Economics can turn normal modes of thinking on their ear. When you go to graduate school to get an MBA, you should be confronted with a lot of concepts that make you think differently.
When I attended Chicago Booth one of the first lectures I heard was about the “marriage market”. Professor Kevin Murphy spoke to us about basic economic concepts, and then talked about marriage.
There was a supply curve and a demand curve for marriage, and each of us interacted in that market to maximise our utility. We are all rational investors when it comes to marriage.
Buybacks have been the rage for a while on Wall Street. More than a few companies engage in them, the most recent one being Warren Buffett’s buyback of Berkshire Stock ($BRK.A$BRK.B). The reality is they just line the pockets of corporate management and investment bankers that devise them.
Generally, when a company buys back stock, it’s signaling to the market a couple of things. First, it doesn’t have a better use for its capital. It can’t get a positive net present value rate of return on expansion. It can’t invest the stock in some other type of security, or in another firm for acquisition because the numbers don’t add up.
Management doesn’t want cash sitting on the balance sheet because that puts a big target on the companies back. Excess cash makes the company cheaper to acquire.
This leaves two choices. Dividend or stock buyback.
When they buyback stock, investors often think that the float of the company is going to go down. It never does, because normally the company reissues stock via an options package. Over time the float builds up and if cash builds up again, management simply buys themselves out of their options. It’s a never ending cycle.
Buybacks are “Keynesian” because they are sold to investors as “priming the pump”, “creating demand for our stock”, or “our stock is being incorrectly valued by the market so we are buying it.”
Mr. Market is efficient though. Why is one executive team or investment banker smarter than the thousands of investors interacting in the market? Using company cash to buyback stock signals nothing-except that the executives of the firm cannot figure out a productive use of the cash to expand their business to increase shareholder value. That’s not good or bad, it just is. Sometimes there isn’t anything a company can do with it’s excess cash.
Dividends on the other hand adhere to the Chicago School. The company that issues a dividend says it trusts the individual to make a decision. The power of individuals acting on behalf of their own self interests aggregate to a higher rate of return than a company stock buyback. Companies should empower their shareholders with the excess cash that’s rightfully theirs anyway. Shareholders are taking the real money risk on the company buy buying shares.
Take that same concept to a different place.
Big government is no different than the company executives and investment banker in the back room, buying back shares of stock for their benefit using your money. Instead, they ought to be giving the money back to you in the form of lower taxes, or lower spending and less services.
Think about that the next time you read about a buyback.
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