The issue of corporate buybacks has suddenly come front and center. Should government regulate buy backs?
Let's take a look at the issues and the context around it.
One of the primary responsibilities of a corporate CEO is the profitability of the organization. Capital structure is a major factor in that responsibility. For those not familiar with capital structure, it is the mix of equity and debt capital which supports the operations of the organization. Like the three bears, it is important to get it just right – not too hot and not too cold. Too much debt can put a firm at the risk of bankruptcy, while not enough fails to leverage their owners (shareholders) capital sufficiently.
Over the last several years, the pickup in buybacks has quickly accelerated to historically high levels. It is interesting to note that the increase in buybacks has closely tracked the rise in the market’s price level. Like the average individual investor, corporate managements have been shown to be just as bad in determining the time to buy shares. Many companies have been buying back shares at precisely the time when their shares are relatively high. That isn’t a smart move. Should government also regulate when individual investors can and cannot buy shares? That is something that few if any investors would want.
The cash flow of companies can be used a number of ways. Buybacks is just one of them. Funds can be used for operations, purchases of other companies, purchases of equipment, paying a dividend or paying down debt. The executive in conjunction with the board of directors makes those decisions based upon their strategic plan.
While many CEO’s have “goosed” their per share earnings with the financial engineering technique of buybacks, the choice is theirs. The CEO and their constituents will shoulder the responsibility if their capital structure takes them into bankruptcy. That said, it is often a wiser move to invest in their businesses or pay a dividend directly to shareholders. If they have financially remunerative projects, by all means invest in them. If they don’t have great projects, give the funds back to the shareholders through dividends and let them decide the best places to use the funds. But should government tell CEO’s which choice they should make? The company's stock price will eventually reflect on how effectively a company has performed in this task. In the short term, it may or may not judge these actions well, but in the long-term the market will get it right.
If buybacks were regulated, the government would essentially be determining how much leverage a corporation can or can not have. Why should a CEO who is more cost effective in running their operations be hamstrung and not be able to choose a capital structure that is appropriate for their skill level in managing their business?
While we all know there will always be people and organizations who push the boundaries, should all CEO’s suffer the fools who don’t know how to properly achieve a reasonable level of capital structure? Let the market decide this one.
Regulations always results when the few push anything too far and, then, everyone pays. There will always be “bad apples”, but you can’t legislate morality or intelligence. Buybacks are no different.
