Every few days an investment banker takes a position in a profitable and cash rich company and suggests a leveraged share buy-back. Why not? Interest rates are low and reducing the number of shares outstanding has the immediate effect of increasing earnings per share. When the stock rises the investment banker will sell the shares it controls and realize a profit. The investor does not care that the company may be harmed years later if it goes through a challenging period and finds itself unable to meet its obligations. Judiciously repurchasing shares and paying higher dividends with excess cash is part of management’s responsibility to stockholders. However, the long-term fiscal soundness of the company is of paramount importance.
Have we forgotten that our mortgage lenders induced middle-class Americans to over-leverage their homes though refinancing and home-equity mortgages. Such excess debt coupled with other irresponsible lending practices, created the housing and mortgage bubbles, the bursting of which caused the Great Recession. When home prices declined millions of middle-class Americans lost their homes and their life savings. Home owners didn’t foresee the risk and were blind-sided. We should have limited excess housing debt.
The strength of corporate balance sheets and rising profits helped the US to get through the Great Recession. We should adopt a federal law limiting corporate borrowing to finance stock repurchases. Otherwise too many corporate executives anxious to please powerful outspoken investors or to raise short-term earnings to justify large compensation packages, will engage in stock buy-backs that impair the long-term soundness of their corporations.