Hey airlines: Don’t use coronavirus bailout money on stock buybacks
Businesses buy back shares to compound cash. Here’s what a stock buyback is and how it affects companies, the economy and you.
Due to the stay-at-home orders that more than 95% of Americans are under currently — plus many countries shutting borders abroad — it’s needless to say that the airline business is not doing well.
This understatement led to a large statement at the end of March from Congress in their third stimulus package: $50 billion earmarked for airlines. Half of that value was designated as direct aid, most of which will be used to pay employees. And of that $25 billion, 70% of the money would be given to the airlines outright, but 30% would have to be paid back to the government.
Major airlines agreed to the this Payroll Support Program, the Treasury Department announced Tuesday, after negotiations with Secretary Steven Mnuchin.
The lead up to these negotiations caused drama in Washington; top Democrats sent a letter asking Mnuchin not to require too much money get paid back to the government. Similarly, the Association of Flight Attendants’ pleaded with Mnuchin to negotiate softly to avoid more job cuts.
But not all airlines are created equal when it comes to needing support. There’s the competition within the industry itself to consider when offering aid; Delta, American Airlines, United and Southwest monopolize the market. These aren’t your go-tos? Then watch out: Other companies are likely facing a bigger hit for the future — and might need to make more drastic cuts now — lest they get pushed out of the market without enough much-needed support.
If all of this wasn’t enough to worry about, there’s a blaring concern that companies will misuse their cash by using funds for stock buybacks; airlines have spent about 96% of their free cash flow on buybacks in the past decade.
What are stock buybacks exactly?
Stock buybacks occur when a company purchases shares of itself from the marketplace with its own cash. Companies buy back their own stock to combat a falling stock price. Generally, this increases the market capitalization: the total dollar value of a business’ shares listed across an exchange.
This has faced criticism on both sides of the political aisle; the federal government doesn’t want taxpayer money to go toward companies inflating their stock price instead of paying their workers. Both Trump and Democratic leaders, including Senator Elizabeth Warren of Massachusetts and Senator Bernie Sanders of Vermont, have been outspoken against buybacks.
Why are stock buybacks so popular for companies?
Well, reinvesting boosts a company’s value for investors, but what does that mean? Here’s an example: Company A has just issued a buyback to purchase half of its shares on the market. By doing this, Company A has increased its earnings per asset and earnings per share. Company A now has better numbers for other people to invest in without really doing anything to change its performance.
This used to be considered stock manipulation — or market interference caused by creating false or misleading appearances — which, before 1982, was illegal. However, the Securities and Exchange Commission relaxed the rules, ultimately allowing for the current boom of buybacks.
It’s not so much a boom as it is an explosion: Publicly traded companies across all industries in the U.S. spent almost 60% of their profits on buybacks between 2015 and 2017, a 2018 Roosevelt Institute study found. And these years do not even account for the Tax Cuts and Jobs Act of 2017, which saw corporate tax rates fall from 35% to 21%.
Now lower taxes don’t necessarily mean more buybacks. Lower corporate tax rates simply mean businesses hold onto more of their money — which is great if they use the extra savings to invest in their workforce or new innovations. But since the Trump administration’s tax relief passed, 57% of savings brought on by the act have been used on stock buybacks.
How does it affect you?
So this helps the stock market — generally, most people are happier when the market is doing well. And you might think, “well, if that particular company’s stock is part of my retirement or pension fund, it doing well is good news for me, right?”
Wrong. The people who benefit the most are short-term, speculative investors (people who make high-risk investments inline with daily market movements) and day traders, according to a 2015 Wall Street Journal article. People investing in their retirement or pension fund — long-term investors — are actually losing out.
And businesses which dedicated a greater proportion of profits to share repurchases experienced lower total shareholder returns on average, a 2017 Fortuna Advisors analysis found. Basically, companies that bought back stocks ended up with fewer future gains than ones that did not — not really a win for the corporation, more so a short-term bonus for its executives and board.
What are the arguments for stock buybacks?
A 2018 Tax Foundation study outlined the main two arguments for buybacks: 1. cash used on them could not have been used for other investments, as company leadership would have considered that beforehand, and 2. repurchasing of the stock will see the sellers invest their new cash into newer stocks.
The main problem with the first argument is that some companies are borrowing money on low interest rates from the Federal Reserve to fund their stock buybacks. These low interest rates — that are supposed to be used to stimulate the economy — are instead lining the pockets of a few CEOs and short-term speculative investors. For example, American Airlines spent more than $12 billion on buybacks while generating negative cumulative free cash flow: Instead of putting that money into resources to run the business, leadership spent it altering the price of its shares. Essentially, it had to borrow money to actually pay for these buybacks because it didn’t actually have the cash to spend on hand, which signals it did not only repurchase stock after looking at all other investments.
The second argument is that the returned cash could be used in boosting innovative firms for the future, but that’s a vague and fairly optimistic viewpoint.
What could companies invest in instead?
Rather than generating CEO lunch money, companies could look for opportunities to invest in new technology or their workers.
Investing in a company’s workforce by raising wages and adding benefits improves a company’s long-term growth and potential for innovation, many studies — including this 2004 one from Bassi Investments, Georgetown University and the Federal Reserve — show. And this can bolster productivity, profitability and stock market performance.
How could we compel companies to divest from buybacks?
One way to decrease the desire to buy back is to eliminate CEO bonuses that are contingent on certain stock market numbers. This would limit some of the incentives to repurchase stock and increase consideration for long-term growth investments.
Another is to regulate companies and force them to include a representative for their workers on the board. Many major corporations already do this, allowing employees to have a seat at the decision-making table. In the end, a company’s upper management will have the final say on how its capital will be spent, regardless of what a representative or the employees themselves say.
How does this circle back to the current pains of the airline industry?
For one, we’re not looking to have airlines buy back stocks right now. That would help no one — barring a few extra bills remaining with airline CEOs, but they’re not really the ones hit hardest by the coronavirus outbreak.
Could airlines really have been better prepared for this crisis by not repurchasing stock in favor of a “rainy day fund?” That would be a naive way to look at it, as this pandemic’s impact on flying is more of a “Noah’s ark flood” than a rainy day problem. But perhaps a little less CEO inclination to fill the money bucket in the past would have prevented airlines from being left high and dry right now.
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