On Stock Buybacks, Congress Has No Business Telling Companies How To Manage Their Balance Sheets

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Although the United States government has run up a national debt that exceeds the Gross Domestic Product, two spendthrift United States senators have the temerity to lecture American corporations about how the latter should manage their balance sheets.

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Balance Sheets
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Senators Bernie Sanders (I-VT) and Charles Schumer (D-NY) recently proposed forthcoming legislation that aims to prevent corporations from buying back their own stock unless those corporations meet a series of certain conditions. Those conditions include a set minimum wage of $15 for all workers, a guaranteed seven days’ worth of paid sick leave, and offering “decent pensions and more reliable health benefits”—essentially a progressive wish list for corporate behavior.

Why There's Nothing Wrong with Large Corporate Cash Reserves

What’s so nefarious about a corporate buyback? Nothing, really.

As Erica York of the Tax Foundation explains:

When companies have more cash than they can use for their current investment opportunities, they can either hold on to that excess cash, or return it to shareholders. One way firms can return excess cash is to repurchase some of their own stock; this option is advantageous because the company does not have to commit to repurchases, allowing flexibility for timing and amount, and it doesn’t set up an expectation that the distribution will occur on a regular basis (like dividend payments).

One of the misguided rationales behind the proposed legislation is the notion that corporations are failing to invest available cash at acceptable levels. On one hand, companies are indeed retaining large sums of cash.

Although a cash reserve is a foreign concept to debt-addicted US senators, prudent companies may keep some cash reserves for several reasons. For instance, capital may be a hedge against market or political risk or a war chest for future acquisitions.

Large corporate cash reserves or stock buybacks do not indicate a failure to properly invest. Despite large cash reserves, high dividends, and stock buybacks, corporate investment, and research and development have each increased.

Corporations don’t need input from senators when it comes to corporate development or treasury decisions. Corporate decision-makers and their financial analysts are in a much better position to determine how best to spend or invest their after-tax dollars.

Corporations Make Rational Decisions

Politicians are presumptuous to instruct corporations on investment and research spending. There is no optimal level of R&D expenditure that is true for all companies across industries or across all stages of a corporation’s business life cycle. Despite the suggestion that US corporations are neglecting their future when they engage in stock buybacks, there is no compelling evidence to indicate companies are buying back shares to the exclusion of investing in their future.

Corporate managers tend to make rational decisions: Corporations hold onto cash when corporate managers cannot find an investment that they expect to yield a higher return. And when corporations accumulate a surplus, sometimes they return a portion of available cash to their shareholders. Obviously, shareholders would never invest in companies, whether as debt or equity, if they didn’t expect a return on their investment. Returning value to shareholders is a feature, not a bug, of a healthy capital market.

This is where a stock buyback comes in. Once a company decides to return value to its shareholders, it may do so by means of a dividend or a stock buyback.

One advantage of stock buybacks over dividends is that shareholders avoid double taxation when a corporation redeems and retires its shares. By contrast, a shareholder is subject to tax when it receives similar value in the form of a dividend.

The US economy is growing, creating jobs, and experiencing wage growth. Senators like Sanders and Schumer are in no position to tell CEOs, executives, and shareholders how to best generate profits and create jobs. Their proposed legislation is just another example of legislative overreach attempting to regulate the internal decision-making of US corporations and impose significant costs on employers. When governmental meddling puts the brakes on economic growth, workers won’t be spared the financial harm of misguided policy.

Doug McCullough

Doug McCullough is Director of Lone Star Policy Institute.

This article was originally published on FEE.org. Read the original article.