Stock Buybacks Were Once Illegal. Why Are They Legal Now?

Michael Evans / Public Domain

The SEC changed policy during the Reagan administration in 1982.

The notion of stock buybacks has gained increased attention in recent years, primarily in light of America's growing wealth and income inequality but also for the Republican tax plan that President Donald Trump signed last year.

As corporations continue pumping cash into stock repurchase programs -- at the expense of investing in employees and society on the whole -- it is worth noting that the practice has only been legal for the past few decades.

When did the change occur?

According to Vox,

Buybacks were illegal throughout most of the 20th century because they were considered a form of stock market manipulation. But in 1982, the Securities and Exchange Commission passed rule 10b-18, which created a legal process for buybacks and opened the floodgates for companies to start repurchasing their stock en masse.

The SEC's decision to make this shift came against the backdrop of President Ronald Reagan's era of deregulation and coincided with the rise of 'free market' economists preaching a new type of social responsibility for business: increasing profits.

This shift in corporate mentality is well appreciated in statements on social responsibility from the Business Roundtable, a politically conservative association of chief executive officers of top American companies, as they differ from 1981 to 1997.

The 1981 statement still held that companies were obligated to consider their social impact alongside making profits:

Corporations have a responsibility, first of all, to make available to the public quality goods and services at fair prices, thereby earning a profit that attracts investment to continue and enhance the enterprise, provide jobs, and build the economy.

[. . .]

That economic responsibility is by no means incompatible with other corporate responsibilities in society.

But by 1997, the message had drastically changed, much in line with economist Milton Friedman's iconic words arguing the only “social responsibility of business is to increase its profits”.

[T]he principal objective of a business enterprise is to generate economic returns to its owners. . . . [I]f the CEO and the directors are not focused on shareholder value, it may be less likely the corporation will realize that value.

Fast forwarding to the present, the notion that a company's obligation is first and foremost to its shareholders has taken firm root in the business world, leading to more and more stock buybacks.

Some economists see this is a positive turn, but others believe it has coaxed along the societal maladies of stagnant wages, underemployment, and growing income inequality, to name a few.

There’s a lot of debate about whether buybacks are a good thing or a bad thing. Proponents note that they are, indeed, money going back into the economy, and they lead to a rise in stock prices, which can have a marginally positive effect on consumer confidence and consumption. And shareholders are, obviously, people — albeit not the majority of them. Again, about 80 percent of all stocks are owned by the richest 10 percent of Americans.

Detractors, however, warn that buybacks could worsen wealth inequality. “Stock buybacks have been a prime mode of both concentrating income among the richest households and eroding middle-class employment opportunities,” William Lazonick, a professor at the University of Massachusetts Lowell, recently told CNN Money.
...

Deloitte researcher Lester Gunnion recently pointed out that share buybacks and dividends have been increasing in recent years while business investment is on the decline. There is concern that businesses are swapping one for the other.

While Republicans promised great gains for working Americans with their new tax plan, it is difficult to see how such a result could manifest given the current state of economic thought and practice.

As companies continue generous stock buyback programs in the wake of the new tax plan, consider the words of Senator Elizabeth Warren (D-MA) from a 2015 interview with The Boston Globe:

“Stock buybacks create a sugar high for the corporations. It boosts prices in the short run, but the real way to boost the value of a corporation is to invest in the future, and they are not doing that.”
...

“These buybacks were treated as stock manipulation for decades because that is exactly what they are,” she said. “The SEC needs to recognize that.”

Comments