Jerry Bowyer | On January 14, 2021

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You can read the first part of this series here.

Another root of misunderstandings is a simple lack of knowledge about the basics of accounting practices. Buybacks aren’t a subtraction from worker salaries or research and development. They are financed out of profits, i.e., what’s left over after workers and suppliers and the tax man, etc., have been paid. Politicians should know better before they speak, but often they do not.

“For example, when Senators Schumer and Sanders launched their anti-buyback proposal, they wrote: ‘When more than 90 percent of corporate profits go to buybacks and dividends, there is reason to be concerned.’ But this statistic makes a very basic mistake. Net income is already after deducting wages, other expenditures on colleagues such as training or wellness programmes, and intangible investments such as R&D and advertising.”

— Alex Edmans, Grow the Pie

Of course, money paid out to employees and suppliers in the short-run decreases profits and therefore the ability to finance buybacks, but that misses a few very important points.

Regarding the nature of how buyback decisions are actually made in the real world:

“[W]ages and investments come before buybacks not only in accounting statements, but also in the priority with which leaders actually make decisions.”

— Alex Edmans, Grow the Pie

It looks like in this instance, a CFO’s order of priorities corresponds with the order by which financial statements are structured. Profits come after expenditures (including internal reinvestment of revenues) and buybacks come after profits:

“[…] we need to get inside firms and see how they actually make repurchase decisions – do buybacks have higher or lower priority than investment? An influential study by Alon Brav, John Graham, Cam Harvey and Roni Michaely does just this, surveying 384 US Chief Financial Officers (CFOs) on how they make buyback (and dividend) decisions.”

— Alex Edmans, Grow the Pie

The results?

“Strikingly, they reported no such pressure for buybacks. They only buy back stock if they have cash left over after taking all desirable investments. It’s low investment opportunities that lead to buybacks, rather than buybacks leading to low investment.”

— Alex Edmans, Grow the Pie

Edmans and PwC also studied the issue at the behest of the U.K. government and came to similar conclusions, finding only one exception, i.e. only one company which was foregoing investments due to pressure to boost stock prices via buyback.

But maybe these companies are lying. Maybe they are unwilling to fess up to the pattern of focusing on buying short-term shareholder love at the expense of long-term pie growth.

“[B]ut the CFOs admitted that they might cut investment to avoid cutting the dividend, attenuating concerns that they won’t truthfully acknowledge short-termist behaviour.”

— Alex Edmans, Grow the Pie

So, it looks like companies use buybacks rationally, by and large: buying back shares rather than reinvesting, when they’ve run out of good internal investment opportunities.

“Other research investigates the link between buybacks and investment. Gustavo Grullon and Roni Michaely show that enterprises repurchase more when growth opportunities are poor, and Amy Dittmar finds that they do so when they have excess capital.”

— Alex Edmans, Grow the Pie

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.