Larry Fink: Don't Do Buybacks This Year Or Else I'll Write Another Stern Letter Next Year

Or why blaming buybacks on short-termism is like blaming unplanned pregnancies on the Weeknd.
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Corporate America's self-appointed ombudsman Larry Fink is back with his annual harangue of fellow executives, and although the letter comes with a Trump-era twinge this time around, it harps on the same basic themes as it has for several years: Companies should make long-term plans, spare a thought for the environment, and knock it off with all those dang stock buybacks.

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As usual, the culprit is the dreaded short-termism, particularly as it applies to companies gobbling up their own shares. “Companies have begun to devote greater attention to these issues of long-term sustainability, but despite increased rhetorical commitment, they have continued to engage in buybacks at a furious pace,” Fink wrote, noting that shareholder payouts topped S&P 500 operating profits.

Though the buybacks-to-profits ratio might not be the greatest metric to assail repurchases, Fink makes an obvious point: Buybacks eat up cash that could be used to, say, build giant LEED-certified factories in the rust belt. But it's curious that he comes marching out every year to shout “short-termism” at an institutionalized practice that most companies engage in constantly. Companies that buy back stock do so with cyclical consistency.

If you have to flag buybacks every year, can you really chalk them up to short-termism?

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(Yardeni Research)

Fink has described short-termism as analogous to the famous marshmallow experiment of yore, in which kids got a marshmallow and were told they could eat it now or wait 15 minutes and get another one. But that's not how buybacks work. For a decently functioning company, every quarter generates cash flow which can be plowed back to shareholders in the form of buybacks. Whether companies eat the marshmallow or not, another one will probably arrive soon.

What drives buybacks isn't a transitory urge to deliver paper gains to shareholders but a desire to get paid. From the time wide-scale repurchases were permitted in the early 1980s, the growth of buybacks followed closely the use of executive stock options in compensation plans. The two phenomena remain tightly correlated: From 2008 to 2014, S&P 500 companies that granted stock options reduced their common shares outstanding by a cumulative 5.4 percent, while those that didn't held their share count steady.

There's an obvious explanation: Stock options dilute shareholder equity, so buybacks are needed to keep everyone happy. The problem here is that this arguably amounts to a transfer from shareholders to executives – compensation that isn't precisely recorded on the balance sheet.

This is all leaving aside the well-documentedpractice of companies juicing their earnings-per-share with well-timed buybacks in order to keep EPS-based bonuses flowing – a properly short-termist habit, sure, but not the sole driver of buybacks.

So what are we talking about when we talk about excessive buybacks? It's not short-termism; it's executive pay. In fact, for top brass whose options take several years to vest, buybacks could actually be seen as an example of the longer-horizon thinking Fink celebrates. Blaming 2016's stock buybacks on short-termism is akin to blaming 2016's unplanned pregnancies on the Weeknd. Let's not confuse a contributing factor for the underlying cause.

Surely Fink knows all this. But he also knows that slamming “short-termism” is the rare move that sounds both politically virtuous and palatable to the C-Suite. No one wants to be myopic, after all. Acknowledging buybacks as what they really are, however – CEO compensation through the back door – would be gauche.

And though Fink makes noise about keeping executive compensation at sane levels, BlackRock's record on that front is hardly courageous. The asset manager voted for corporate pay plans 97 percent of the time and okayed 95 percent of stock buyback plans in 2015.

If you want to argue stock buybacks are out of control, fine! Just be aware you're also saying the same about CEO pay – which is also fine! It's just that maybe a guy who pulled down $26 million last year has a reason to take it easy on that front.

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