Share Buybacks Spike — Dropping A Strong Hint At What CEOs Plan To Do With Tax Savings

Long-term investors and workers hoping that the tax overhaul and repatriation holiday will encourage investment in growth and a rise in wages should brace for disappointment.

A spike in share buyback and special dividend announcements this week reveals that companies are more likely to use any money saved on an all-too-familiar item: shareholder returns.

Bank of America Corp. BAC, +0.94% Home Depot Inc. HD, +0.77% Johnson Controls International Inc. JCI, +0.13% T-Mobile US Inc. TMUS, +1.00% Ciena Corp. CIEN, +0.82% and even Madison Square Garden Co. MSG, +0.40% are among the companies to unveil new buyback authorizations this week, rushing in even before a final tax bill has been formulated.

“I expect a lot more announcements of rewards for shareholders,” said William Lazonick, professor of economics at the University of Massachusetts Lowell and director of the Center for Industrial Competitiveness.

For anyone who saw the appearance by President Donald Trump’s top economic adviser, Gary Cohn, at the Wall Street Journal’s CEO Council meeting in November, the flurry of announcements is not a surprise.

Audience members there were asked to raise their hands if their company planned to invest more if the Republican tax bill were to pass. When very few hands went up, Cohn expressed surprise, asking, “Why aren’t the other hands up?”

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Executives later told reporters that they would use the anticipated tax savings to reduce debt, increase buybacks or pay dividends. David Mendels, the former chief executive of online video company Brightcove Inc. BCOV, -2.82% and before that an executive at Adobe Systems Inc. ADBE, -0.60%   , called the idea that companies would do otherwise “bonkers.”

See: Despite Gary Cohn’s claims, former CEO says companies would probably ‘pocket’ tax cuts

“The fact that they have no problem saying that shows that CEOs believe that this is a natural way to run a company,” said Lazonick. “It’s become an ideology, the capital-return program. But it makes no sense because they are not rewarding people who actually invested in the company, just those who bought shares on the open market, and they’re doing it at the expense of innovation and people.”

A 2004 tax holiday implemented by President George W. Bush to encourage companies to bring overseas cash home also failed to encourage investment in growth. That tax break came with the stipulation that funds brought back were not to be used on shareholder returns.

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Carmine DiCesare, a consultant at FactSet, said that holiday led to an estimated $300 billion–plus in earnings being repatriated to the U.S. However, a FactSet analysis of S&P 500 index SPX, +0.55% constituents showed that share repurchases nearly doubled to $202.7 billion in 2004 from $115 billion in 2003, while special dividends paid jumped nearly sixfold to $179.4 billion from $30.3 billion.

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On the investment side, capital expenditures, which is what creates jobs and pumps money back into the economy, inched up just 3.5% to $385 billion in 2004 from $372 billion in 2003, DiCesare said.

“While there was an increase in capital expenditures, the enormous spikes in special dividends and share buybacks indicate that a large portion of repatriated assets were used to reward shareholders directly,” DiCesare wrote in a research note.

There’s a reason companies can be expected to act as they have in the past. As ex-CEO Mendels said, in his real-life experience as an executive, “tax rates never came up in discussions about hiring or pay levels.

“Again, we would hire more people if we saw growing demand for our products and services. We would raise salaries if that is what it took to hire and retain great people. But if we had a tax cut that led to higher profits absent those factors, we would ‘pocket it’ for our investors,” he said.

The S&P 500 was up 0.5% Friday, and has gained 18% in 2017, while the Dow Jones Industrial Average DJIA, +0.49% has risen 23%.