Are Shareholders Real Winners From the Corporate Tax Cuts?

BOCA RATON, Fla., May 15, 2018 /PRNewswire-USNewswire/ -- In the opening months of 2018, companies gobbled up their own shares at an exceptional rate thanks to the huge windfall created by the Tax Cuts and Jobs Act, which reduces the corporate tax rate from 35 to 21 percent and allows U.S. firms to repatriate massive amounts of foreign profits at greatly reduced rates.

Shareholders have won as companies have hiked stock buybacks and dividends. Buybacks are an effective means of distributing a positive transitory shock to cash flow without rendering an implicit commitment to regular distributions (in the case of dividends). Wall Street typically sees share buybacks as a positive sign of financial strength. By eliminating shares, buybacks can inflate a critical measure of profitability, earnings per share.

While many remain optimistic that the law will benefit the economy, company executives must balance appeasing shareholders with investing in the future to drive more long-term growth and staying nimble lest the economy dips into a recession.

My fellow researchers and I have found evidence that managers often fail to complete announced Open-Market Repurchase (OMR) plans due to lack of capability to manage uncertainty in the firm's future cash flow. We traced all OMR announcements between 1993 and 2011 reported to the Securities Data Company mergers and acquisitions database. The data showed that on average, firms repurchased 65.6 percent of the shares announced in the two years following the initial announcement with a high completion rate revealing managers' ability to forecast and adapt to surprises in firms' future cash positions.  

Following higher-than-expected earnings in the first quarter, Goldman Sachs is putting share buybacks during the second quarter on hold and using profits to support future investments. Our study would seem to support such an approach and cautions that the decision regarding stock repurchases hence should be made jointly with cash management and other financial policies in order to avoid underinvestment or financial distress.

Jian Cao is an associate professor and Stone Fellow in the School of Accounting at Florida Atlantic University's College of Business. The opinions expressed in this article are those of the author and do not reflect or represent the opinions of Florida Atlantic University.

SOURCE Florida Atlantic University College of Business

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