Senators Chuck Schumer of New York and Bernie Sanders of Vermont recently announced they would introduce legislation to prohibit a public firm from repurchasing its own stock, unless the firm first invests in employees and communities, including paying workers at least $15 per hour and offering “decent” pension and health benefits. Welcome to the newest form of virtue-signaling on Capitol Hill, in which Democratic senators demonstrate their concern for employees by proposing bills that severely restrict — or even outlaw — buybacks. The proposals are based on misleading measures of corporate capital flows, as well as on a profound misunderstanding of how the US economy works. If enacted, such bills could threaten not only the capital markets but also the workers and communities the senators claim to care about.
Leading Senate Democrats appear to believe that repurchases, when added to existing levels of dividends, harm workers and impair long-term investment by starving firms of needed capital. The Schumer-Sanders bill would join legislation introduced by Schumer and Senator Tammy Baldwin of Wisconsin to give the Securities and Exchange Commission authority to reject buybacks that, in its judgment, hurt workers. It also would require boards to certify that a repurchase is in the “best long-term financial interest of the company.” Baldwin has introduced another bill, cosponsored by presidential candidate Senator Elizabeth Warren that goes even further: It bans all open-market repurchases.
The accepted wisdom among the Democratic leadership is flat-out wrong: There is no evidence that the overall volume of corporate payouts to shareholders, through repurchases and dividends, is excessive. Buyback critics say that S&P 500 firms don’t have enough investment capital because dividends and repurchases routinely exceed 90 percent of their net income. Between 2007 and 2016, for example, these companies distributed $7 trillion to shareholders, mostly via repurchases. That was 96 percent of total net income. But our research shows that public firms recover from shareholders — directly or indirectly — about 80 percent of the capital distributed via repurchases. Shareholders return this capital by buying newly issued shares, mostly from employees paid with stock, but also directly from firms. Taking into account all types of equity issuances, net shareholder payouts in S&P 500 firms during the decade 2007-2016 were only about $3.7 trillion, or 50 percent of total net income. This pattern persisted through the third quarter of 2018, the latest period for which data are available, after President Trump’s tax cut had gone into effect.
At this level, net shareholder payouts don’t appear to impair investment capacity or firms’ ability to pay workers. Indeed, our research shows that total capital expenditures as well as R&D expenditures by public firms are both at the highest level ever. Moreover the intensity of investment at public firms, measured by the ratio of capital expenditures and R&D to revenue, has been rising over the past 10 years and is near peak levels not seen since the late 1990s. In fact, R&D intensity at public firms recently reached an all-time high.
One might argue that firms would invest or pay workers more if they had more cash at their disposal. But there is no shortage of cash. During 2007-16, cash balances at S&P 500 firms also rose by 50 percent, reaching around $4 trillion, providing ample dry powder for additional expenditures. By the end of third-quarter 2018, these stockpiles had reached $4.5 trillion, even after the increase in corporate buybacks following the tax cut. This astonishing level of idle cash suggests that net shareholder payouts are not too high, but may actually be too low.
The various proposals to restrict or ban repurchases would make it harder for public firms to return capital to investors. Indeed, that is the whole point. But the problem with damming up these funds in public companies is that young and growing private firms, which collectively require enormous amounts of equity capital, will find it harder to obtain financing. Private firms are vital to the US economy. They account for more than 50 percent of nonresidential fixed investment, employ almost 70 percent of US workers, and generate nearly half of business profits. And historically, private firms funded by venture capital and private equity funds, including Silicon Valley startups, have generated tremendous innovation and job growth in the United States, including many high-paying jobs. Forcing large public firms to retain funds they cannot profitably deploy will make it harder for these potentially fast-growing firms to hire more employees, pay higher wages, and invest in their communities.
To be sure, firms could respond to restrictions or a ban on buybacks by issuing larger dividends. If firms can easily substitute dividends for repurchases, there will in fact be little harm. But once Congress has begun making decisions about capital allocation, why would it want to limit itself to repurchases? Indeed, even before their antibuyback legislation has been introduced, Schumer and Sanders have indicated that policy makers should also “seriously consider” proposals to limit the payout of dividends. If Congress goes down this road, excess cash will be mis-invested and mis-spent by large public companies, while private firms are deprived of growth capital. Stock prices will decline, 401(k) savers will be hurt, and IPOs will dry up: Who would invest in a public firm if future profits will not be returned to investors?
Even worse, once federal legislators have given themselves the authority to decide how much public firms can distribute to investors, they will be tempted to use their toehold in corporate governance to add more mandates and restrictions, ostensibly to address other “problems” in corporate America, but actually to benefit key electoral constituencies and contributors. Crony capitalism will replace real capitalism. Let’s hope Congress doesn’t lead us down this path.
Jesse M. Fried is a professor at Harvard Law School. Charles C.Y. Wang is an associate professor at Harvard Business School.