On August 7, 2022, Congress passed the Inflation Reduction Act (IRA), which imposed a 1 percent excise tax on share repurchases by public corporations.  President Biden proposed quadrupling the tax to 4 percent in his 2023 State of the Union speech. Supporters of the tax, including the White House, argue that it will discourage companies from share repurchases and divert cash to the workforce and socially and environmentally responsible investments. Lawmakers say that companies favor share repurchases to boost executive compensation at the expense of average employee compensation, which has stagnated over the years.

Stock buyback taxes could influence corporate decisions and lead to different outcomes. For instance, companies would pay more cash dividends instead of repurchasing shares. The Joint Committee on Taxation assumes that more dividends will force the ultra-wealthy to pay ordinary income taxes on cash dividends. In contrast, share repurchases would only be taxable at capital gains rates if realized. Critics contend that the tax could reroute the flow of money and reduce the flexibility that companies have regarding payout policy. In a new paper, we address the question of whether these criticisms are warranted.

The debates over the relative merits and demerits of share repurchases reached a crescendo after the passage of the Tax Cuts and Jobs Act (TCJA) of 2017, which reduced corporate income tax rates and the taxes on the repatriation of foreign income. The latter resulted in “windfall” profits, which lawmakers argue were spent on share repurchases rather than necessary investment in the workforce, capital expenditures, and research and development. It is important to note that this debate over share repurchases has existed since they became legal in 1982.  The Securities and Exchange Commission (SEC) adopted Rule 10b-18 in 1982, which granted “safe harbor” protection to U.S. corporations. The passage of Rule 10b-18 unleashed a dramatic increase in corporate share repurchases that have continued to this day.

Growth in share repurchases, however, has not been without controversy. Politicians have been at the forefront of opposition to them. The earliest instance of political pressure on corporations to divert cash from repurchases to other investments was in 2008 when senators Charles Schumer and Robert Menendez and representatives Rahm Emmanuel, and Ed Markey wrote to CEOs of ExxonMobil, BP, Royal Dutch Shell, Chevron, and ConocoPhillips. They criticized these companies for collectively spending $194 billion on buybacks from 2004 until the first quarter of 2008. They stated that the $194 billion would have been sufficient to provide $2,000 rebates to every family in the U.S., produce 5 million plug-in hybrid cars, and power 3.5 million solar-powered homes. Further, they criticized these firms for underinvestment in R&D.

These criticisms reached a new high in the aftermath of the Tax Cuts and Jobs Act of 2017, when many senators faulted corporations for spending the savings from the tax cuts on additional repurchases. For example, Senate Democrats released a report in November 2018 claiming that companies authorized $882 billion in share repurchases in 2018. The report accused these companies of laying off workers while spending billions of dollars on share repurchases. Highlighting several observations, an op-ed piece written by senators Chuck Schumer and Bernie Sanders in the New York Times in 2019 captured many of the criticisms leveled by politicians against share repurchases. First, they state that repurchases make firms less resilient, weaken firms in the long term, and reduce workers’ productivity as a significant share of profits is diverted to dividends and repurchases. Second, they claim that repurchases restrain firms from making meaningful investments in R&D and equipment, paying higher wages, providing paid medical leave, offering better retirement benefits, providing better worker training, and making sufficient pension fund contributions. They also claim that, while median employee compensation has stagnated, CEO compensation has surged.

Joining this chorus against repurchases by politicians were labor unions, think tanks, and the popular press. For instance, Communication Workers of America urged senators to rein in corporate repurchases. They stated that Verizon repurchased $5 billion worth of shares while turning down striking employees, stating that the company could not afford wage increases, improved health care, or job security. Activist hedge fund managers like Paul Singer at Elliott Management targeted AT&T and demanded that the company lay off employees and spin off assets. AT&T then consented to $30 billion in share repurchases. Popular news outlets like the New York Times and The Washington Postare primarily disposed against share repurchases.

Criticisms in the post-TCJA era have accused some companies of diverting billions of dollars to share repurchases while also queuing up to seek government aid during the COVID-19 crisis. Criticism against the airline industry was particularly harsh. In September 2020, the U.S. Treasury finalized bailout loans for seven airlines up to a maximum loan concentration of $7.5 billion per airline. The four biggest airlines, including Boeing, spent $70 billion on share repurchases in the five years preceding the pandemic. In the 10 years before the COVID-19 crisis, the four biggest airlines, Alaska Airlines and Jet Blue Airways, spent about 90 percent of their free cash flow on share repurchases. Airlines and other companies that sought relief during the pandemic were heavily criticized. The criticism was that, instead of spending money on share repurchases, companies could have shored up capital and liquidity, thus making the companies more resilient to shocks.

Given these criticisms, it is little surprise that, in addition to the recently passed Inflation Reduction Act, at least four bills have been proposed to curb share repurchases. Prominent among them is the Reward Work Act, originally introduced as Senate Bill 2605 in the Senate by senators Tammy Baldwin, Elizabeth Warren, and Brian Schatz in March 2018, joined in April 2018 by Kirsten Gillibrand, and in November 2018 by Bernie Sanders. Other acts include the Stock Buyback Reform and Worker Dividend Act of 2019, proposed by Senator Sherrod Brown, and the Worker Dividend Act, proposed by senators Cory Booker and Bob Casey. Representative Joe Kennedy II reintroduced the Worker Dividend Act in September 2019. The common theme across all these acts is to curb share repurchases. Some go as far as repealing Rule 10b-18.

In our paper, we critically examine the arguments for curtailing stock repurchases from the basic corporate finance theory perspective and conclude that they are without merit. We also subject the criticisms to empirical scrutiny. Fundamentally, the political criticisms revolve around firm resiliency and employee welfare. Politicians claimed that share repurchases weakened firms and could not survive a crisis like COVID-19 without government support. We test whether share repurchasing firms in general have poor cash surplus levels. We also extend this line of testing by using firm-level crises defined as a 25-percentage point fall in sales from the previous year. We examine the behavior of share repurchasing firms following these firm-level crises and find that share repurchasing firms had sufficient cash surplus. Following such crises, they reduced share repurchases and increased cash surpluses, which suggests responsible behavior by share repurchasing firms.

Next, we test the political criticism that share repurchases reduced employee welfare. We chose hiring, employee compensation, pension unfunded liabilities, and employee morale. We find that share repurchasing firms did not harm the employees. Our results suggest that share-repurchasing firms have better pension funding, employee morale, and employee compensation. We also examine whether share repurchasing firms are associated with increasing CEO total compensation and find that the political criticism regarding share repurchasing firms benefitting CEO compensation is not valid.

We make several contributions. First, we examine the theoretical validity of the criticisms leveled by politicians.  Second, we formulate testable hypotheses based on several criticisms of share repurchases made by politicians and the media.  Finally, based on a large sample of share repurchases, we empirically test whether data supports the criticisms of share repurchases. Our theoretical analysis and empirical tests conclude that the political and media opposition to share repurchases is without any theoretical or empirical justification.

This post comes to us from professors Kose John at New York University’s Leonard N. Stern School of Business, Subramanian R. Iyer at the University of New Mexico, and Ramesh P. Rao at Oklahoma State University’s Spears School of Business. It is based on their recent article, “Politics and Regulation of Share Repurchases: Theory and Evidence,” available here.