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  • For years, companies have been engaging in a practice of repurchasing their shares

  • in order to drive up stock prices and buoy demand.

  • While largely an American phenomenon, buyback activity in Japan has been at record highs,

  • while the trend is also on an uptick in Europe, China and emerging markets.

  • As markets get volatile and rescue plans are needed to save these companies,

  • the practice of stock buybacks is receiving scrutiny.

  • So what are buybacks, and why do they cause such mixed reactions?

  • Let's say a company has made 100 lots of its shares available in the open market

  • which are then bought by retail investors

  • and professional traders.

  • A stock buyback happens when a company uses

  • the excess cash it has on hand

  • to buy back some of these shares in the marketplace

  • in order to drive up the price of its stock

  • and increase overall demand.

  • While stock buybacks happen across major bourses worldwide, American companies have been

  • leading the way, with almost $1 trillion worth of such deals in 2018.

  • That was driven partly by President Trump's tax reform,

  • which lowered the corporate tax rate from 35% to 21%.

  • Flush with that extra cash, some companies chose to spend it on buybacks

  • to enhance shareholder value, instead of reinvesting it in creating jobs or on their employees.

  • Apart from Japan, buyback activity outside the U.S. has been limited

  • mainly because of investor appetite for dividends, legal restrictions,

  • and the focus on reducing debt levels.

  • Across the Atlantic, European companies spent around $150 billion on buybacks in 2018

  • or about 6% of their cash, compared to 25% - 30% in the U.S.

  • In Japan, $52.5 billion of buybacks were recorded in the same year,

  • encouraged by investors and sluggish performance of Japanese stocks.

  • But why is this contentious when most big companies, including BP,

  • Royal Dutch Shell, and Aviva engage in some form of buyback activity?

  • When a company has excess cash, it usually invests the money back into its own business,

  • pay dividends directly to shareholders, or it can buy back its own stock.

  • Critics of buybacks say that companies are inflating their stock prices artificially.

  • The practice is usually seen as diverting the use of cash from other important investments

  • such as higher employee wages,

  • building more factories,

  • creating more jobs, and innovation.

  • Company executives who are compensated

  • in stock ownership also stand to gain from buybacks.

  • Low interest rates have also encouraged buybacks fuelled not by cash,

  • but debt, which makes it precarious

  • for companies during a recession.

  • However, buyback supporters argue that

  • money gained by shareholders is usually reinvested

  • in other companies and spurring growth in the economy.

  • Proponents of the laissez-faire approach

  • also argue that investing that excess cash internally,

  • such as higher wages for existing employees,

  • may affect a company's competitiveness,

  • especially for older companies with high cost structures.

  • This may eventually cause companies to shrink and prevent the creation of new jobs.

  • Nowhere is the practice of stock buybacks more evident than in the airline sector

  • as the pandemic casts a long shadow over the economy.

  • In the past five years, five of the largest U.S. carriers doled out $45 billion to investors

  • mostly in the form of stock buybacks.

  • Europe's largest budget airline Ryanair has also halted its share buybacks

  • while Australia's flag carrier Qantas has shelved similar plans.

  • With much of the global economy coming to a standstill,

  • governments are coming to the rescue

  • in the form of bailouts and subsidies.

  • However, there are caveats.

  • The European Banking Authority has demanded that with their pay-out assistance,

  • all EU banks should stop dividends and share buybacks.

  • Eiopa, the European Union's insurance regulator, has also called

  • for insurance companies to halt dividends and share buybacks.

  • This will affect a few big companies like Allianz and AXA

  • both of which have share buyback programs.

  • In Washington, lawmakers are also demanding tougher conditions

  • for companies seeking federal aid, with U.S. President Donald Trump chiming in too.

  • Will you guarantee that the money, the billions, the tens of billions of dollars,

  • hundreds of billions of dollars even, that's going to go these industries,

  • will not go to executives' bonuses, or to more stock buybacks?

  • Well, we don't want that.

  • In fact, some companies as you know, did stock buybacks, and I was never happy with that.

  • Under pressure from regulators and politicians, some companies are taking heed of the backlash.

  • Major corporations such as Royal Dutch Shell, Ryanair, HSBC and Barclays

  • are scrapping their plans for buybacks and dividend pay-outs

  • as stockpiling cash takes precedence.

  • Notably, Japan's SoftBank Group, which has seen its share price plummet

  • amid the market selloff following the coronavirus pandemic, is bucking the trend.

  • SoftBank, which has stakes in numerous unicorns like Slack and Uber

  • plans to embark on an ambitious stock buyback.

  • With unemployment numbers surging worldwide, the focus is on reversing that trend.

  • In the first quarter of 2020, China's official unemployment rate hit 5.9%, or 26 million people

  • while unemployment in the United States rose to 4.4% in March.

  • According to the International Labour Organization, the pandemic may claim as many as 24.7 million jobs.

  • While the practice of stock buybacks isn't likely to go away anytime soon,

  • many companies are hitting the pause button.

  • As the pandemic rattles the global economy, lawmakers worldwide are calling for bailouts

  • to come with strings attached

  • meaning it's likely that buybacks will continue to remain under scrutiny for a while.

  • Hi guys, thanks so much for watching.

  • If you've enjoyed this content, do subscribe for more.

  • And in the meantime, stay safe.

For years, companies have been engaging in a practice of repurchasing their shares

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Why are stock buybacks controversial? | CNBC Explains

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    Summer posted on 2020/06/08
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