First Step to Fix the Markets: Let Shareholders Vote on Buybacks

| About: SPDR S&P (SPY)
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I have written an article in the past about my negative thoughts on share buybacks. In my opinion, they are a horrible waste of capital.

If I were Obama, the first step I would take to fix the markets is the following:

Allow shareholder votes such that if a board of directors determines that there is excess capital that can be used for share repurchases, that the shareholders (via a vote) could instead opt to receive the cash as a payout (dividend).

Under this scenario, there would be an either/or scenario – the cash pool would entirely be spent on a share buyback OR a dividend, depending on the shareholder majority vote. I would also be tempted to disallow mutual funds from voting, but that may be a subject for a different article.

What would this accomplish? First, I believe that shareholders DO NOT feel like owners of the companies they invest their money in. But they should. They are the owners! If I ran my own business, you would be crazy to think that I would allow someone else to tell me what I could do with excess profits that weren’t reinvested in the business. By allowing a shareholder vote, owners (shareholders) of the companies would determine where excess profits were sent, NOT some incompetent board of directors. To be honest, I can’t even contemplate an argument against my proposal.

A second benefit to such a shareholder vote is that it may force boards of directors to do away with obscene stock and stock option awards. My theory on this is that if shareholders were smart and wouldn’t allow these terrible share buybacks, boards of directors would be less willing to dilute the number of shares (via stock compensation) since there would be no opportunity to buy shares back to offset the dilution. The real effects of excess and obscene compensation would be more recognizable.

I would bet that after this recent run of corporate management malfeasance, shareholders would almost always opt to take cash right away rather than let the board of directors throw it away. If this is too strong a statement, explain why Goldman Sachs (run by the smartest guys in the business) buys back stock at much higher prices than when it issued shares to raise capital. There are many examples of companies doing this. The only argument against taking cash versus doing a share buyback is the tax hit of 15% on dividends.

My second recommendation to Obama would be to LOWER the dividend tax (a zero percent rate would make the most sense), making the share buyback less of an attractive option.

It is my opinion that implementing these rather simple measures would greatly restore credibility in the stock market. Allow the owners more power, pure and simple.