Corporate Finance Puzzle 1: Buybacks, Dividends and Reinvestment

Buybacks have been at the center of a heated debate in the United States, with some arguing that they are the reason for companies not reinvesting in new factories, widening income inequalities and a variety of other social ills. In an op-ed in the New York Times on February 4, 2019, Senators Schumer and Sanders make their case for why buybacks should be restricted. You can find the link below:

Implicit in the opinion piece are three assumptions, and without any prejudgment, here they are:

1.    It is better for an economy in terms of job and growth, if all companies in that economy reinvest their money back into their businesses rather than return them to shareholders.

2.    When cash is returned to shareholders, in buybacks or dividends, it leaves the productive economy and is consumed or disappears.

3.    Income inequality and low wages for those at the bottom of the scale are central problems that we would all like to solve, and it makes sense to tie whether a company can return cash to shareholders to behavior that will contribute to making these problems smaller.

I know that we live in political times, and that our red or blue predispositions can affect how we react, but please try to set your political priors to the side and think through each of these assumptions as objectively as you can.

  1. Is it true that an economy is better in terms of jobs and growth, if all companies have to reinvest their money back into the businesses instead of returning cash to shareholders? If yes, explain. If not, why not?
  2. What happens to the cash retutrned to shareholders in the form of buybacks? In 2018 alone, companies returned almost $600 billion in cash to shareholders. Where did it go?
  3. Asssume that we all accept inequality and low wages as problems, and want to solve them.

I know that I run the risk of creating biases, but here are two blog posts of mine (one old and one from this year) that you are welcome to read, rip apart or use: