Capital Structure, Leverage & Distributions

386701) Read the article: “Are Buybacks Really Shortchanging Investment?” found in the Module 6 content.

Provide your technical analysis and reflection on that question.

FRIED, J. M., & WANG, C. C. Y. (2018). Are Buybacks Really Shortchanging Investment? Harvard Business Review, 96(2), 88–95.

2. Provide short responses to each student and provide atleast one credible resource per response.

Student 1

One reason, a company buyback shortchanges investment, may be because it lacks profitable investment opportunities to grow, a drawback for its long-term investors. However, a company may have borrowed and increased their debt to pay for the buybacks. One can argue the loan is an investment opportunity for another firm.

Also, instead of government regulation, preventing companies from buybacks, companies whose buybacks are invested directly or indirectly, can be measured for value creation and rewarded, if it results in innovation, job creation, and has an overall benefit to the US economy. As William, at Harvard Business Review, identified from his research, “From the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations. They retained earnings and reinvested them in increasing their capabilities, first and foremost in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth,” (Lazonick, 2014).

Student 2

Returning capital to investors at the expense of reinvestment is simply a tool that is used to find equilibrium. Whether or not it is used excessively, would depend on market conditions and industry needs. The name of the game here is efficiency! If reinvestment was more profitable, then companies would reinvest. If market dynamics discouraged reinvestment and future growth, then companies would return capital to investors. So as to balance the market and attract new investors, which would insure future growth despite the lack of reinvestment.

In other words, the arbitrage would close in either direction. So it really becomes irrelevant trying to debate the nature of the issue, beyond understanding why it exists. And further debate doesn’t translate into making money. Is a distraction, which creates inefficiency. The market is going to do what it has to do, regardless of our opinion. So why would you want to focus on 3rd and 4th-order derivatives such as these? The focus should be on getting the 1st derivative right and positioning yourself accordingly! That’s what makes money and adds efficiency. The rest will sort itself out as the cycle progresses.