Jerry Bowyer | On January 21, 2021

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It’s important to remember that reinvestment is a matter of trade-offs, not an unalloyed good.

“Importantly, the number of value-creating investment opportunities a company has will always be finite – no matter how hard a leader works or how many ideas she has.”

— Alex Edmans, Grow the Pie

For example:

“A retail chain might build several new stores, choosing the most attractive locations first. But after a point, further shops would either be in unattractive locations or stretch management so thin that it couldn’t properly run the initial additions. So the CEO uses her remaining cash to buy back shares.”

— Alex Edmans, Grow the Pie

To treat reinvestment as bonum in se, as a moral absolute, is to invite CEOs to engage in empire building at the expense of shareholders, to pursue growth for its own sake — which can be a value destroyer.

“[E]ven if growing the company destroys value, a leader may do so to increase her prestige and pay. Similarly, raising worker salaries may help the CEO justify higher pay for herself, if society is scrutinising pay ratios. So using cash for buybacks rather than investment may actually be against the CEO’s personal interests, contrary to popular perception.”

— Alex Edmans, Grow the Pie

And this empire-building rationale, an infinite institutional growth imperative ideology, does not just damage shareholders, it can damage society at large:

“If a firm doesn’t use real resources such as labour and raw materials, other firms can use them to create value. And the same is true for financial resources. Even though a buyback involves money leaving the firm, that money doesn’t leave the economy – it gets invested elsewhere. The main difference is that it’s shareholders, not the firm’s CEO, who decides where to invest the money…”

— Alex Edmans, Grow the Pie

Resources are limited. When CEOs go beyond productive investments in their companies, they are using up natural resources and, more importantly, human productivity by having people work on the wrong things. The story of Countrywide and other participants in the housing bubble show how destructive it can be when CEOs adopt a grow-at-all-costs mindset.

One of the most limited resources is capital. When companies withhold earnings from shareholders, either hoarding earnings in cash accounts or spending it lavishly on non-productive internal growth initiatives, it is keeping that capital away from uses which are more productive for the investors and for the economy in general.

“Investors are very unlikely to sell shares in a buyback to sit on cash, so they’ll only sell if they have better investment opportunities elsewhere. Start-ups are financed by venture capitalists, who get much of their money from institutional investors that also own shares in public companies. It’s mature firms showing restraint and buying back stock (or paying dividends) which allows these investors to put money into venture capital, financing the enterprises of tomorrow.”

— Alex Edmans, Grow the Pie

Oaks grow, but mature ones also drop acorns to the ground. Demonizing buybacks is basically deriding the importance of acorns.

Originally published on Townhall Finance.

Jerry Bowyer

Jerry Bowyer is a Forbes contributor, contributing editor of AffluentInvestor.com, and Senior Fellow in Business Economics at The Center for Cultural Leadership.

Jerry has compiled an impressive record as a leading thinker in finance and economics. He worked as an auditor and a tax consultant with Arthur Anderson, as Vice President of the Beechwood Company which is the family office associated with Federated Investors, and has consulted in various privatization efforts for Allegheny County, Pennsylvania. He founded the influential economic think tank, the Allegheny Institute, and has lectured extensively at universities, businesses and civic groups.

Jerry has been a member of three investment committees, among which is Benchmark Financial, Pittsburgh’s largest financial services firm. Jerry had been a regular commentator on Fox Business News and Fox News. He was formerly a CNBC Contributor, has guest-hosted “The Kudlow Report”, and has written for CNBC.com, National Review Online, and The Wall Street Journal, as well as many other publications. He is the author of The Bush Boom and more recently The Free Market Capitalist’s Survival Guide, published by HarperCollins. Jerry is the President of Bowyer Research.

Jerry consulted extensively with the Bush White House on matters pertaining to the recent economic crisis. He has been quoted in the New York Times, The Wall Street Journal, Forbes Magazine, The International Herald Tribune and various local newspapers. He has been a contributing editor of National Review Online, The New York Sun and Townhall Magazine. Jerry has hosted daily radio and TV programs and was one of the founding members of WQED’s On-Q Friday Roundtable. He has guest-hosted the Bill Bennett radio program as well as radio programs in Chicago, Dallas and Los Angeles.

Jerry is the former host of WorldView, a nationally syndicated Sunday-morning political talk show created on the model of Meet The Press. On WorldView, Jerry interviewed distinguished guests including the Vice President, Treasury Secretary, HUD Secretary, former Secretary of Sate Condoleezza Rice, former Presidential Advisor Carl Rove, former Attorney General Edwin Meese and publisher Steve Forbes.

Jerry has taught social ethics at Ottawa Theological Hall, public policy at Saint Vincent’s College, and guest lectured at Carnegie Mellon’s graduate Heinz School of Public Policy. In 1997 Jerry gave the commencement address at his alma mater, Robert Morris University. He was the youngest speaker in the history of the school, and the school received more requests for transcripts of Jerry’s speech than at any other time in its 120-year history.

Jerry lives in Pennsylvania with his wife, Susan, and the youngest three of their seven children.