favour traders, hedge funds, and executives. In fact, through buybacks, corporate leaders can artificially boost stock prices and EPS, triggering stock-based bonuses and profiting from stock options and vested stock awards.

The explosive growth in buybacks raises concerns about the opportunity cost of diverting funds away from productive investments. Companies increasingly resort to debt to finance repurchases, prioritizing short-term financial gains over long-term value creation. With the climate crisis looming large and a complicated geopolitical landscape, it becomes increasingly difficult to justify allocating trillions of profits to buybacks rather than investing in new generations of clean technologies or developing human capital.

The awareness of the importance of profit distribution to a larger stakeholder base is gaining ground also in the private equity world. KKR recently distributed USD 75 million out of USD 1 billion in profits from a company sale to employees, recognizing their role in value creation (FT, 2024). For many employees this windfall remuneration unexpectedly changed their lives. Such moves reflect a broader sentiment that capital should be used to generate technological innovation and create lasting, shared value, rather than merely extract short-term gains.