By Lacie Blankenship
Stock buybacks have been a hot topic in recent political conversations. Vanderbilt Business professors shed light on the impact of stock buybacks on stock liquidity and volatility and why that matters.
What is a stock buyback?
Stock buybacks, also known as share repurchases, occur when a company purchases its own shares from the marketplace. Buybacks increase the demand and value of company shares, providing investors with a return on their investment. In recent months, this financial tactic has come under heightened scrutiny for potentially having an outsized benefit for company executives with large stakes in their own companies.
Why does this matter?
The Biden Administration recently unveiled tax plan includes a provision that levies a 1% surcharge on repurchasing companies, adding fuel to the stock buyback debate.
In a recent report released by the U.S. Chamber of Commerce and published by the Center for Capital Markets, Craig M. Lewis, Madison S. Wigginton Professor of Finance, and Josh T. White, Assistant Professor of Finance and Brownlee O. Currey Jr. Dean’s Faculty Fellow, found that stock buybacks have an overlooked beneficial effect on stock liquidity (the ability for quick and low-impact transactions) and stock volatility (degree of price movement).
Professor Craig Lewis
“Much of the political rhetoric around stock buybacks focuses on benefits for executives or large investors,” notes Lewis. “Despite their growing importance, the implications of buybacks for independent retail investors are often absent from this conversation and we sought to explore that perspective in this report.”
What does the research tell us?
Study Background
By using a large sample of 10,000+ U.S. companies over 17 years, the study, Corporate Liquidity Provision and Share Repurchase Programs, presents evidence that “managers [of public companies] strategically utilize share repurchases ([stock buybacks]) to increase stock liquidity and reduce volatility,” and therefore stabilize stock prices, benefiting all investors.
The study found 6 key benefits associated with buybacks:
- Greater Liquidity: Companies repurchasing stock provides substantial liquidity that facilitates orderly trading and reduces transaction costs for retail investors.
- Reduced Volatility: Stock buybacks significantly reduce realized and anticipated return volatility. Imposing limitations on buyback activity would increase stock market volatility and force retail investors to bear greater amounts of downside risk.
- Retail Investors Impact: Stock buybacks generate an economically large benefit for retail investors. Since 2004, buybacks have saved retail investors $2.1–4.2 billion in transaction and price impact costs.
- Proactive Repurchase Activity: Managers utilize market-based estimates of future volatility to inform their buyback decisions. When volatility is expected to be higher, managers increase their buyback intensity to stabilize stock prices, thus reducing costs for retail investors.
- Response To Uncertainty: Studies show that economic policy uncertainty increases stock price volatility and illiquidity. Managers respond to elevated policy uncertainty by strengthening their buyback activities. Retail investors benefit from price certainty about the value of their investments during periods of greater uncertainty.
- Strategic Liquidity Supplier: Managers expand stock buyback activity during critical periods when investors sell relatively large amounts of shares. Thus, managers use buybacks to actively mitigate price pressure during periods of net selling pressure.
Professor Josh T. White
Lewis and White’s research demonstrates that stock buybacks positively contribute to the welfare of all investors and stock transactions, not just the large shareholders.
“It is important to understand how financial policies impact retail investors, who now account for over 20% of U.S. equity trading volume,” says White. “Our study demonstrates how buybacks lower trading costs and reduce downside risk for these key stakeholders.”
Study Implications
This research has powerful implications for policies regarding share repurchase regulation, taxation, and bans. Knowing that stock buybacks positively influence stock price stabilization, it is notable that limiting or taxing corporate buybacks will reduce opportunities to “supply liquidity and reduce volatility,” ultimately resulting in harm.
