Stock markets: Buybucks can hurt your back

Stock markets: Buybucks can hurt your back

For more than three decades, financial engineering probably played a bigger role in wealth creation than the economic activity on the ground. Some financial innovations have helped improve economic activity, and some have broken the financial systems they were meant to strengthen. One of the tools of financial engineering is the buyback of shares by companies. It allows CEOs to decide if their companies’ stocks are trading below what they think they should trade, and to drive them up by buying them in the market with shareholders’ money.

It is said to be a way to return money to shareholders when companies lack meaningful investment opportunities for future growth. Historically, excess cash or a portion of profits was paid out as dividends to equity investors. But stock buybacks are good for corporate executives because stock prices rise without any improvement in corporate performance as the number of shares decreases and tax expenditures are lower. Sebi is now reviewing the rules governing share buybacks. A committee led by HDFC CEO Keki Mistry submitted suggestions after studying experiments that show the tool has been used to manipulate stock prices. This comes when there is a debate about whether the practice has helped or hurt economies, as managements led by executives with huge stock options focus on short-term gains. , rather than investing in the company’s long-term growth.

Economist William Lazonick says share buybacks in the United States have led to higher earnings per share and higher stock prices, but they have created little capacity. It is about value extraction rather than value creation. In India, where capital is presumably scarce, stock buybacks may be a travesty for most businesses. The Sebi consultation paper ( highlights that stock buyback provisions have been more misused than used, exposing loopholes, including the proposed phasing out of purchases through exchanges, openly used to influence stock prices. The commission is proposing to end the on-exchange route of buybacks by April 2025, after concluding that the practice violates the integrity of the markets.

Recommending an increase in the size of the redemption, it says that while a limit of 25% of reserves and paid-in capital may continue to exist, with respect to redemptions made on the open market, the limit may be “raised for takeovers by tender”. Admitting that open market takeovers are “subject to a greater degree of abuse” leads to the conclusion that even the tender route is subject to “abuse” but to a lesser degree. The committee suggests that companies with zero net debt should be allowed to carry out share buybacks twice a year instead of once, and that Companies buying back shares should not have a capital structure where the debt to equity ratio does not exceed 2:1 Although financial condition may be considered reasonable to run a business, the question is whether a company should spend resources on rac hedging shares instead of repaying debt. If the second takeover could only be carried out by a company with zero net debt, why not the same principle for the first takeover as well?

Taxation works against long-term investors who stay invested in the companies because they end up paying for those who sold their holdings in the takeover. The promoters profited from this to the detriment of the minority shareholders. A committee analysis shows that in 19 of the 68 listed companies that have bought back shares, the promoters have contributed more than their stake before the buyback. In these 19 companies, the total tax paid was Rs 2,988.79 crore, of which the tax paid by these companies on the shares contributed by the promoters was Rs 2,734.35 crore.

In almost every way, buying back stocks goes against the basic market principle of price discovery. It legitimizes corporate stock price rigging. When fund managers and index managers insist on larger floats for better price discovery, reducing the float is a penalty for inflating the stock price. Moreover, the state ends up losing in the game of share buybacks. For every Rs 1,000 crore dividend paid, the state receives around Rs 350 crore in tax revenue, excluding certain holding structures in tax havens. If the same Rs 1,000 crore is used to buy back shares, the revenue drops to Rs 230 crore.

Although Sebi is apparently seeking to change tax laws, it may be worth considering whether or not to allow share buybacks. Conventional dividend payments can protect market integrity and encourage companies to invest and build capacity.

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