from the archives. Jeez, this one makes me feel old... I've been writing/shitposting-on-the-internet for a long time now :/
Scoresby had me look through is highly entertaining post on forks and whether dumping a forked coin can change its price (#851168). @Scoresby
It reminded me of this type of pre-rona conversation: stock buybacks are bad, it's financialization of corporations and doesn't invest in workers blah-blah.
Monetary economics makes perfectly clear that money spent always goes somewhere. In this case, corporations buying back their own shares transfer funds to sellers of those shares — the funds do not “vaporize.”
What Happens When Companies Buy Back Their Own Shares?
Economics teaches us to think through problems wholly. Rather than accepting naive explanations that quickly come to mind or seem obvious on the surface, economic analysis delves deeper. In opaque and complicated financial systems like ours, a seemingly simple transaction can include countless more, blurring the assessments of what is going on.
With profits (or indeed newly issued debt), companies may buy and retire their own outstanding stock, authorized and managed by senior management whose salaries and bonuses are strictly tied to the company’s stock price. This, of course, looms large in the eyes of left-leaning critics. Share buybacks benefit “shareholders and corporate leadership” rather than their workers, argue Bernie Sanders and Chuck Schumer. Similarly,both Yglesias and Wolf seem to think that management is passing over productive investments and that buybacks add no value, effectively short-changing not only workers but ultimately owners as well, enriching only management.
What share buybacks do is intentionally reduce the outstanding capital of one’s own company. The managers are putting cash behind their conviction that owners can make better use of spare funds than the company can. As Erica York persuasively explains, companies buy back shares when they have “more cash than investment opportunities.”
Notice how Wolf’s sleight of hand undermines his argument. He says that share buybacks do not add value to “the company” with the implication that they don’t add value to the economy. The seller — the counterparty to the actual buyback transaction by the company — can either use the proceeds to buy another financial investment or consume them in the real economy. Below we’ll see how that benefits the economy.
So, two things happen when a corporate buys back shares (either with debt, which shifts their debt-equity ratio or retained earnings/profits):
- WHen canceling some of the outstanding shares, every remaining share now represents a larger piece of the overall company. As this transaction didn’t change anything about the company’s underlying operations, every share should now be slightly more valuable.
- Second, if management successfully replaced expensive equity with cheap debt, the company’s effective cost of capital has fallen — making the shares more profitable investments, all things equal (in jargon, while net income falls due to higher interest rate expenses, the return on equity increases as the fewer shares outstanding more than offset the reduction in net income). This is value creation for the company’s shareholders as well as releasing funds for financial markets to profitably invest elsewhere.
This by, the flows of funds and dynamic impacts is, I think, why Scoresby's post made me recall this:
CONCLUSION
"The confused objections to share buybacks illustrate the failure to look past the immediate effect and to understand what financial markets do. In a decentralized way, reacting and incorporating the best available information, they transfer funds from those with money but no ideas to those with ideas but lacking money. Financial markets efficiently allocate capital across the economy, but do so in roundabout ways that are easy to miss."