House Financial Services Subcommittee Hearing on Stock Buybacks

House Financial Services Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets

“Examining Corporate Priorities: The Impact of Stock Buybacks on Workers, Communities, and Investors”

Thursday, October 17, 2019

Key Topics & Takeaways

  • Short Term Financial Engineering: Coffey stated that his firm works through financial models, proxy disclosure forms, and talk to company management teams to gather information and react accordingly. He added that his firm conducts a risk assessment based on company corporate governance. Fried suggested that a requirement for corporate trading disclosures, similar to those for insider trading, would be beneficial.
  • Disclosures: Fried stated that he is not aware of any studies that researched the impact of disclosure rules in countries like Japan or Hong Kong. He added that their buybacks are generally lower than in the U.S., and the rules have been in effect for years.
  • Stock Buybacks Effects: Palladino stated that stock buybacks are disproportionate for capital gain flow, are influenced due to shareholder pressure, and reiterated concerns about disclosures. Fried emphasized misconceptions regarding buybacks, adding that shareholders bargain for an arrangement to hold boards accountable. Lewis answered that investors benefit from price signaling from stock buybacks for companies that are undervalued, and buybacks optimize debt and equity financing in an efficient taxable method. Coffey expressed the importance of reviewing corporate governance structures and the results of company decisions.

Witnesses

  • Jesse M. Fried, Professor of Law, Harvard Law School
  • Lenore Palladino, Senior Economist and Policy Counsel, Roosevelt Institute
  • Janie Grice, United for Respect at Walmart
  • Derik D. Coffey, CFA, Portfolio Specialist, Channing Capital Management
  • Craig Lewis, Ph.D., Madison S. Wigginton Professor of Finance and Professor of Law, Vanderbilt University

Opening Statements

Chairwoman Carolyn Maloney (D-N.Y.)

In her opening statement, Maloney expressed her concern about the “dramatic” increase in stock buybacks, especially over the last two years. She explained that companies can use excess capital to either invest in research and development (R&D), raise wages, purchase equipment or distribute wealth to shareholders. Maloney stated that she is not opposed to allocating capital to shareholders when companies see success but would like to examine the practice of stock buybacks. Maloney referenced the implementation of Securities and Exchange (SEC) rule 10b-18 as the point when companies began to prefer stock buybacks over dividends as the means to return shareholder investment. She added that the rule was implemented to safeguard against stock price manipulation but has given room to executives to inflate company stock and sell stocks for personal gain. Maloney expressed support for H.R. 3355, the Reward Work Act, the Stock Buyback and Worker Dividend Act, the Stock Buyback Disclosure Act, and legislation that would require companies to disclose details of any repurchase plan.

Ranking Member Bill Huizenga (R-Mich.)

In his opening statement, Huizenga stated that scrutiny of stock buybacks is based on a “myth.” He explained that stock buybacks are a more tax efficient option for capital distribution for companies based on earnings per share (EPS). Huizenga said stock buybacks allow for investors to reinvest in areas of the market which show a greater need rather than not utilizing capital. He added that SEC rule 10b-18 is important and that issuers buying back stocks must adhere to limitations in a manner based on timing, price, and volume. Huizenga continued that companies are required to report quarterly and annually for their buybacks. He added that they must disclose statistics, including the number of shares purchased, the average price of purchased shares, and a maximum dollar amount for repurchasing of publicly announced buybacks. Huizenga expressed concern about the proposals introduced in the committee and suggested introducing proposals that promote more capital and economic opportunity.

Testimony

Jesse M. Fried, Professor of Law, Harvard Law School

In her testimony, Fried discussed how the current rules in place are lax, enabling executives to enrich themselves at the expense of public investors. He suggested requiring disclosure agreements for trades in its own shares within two days of a transaction. He continued that actual cash flows are not reflected from repurchases or dividends, but rather through net shareholder payouts which are dividends plus repurchases minus equity issuance. Fried stated that in 2018, companies distributed $1.4 trillion in repurchase but issued $750 billion in equity, which was a net payout of $650 billion, a portion of firm profits. He said that firms had accumulated $5 trillion in cash in 2018, although there have been record payouts and R&D investments, which is better distributed to shareholders.

