The Debt-Financed Repurchase Craze: A New Normal?

Share repurchases or buybacks refer to the distribution of profits to existing shareholders through the purchase of shares already held by the shareholders. Several factors underlie the share repurchase phenomenon. Corporates repurchase their shares as a way of signalling positive information to the market about the prospects of the company since cash-rich firms would normally be able to finance repurchase programs. If the share price is low, the management can elect to buy back the shares to prop up the prices. Share repurchases can increase the value of share-based compensation of management. These and other reasons explain the prevalence of repurchase transactions among corporates. But repurchase programs may stall the growth of the real economy. The disgorgement of cash could be used to increase wages of employees to spur productivity. More importantly, repurchases tend to stifle investments in fixed assets and other capital projects. Hence, while repurchases might be beneficial to few shareholders, the overall impact on the real economy is not positive.


During the last few decades, share repurchases have become popular as a means to return cash to shareholders. In 2007 alone, share repurchases peaked at more than $700 billion near the market top. The evidence explicitly argues that these firms are cash-rich and financially less constrained. In other words, financially constrained firms with limited free cash flow are unlikely to be able to finance repurchase programs without external finance. In fact, a large number of share repurchases are funded with external debt and/or equity finance. In 2009, for instance, 37 companies announced plans to spend $39 billion on share repurchases using funds from debt finance. A recent case in point is Apple Inc. that has consistently borrowed to finance dividends and share repurchase programs since April 2013. For example, Apple announced in April 2013 that they would return $100 billion to shareholders in the form of a repurchase by the end of 2013, partly from debt finance.


Among US multinationals, the tax costs of repatriating cash generated from abroad has defined the motivation to borrow to finance repurchase programs. For example, Apple has recently sold $5 billion debt to finance share buyback worth $300 billion by end of March 2019. By this approach, Apple is able to save on repatriation tax costs of its $261.5 billion of cash with 94% of the cash lodged outside the US. Another motivation driving the repurchase boom is positive global economic outlook and central bank policy rates that have culminated in a growing enthusiasm among investors in corporate bonds. In a more quiescent bond market, with increased buoyancy among investors, companies can now borrow at significantly lower costs since the financial crisis. And with a sustained economic growth coupled with delayed policy rates increases, any sign of debt-financed share repurchases atrophy could take some time. There is ample evidence that firms take advantage of inaccurate and optimistic credit ratings to issue more debt. Cheap debt implies favourable debt market conditions in terms of lower interest rates or narrow credit and/or term spreads. They also engage in cross-market timing where firms can borrow to finance the repurchase of undervalued shares.


Despite the additional cash generated through debt finance, share repurchase programs have resulted in decreases investment in capital projects. Wages have also taken a hit to decimate productivity. In the end, if interest rates begin to pick up and the cost of borrowings increases, this craze will gradually pare down. But until then, the craze will persist insofar as the corporates have the cash and the investors are ready to cash in on their holdings.


Daniel Gyimah

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