Senator Elizabeth Warren appeared on CNBC last week, sparring with hosts Becky Quick and Joe Kernan over stock buybacks.
Both sides here either forget about, miss, or fail to prioritize the key behavioral incentives that drive this activity.
It is true that company managers are shareholder agents—and are obligated to pursue projects to the end of wealth maximization. If the managers perceive that they do not have enough net present value–positive projects to pursue, they often pay dividends or do share buybacks.
However, it is also true that the practice of share buybacks does lead to inflated earnings per share (EPS), and ultimately drives stock prices higher—to the point where many companies over the last decade issued debt on an extremely cheap basis in order to buy back shares and return capital to shareholders. This depleted company balance sheets and left many firms in many different sectors wholly unprepared for a top-line disruption such as the response to covid-19.Ultimately, this led to layoffs and bailouts, as companies were unprepared.
All of that said, none of this gets to the root of the problem: Why do companies have no better use for the capital than to buy back their shares?