The Bitter Truth About Corporate Tax Cuts and Stock Buybacks

President Trump signed the Tax Cuts and Jobs Act late last year, dropping the U.S. corporate tax rate from 35 percent to 21 percent. That was less than two months ago, and yet we're already seeing major changes in corporate behavior. For example, companies have announced $3.7 billion worth of bonuses to be paid to employees. That's great news for lots of Americans, but, it's not the only news. U.S. companies have also announced $171 billion in stock buybacks since Jan. 1. In light of that, it's worth remembering that executives can abuse stock buybacks to enrich themselves at the expense of all shareholders. Here's how:

Whether a company buys back shares in the open market or allows shareholders to tender their shares back to the company, the total number of outstanding shares is reduced. So, even if the company’s earnings remain constant, earnings per share (EPS) will increase (i.e., the same earnings spread across fewer shares equals higher EPS). And yet, many companies award bonuses to their executives for increasing EPS. Sound fishy? It gets worse.

Companies don’t always retire those shares that they bought back. Sometimes, they record those shares as treasury stock that can be repurposed later to fulfill a grant of restricted stock units (RSUs), used for compensation. So, the shares that the company bought back, that increased EPS and triggered bonuses for executives, might be paid out to those same executives as RSUs. Still, it gets worse.

Not every management team that wants to buy back stock has the cash on hand to do so: Some of them borrow money. So, the executives who borrow money in the company’s name use it to buy back shares, that increase EPS, that trigger bonuses for those executives, and that are paid out using those repurchased shares. Meanwhile, the long-term investor is stuck paying back a loan.

Source: How Stock Buybacks Make the Rich Richer (and You Poorer)

Don't be surprised if the majority of the money that U.S. corporations save in taxes in used to fund buybacks. In 2004, as part of the American Jobs Creation Act, Congress allowed a one-time tax holiday that resulted in U.S. companies bringing home $312 billion from overseas. Analysts at Bank of America believe that 80% of this money was used to fund stock buybacks (and a Senate report suggests that there was a net loss in jobs at the companies that repatriated their foreign earnings). Executive compensation rocketed higher during this time.

It's now predicted that U.S. companies will devote $450 billion of their tax savings to buying back their own stock. Now, more than ever, investors (and that includes anyone who has a 401k) must be mindful of how their money is used by the executives who run public companies. Tax reform has the potential to benefit all Americans, but that's unlikely to happen unless investors act like rightful owners of the companies they invest in, demanding honesty and accountability from managements. Remember: Executives at public companies work for you. Don't let them work against you.