Buffett on Buybacks
The Oracle Speaks With Censorious Tongue
In an annual letter notably brief by past standards, Warren Buffett, chairman of Berkshire Hathaway, had strong words about corporate share repurchases—or rather, about the political crusade against them.
Quoting his latest letter:
“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).”
Buffett rarely gets involved in political disputes. Even more rarely does he use harsh or judgmental language. “Silver-tongued demagogue” is an exception, and it can only be aimed at members of his own Democratic Party.
In 2022, when both chambers of Congress were under Democratic control, Congress enacted a 1% tax on share repurchases. And in the recent State of the Union address, President Biden recommended that the tax be quadrupled, to 4%.
With buybacks running at a record pace thus far in 2023, the pressure to rein them in is likely to rise. But Buffett is entirely right: penalizing buybacks is political grandstanding and economically injurious. As he noted, “The math isn’t complicated.” When companies buy out a portion of existing ownership at a price that is less than intrinsic value the remaining shareholders gain. When they pay too high a price (a frequent occurrence, due to CEO overconfidence) continuing shareholders suffer.
The opposite is true for companies selling stock. A cheap price hurts existing ownership—a dear one is to their gain. There is no free lunch. As in any stock sale, one party over time will turn out to have been lucky or smart, the other unlucky.
Government does not try to legislate, or to discourage or encourage, issues of stock. Nor should it get into the business of regulating repurchases.
As we have said before, stock issues and repurchases—really mirror images of the same transaction—reflect a management’s verdict on its ability to profitably employ capital. And, they reflect the market’s judgment about the relative appeal of competing firms for the same limited resource: capital.
Markets make mistakes all the time, but the reason Apple today is worth more than AT&T is that investors figured out that people would be using iPhones. Pressuring companies to retain unwanted capital would be like pressuring firms to keep their capital in rotary phones.
One exception to letting the market decide: for businesses that society has deemed are essential, government can and should require adequate levels of capital, so that taxpayers don’t get caught holding the bag. Banks are a prime example.
A notorious violation of this principle occurred in 2020, at the start of the pandemic, when Congress approved a $25 billion airline bailout. Many of the airlines had, previously, depleted their capital with significant share repurchases. Future buybacks were restricted, but the damage was done, and unlike in the case of previous bailouts of car companies (or of banks), the federal government did not receive a major ownership position. The public shouldered the risk after private parties, including executives, pocketed the reward.
Congress, in that case, could have allowed airlines to fail. Typically, carriers who file for bankruptcy are restructured and the physical planes keep flying with little or no interruption to service. The only permanent losers would have been airline CEOs and their investors—who took the risk. But if Congress thinks not letting airlines fail is a good idea, it should set capital requirements in advance of the next bust.
Such examples do not justify a general proscription against buybacks. It is true that CEOs in diverse industries use buybacks to goose the stock with their (often ill-conceived) stock option packages in mind.
The problem is with the boards that approve such packages. All too typically, through options and other management plums, executives are awarded herculean sums for mediocre or worse performance (see my column on General Electric.) Loyal readers will recall many similar cases.
But to penalize companies for repurchasing stock because doing so might boost the share price is insane. Would you penalize corporations for inventing new products, or selling more goods, or earning higher profits? They raise the share price, too.
Share repurchases at Berkshire were a nonevent over most of Buffett’s tenure. But over the past three years, Berkshire has repurchased about 10% of its stock. (Note: I’m a shareholder.) According to Buffett, repurchases were accretive, meaning, they increased the per-share value for remaining shareholders. Time will tell.
Tax on buybacks makes sense in the context that dividends are already taxed. In a world where dividends were not taxed, they would be practically equivalent to buybacks. That’s why buybacks are currently exploding, they are stealth dividends that IRS cannot currently grab.
Dividends and buybacks are by and large equivalent. The main difference is that a dividend stream returns shareholders' money over time, while a buyback tends to be a one-time event.
Both have the very important effect of letting shareholders reallocate capital dollars from a company that does not have much use for the, e.g. in a mature industry, to one that has good opportunities for growth. Forcing a company to stop implementing buybacks, even when it doesn't have many opportunities to use the money internally, leads to stupid investments and excessive spending on management perquisites.
The main criticism of buybacks is that they "goose" the company's share price, and so holders of options (e.g. management) has incentives to declare buybacks even when the company could use the money productively. But that is exactly the same as declaring a dividend increase, which also results in a price pop and less money inside the company. Yet I have heard no proposals to tax dividend increases (as opposed to dividend levels).