Lenore Palladino, Senior Economist and Policy Counsel, Roosevelt Institute

In her testimony, Palladino stated that companies use buybacks to prop up their share prices to benefit share sellers, diverting funds away from company and workforce investment. She expressed concern for the “virtually unregulated” practice of stock buybacks, due to the lack of enforcement for exceeding the trading volume limit of 25 percent and the lack of disclosures. Palladino urged Congress to ban stock buybacks or create bright line standards to limit the use of stock buybacks. Palladino also recommended requiring disclosure agreements to be filed for share sellers, especially executives who are compensated in company stock.

Janie Grice, United for Respect at Walmart

In her testimony, Grice said that as a former employee of Walmart, she often had to choose work over family due to the lack of full-time employment status and a stable schedule. She stated that the recent increase in stock buybacks benefiting executives led her to propose an employee buyback benefit plan, which was ultimately rejected by Walmart. Grice suggested that workforce investment and wage increases would benefit workers and commended the committee’s work to address the practice of “harmful” stock buybacks.

Derik D. Coffey, CFA, Portfolio Specialist, Channing Capital Management

In his testimony, Coffey stated that his firm focuses on small mid-cap products for roughly $2 billion in asset management, with a clientele that largely benefits from buybacks. He said that buybacks help companies manage their capital structure, provide capital allocation flexibility, offset stock options dilution, and provide important price signaling and support. Coffey added that his firm avoids working with companies that are short sighted in their stock buyback schemes. Coffey stated his firm works with companies who utilize their capital for hiring employees and increasing their market share. Coffey said that the legislation considered by the committee could restrict capital deployment, impede the movement of capital, force the use of dividends which offer less flexibility and less efficient tax methods, and could potentially harm share signaling tools.

Craig Lewis, Ph.D., Madison S. Wigginton Professor of Finance and Professor of Law, Vanderbilt University

In his testimony, Lewis stated that critics of stock buybacks assume an implicit perspective that repurchases represent a market failure that cannot be resolved through private action. He added that opponents typically argue that buybacks artificially inflate share price, crowd out investment, result from managerial short termism, and disproportionately benefit the wealthy and corporate insiders. Lewis argued that conjectures fail to provide empirical evidence and are based on misconceptions. He echoed many of the points Coffey stated in support of stock buybacks. Lewis expressed concern about the bills under consideration, stating that they would reduce corporations’ ability to repurchase stocks and fail to provide an example of market failure. He continued that due to the lack of resources the SEC cannot make the determination for how to approve stock buybacks.

Question & Answer

Short Term Financial Engineering

Rep. Juan Vargas (D-Calif.), Maloney, and Huizenga asked about how to determine which companies are being short sighted and how to address the timing of stock buybacks. Coffey stated that his firm works through financial models, proxy disclosure forms, and talk to company management teams to gather information and react accordingly. He added that his firm conducts a risk assessment based on company corporate governance. Fried suggested that a requirement for corporate trading disclosures, similar to those for insider trading, would be beneficial. Palladino said that because executives are not required to report share sales in a timely manner, there is no proper oversight.

Disclosures

Rep. French Hill (R-Ark.) and Maloney asked about the effects of disclosures. Fried stated that he is not aware of any studies that researched the impact of disclosure rules in countries like Japan or Hong Kong. He added that their buybacks are generally lower than in the U.S., and the rules have been in effect for years. Lewis agreed with a statement by Chairman Jay Clayton that the SEC does not have the purview to make decisions on asset allocations.

Stock Buybacks Effects

Reps. David Scott (D-Ga.), Warren Davidson (R-Ohio), Jesus “Chuy” Garcia (D-Ill.), Trey Hollingsworth (R-Ind.), Huizenga, Hill, Vargas, and Maloney asked about how stock buybacks impact capital allocation, company and workforce investment, share prices, and overall economic growth. Palladino stated that stock buybacks are disproportionate for capital gain flow, are influenced due to shareholder pressure, and reiterated concerns about disclosures. Grice responded that employees could provide executives a different perspective by being included in board level decisions. Fried emphasized misconceptions regarding buybacks, adding that shareholders bargain for an arrangement to hold boards accountable. Lewis answered that investors benefit from price signaling from stock buybacks for companies that are undervalued, and buybacks optimize debt and equity financing in an efficient taxable method. Coffey expressed the importance of reviewing corporate governance structures and the results of company decisions. He agreed with Warren Buffet’s principle that disciplined repurchases ensure efficient use of corporate funds, and inefficient companies are punished by the market. Coffey emphasized that capital should be recycled into the market for new opportunities for growth.

For more information about this hearing, click here.