That leads to short term thinking and pumping of stocks, often done by firing R&D and maintenance people.
See page 10:
https://www.zurich.com/-/media/project/zurich/dotcom/investo...
Buybacks come from net income (profit). A business always has a choice of using the profit to pay the business’s owners (via dividend or buybacks) or to invest it back into the business (such as spending on R&D).
Obviously, what portion of the profit is ideal to spend on R&D and what portion of the profit to pay to owners is not an objective truth.
And buybacks are nothing special, except that they allow more flexibility in how to reward the owners.
Never confuse the textbook economics with the reality of individual incentives. Company management used the low interest rate environment of the recent past to borrow money that was then used in buybacks. Executive management generally is in a no-lose situation with regard to compensation, there may be long-term incentives, but the CEO generally can exit within the term of their employment contract with a sizable payout even if they blow up the company. The board is supposed to prevent such tactics, but US corporate governance is largely about cross-pollinating memberships so that CEOs can all vote 'yes' on each other's pay packages.
Are people who buy stocks not incorporating the increased debt levels of the business in their valuation of the share price?
Due to inflation people with large amounts of capital have little choice but to invest somewhere. Ultra safe bonds are also ultra low yield which limits options.
If a business borrows money, and people still buy the shares, then that means people are willing to bet the amount borrowed will still allow for a sufficient return on investment. So where is the problem?
> If a business borrows money, and people still buy the shares, then that means people are willing to bet the amount borrowed will still allow for a sufficient return on investment.
The problem isn’t with the company but with the market. Sure the value of those companies adding debt drops with the reduction in their expected ROI but that’s not the end of the story because you need to consider how that money is reinvested.
Suppose the S&P collectively borrowed 10 trillion dollars doing this. Each company that takes part is as you say a worse choice, but the overall market is now inflated with this money so everything becomes a worse investment simultaneously. Which then sends some money back to the original companies who issued dividends/ buybacks with borrowed money.
Yes, that is what safe means. Risk and reward. Reward without risk is simply expanding the supply of money, aka inflation, aka reduced purchasing power of the currency.
>Suppose the S&P collectively borrowed 10 trillion dollars doing this. Each company that takes part is as you say a worse choice, but the overall market is now inflated with this money so everything becomes a worse investment simultaneously. Which then sends some money back to the original companies who issued dividends/ buybacks with borrowed money.
If everyone did it, then it is not a "worse" investment, it is simply keeping up with the reduction of the currency's purchasing power (e.g. all businesses taking advantage of covid stimulus). But it is a nonsensical premise anyway, since there are insufficient lenders to lend the S&P $10T, and the limited number of lenders will, on average, do due diligence when lending, even to S&P companies.
Anyway, back to the point was hand, which was refuting yborg's claim that business leaders can just borrow willy nilly and pay themselves via gains in stock price via buying back shares.
The only situation this happens is when the business has large stockpiles of cash saved abroad, and so instead of bringing it into the US and having to pay taxes, they are able to borrow money at near 0% interest rates because lenders know they have such huge stockpiles of cash abroad and healthy cash flows. Delaying tax liabilities is simply the logical thing to do when the government has set fiscal policy such that you can find lenders to lend to you at near 0% interest.
Lending like this shouldn’t change purchasing power for real world goods much, the point is it specifically impacts investors.
> Anyway, back to the point was hand, which was refuting yborg's claim that business leaders can just borrow willy nilly and pay themselves via gains in stock price via buying back shares.
Sure, but my point was what happens to individual companies is different than what happens to markets. If half the companies on the S&P did this then the other half would see a small price spike. The price spike in other companies would also increase the valuations of companies that borrowed, not by enough to fully offset the borrowing but still more than zero.
Borrowing isn’t required here, if Google issued a dividend for the majority of it’s reserves a significant fraction of that money would get reinvested in stocks and a small fraction of which would go back to Google.