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Corporations use tax windfall to buyback their own stock

When the Trump tax cut was passed recently, the benefits to middle and lower class taxpayers were compared to the benefits to corporations and 1-percenters by those in favor and those opposed to the cuts. Wiser observers waited to see how the cuts would play out in real-time actions. There was no debate regarding the facts of the lowering of corporate tax rates--only a debate about how the savings might be spent: on higher wages to workers? More jobs? Or something else? 


The tax cuts are increasing the available cash to corporations, which actually creates a problem. Common wisdom holds that a corporation with "too much" cash becomes a target for a corporate takeover (buyers want to get their hands on the cash, and are willing to buy the company to get their hands on it). So a company that doesn't want to be taken over needs to prioritize spending the cash on SOMETHING.  And several companies are choosing to buy back their own corporate shares with the money: over 100 companies have already planned $178 billion in planned buybacks of corporate shares.


This means decreasing corporate assets (cash) and decreasing Stockholders' Equity by paying stockholders to sell their shares back to the corporation instead of to other third-party shareholders. This reduces the number of "outstanding" shares. The company value and income is therefore spread over fewer shares. So each share is worth more.


An analogy: Let's say a box of Girl Scout cookies contains 20 cookies, and there are 10 members of a book club. Each member would get 2 cookies. But if 2 members of book club were offered tickets to another event so that they didn't come to book club, then the 8 members who showed up would get 2 1/2 cookies each (20 cookies divided by 8 members).  


So the tax cut money--instead of being invested in new factory equipment (which would support jobs in a related industry); and instead of being used to increase wages or grant bonuses (which also might be spent to stimulate the economy--is used instead to increase the book value per share, the earnings per share and the market price per share for the remaining stockholders.  The stock sellers also benefit by getting a premium price to tempt them into selling their shares back to the corporation.  


Source: "Trump's Tax Cut in Hand, Companies Spend More on Themselves Than On Wages," by Matt Phillips, New York Times, February 28, 2018. [Cover photo, from the linked article, shows Warren Buffett announcing that Berkshire Hathaway may buy back some of its own stock. Andy Kropa/Invision via AP]

Follow up

  • What is the opposite of using cash to buy back corporate shares from the market? [Hint: there is more than one answer to this.] Name one method that increases the balance in the Stockholders' Equity section of the balance sheet (this is done when a corporation is initially formed). Name another method that increases the number of shares outstanding, but does NOT increase the Stockholders' Equity balance (Apple stock did this one June 9, 2014). Explain the effect of these actions to individual stockholders. 
  • Define "book value per share," "earnings per share (EPS)," and "market price per share." How to the numbers relate to each other, value-wise. Explain why. 
  • What is the effect on the stock market of corporate stock repurchases? Why?
  • What is the difference between "repatriating cash" (which was a planned outcome of the tax cut) and "repurchasing stock"?