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If Congress limits the ability of companies to buy back shares, it would backfire and likely result in more companies taking themselves private through leveraged buyouts, a Wall Street research firm said.
"Going private is essentially a 100 percent buyback," said Brian Reynolds, asset class strategist at Canaccord Genuity. He adds that CEOs are motivated to increase their companies' stock price. "If regulators are going to make it less profitable to be public, then we'll have more private companies."
Reynolds said it's often the case that legislation meant to curb corporate excess backfires, and creates new problems as companies find ways around rules. For instance, he said post-Enron legislation only encouraged more shadow banking.
As for buybacks, Congress has been bristling at the record stock repurchases by corporate America, popular particularly in the post-financial crisis era of low interest rates. Companies used cheap debt to buy back stock to reduce their shares outstanding and boost stock prices and earnings per share. Democrats have used evidence of this surge in buybacks as a way to criticize the GOP corporate tax overhaul.
Sen. Marco Rubio, R-Florida, on Tuesday was the latest prominent legislator and the first Republican to support action that would limit buybacks or make them less palatable to corporate executives. Rubio backed a plan that would raise taxes on capital gains as a way to discourage companies from pursuing share repurchases.
Last week, Senate Minority leader Chuck Schumer D-N.Y., and Vermont Sen. Bernie Sanders said they proposed legislation that would force companies to invest in their workforce and communities through better pay and benefits before they could spend on buybacks.
"It doesn't make sense for most companies to invest in plant and equipment and hiring because nominal GDP growth is in a four decade downtrend. If every company started investing in plant and equipment, the result would be deflation, which would be far worse for the economy," said Reynolds, in an interview. He said demand is not there to support that.
"I think you need a real change in the executive branch and in the Senate for this to pass," said Reynolds. "I think that's not going to happen for two years, and it's going to be coincident with when I think the next LBO wave begins anyway. As most big rules and regulations have backfired in the past, this would backfire."
Reynolds said he would not expect legislation against buybacks for at least two years, since a GOP Senate would not endorse it. Reynolds noted that after shoddy accounting at WorldCom and Enron were exposed, and their off-balance sheet financing revealed, regulators moved to limit the use of the special purpose vehicles to hide assets.
But the new regulation actually resulted in more shadow banking in the next cycle. He said those special purpose vehicles were 'turbo-charged' and became the structured investment vehicles that helped spur the financial crisis.
Reynolds said he believes the 2010 Dodd-Frank law, then created to combat excesses that led to the financial crisis, have given way to even more shadow banking.
After the problems with special purpose funds, the SEC essentially banned the type of money market funds that utilized them and allowed the issuing firms to hide assets, Reynolds noted. "This ban has backfired with an estimated $400+ billion going into lightly regulated cash funds that want to take even more risk, resulting in private liquidity funds, levered insurance products, and increased structured finance activities like CLOs designed to meet the increased risk appetite," he wrote in a note.
Reynolds said Congress, in all of these cases, was only treating the symptom and would be doing that again with buybacks. He also puts public pensions at the root of the problem.
"The problem is that our nation's public pensions have become the dominant global investor, are grossly underfunded and thus have to reach for risk, and are essentially unregulated because of states' belief that they are sovereign," he said. "Thus, they reach for yield and have generated repeated financial boom and bust cycles since the early 1990s."