Comment: The case for dividends over buybacks
Corporate cash reserves are swelling, leading to decisions about what to do with them. The order of priorities seems to be: give executive bonuses, buy back shares, do some M&A, invest in the business and last – and least – pay dividends. Well, not quite last: repaying debt seems an even lower priority.
Are buybacks good for shareholders? Perhaps, up to a point, except there is so often an uncanny relationship between the number of shares bought back and the number distributed in stock options. We are assured – usually by people who have been fighting tooth and nail to avoid expensing stock options on their books – that buybacks are a tax-efficient way of distributing cash to shareholders. There is indeed a tax on dividends, but there is also a tax on capital gains, so if there is any water in the argument that continuous buybacks raise stock prices, then those who seek to cash in will be paying capital gains tax on this reputed increase in value.
Milo Mindbender in Catch 22 used to appropriate his comrades’ parachutes and replace them with ‘A share’. Many retirees must have felt the same falling feeling recently when they tried to draw down the shareholder value for which they forwent dividends.
It is, ultimately, all about power. When the Banks fell off Wall St, all the presidents’ men did indeed put them back together again, and bonuses at publicly traded banks hit $135 bn in 2010. The shareholders who had been told their stock would rise in value because of all those buybacks saw their dividends going to the people who crashed their portfolios almost to penny stock levels at one point.
Indeed, I was amazed at the naivety of some bankers to whom I extended therapy for not diversifying, when I discovered how many of them had kept all of their stock in, for example, CitiBank, as it performed Humpty Dumpty imitations. Cisco is a good example: it has never paid any dividends, but its share-purchase program has bought back a third of its stock – which has blipped recently, but is down some 70 percent over a decade of buybacks.
Unlike many of the companies that suffered then, Cisco makes essential products and delivered profits. It has some $25 bn net cash in its back pocket, and it is only now thinking of doling out a meager dividend – mostly, one suspects, because more portfolio managers now demand dividends from stock they hold.
So what’s in it for the corporate managements? It’s back to being all about power. Not only do buybacks conceal stock options, but they also reduce the number of stockholders, perhaps gently guiding unhappy stockholders toward the exit, consolidating control in executive-appointed boards.
But apart from votes for boards on emoluments and other decisions that the Business Roundtable has fought against tenaciously and bitterly, the buybacks disenfranchise shareholders from decisions on the most basic issue: what happens to their money. Dividends enfranchise shareholders and allow them to take the cash, spend or reinvest in the same company or elsewhere. It is, as it should be, their decision – not a CEO’s.