Are Stock Buybacks Crowding Out Real Investment? Empirical Evidence from U.S. Firms

Abstract

We investigate the role of financialization in the decline of investment for U.S. non-financial firms from 1992 - 2017. We show that the tendency to maximize shareholder value, fuelled by stock-based manager compensation, has led U.S. firms to divert resources from real investment to share repurchases to increase stock prices. Using micro-data from U.S. firms balance sheets and manager compensation, we estimate two dynamic panel data models: (i) to analyze the effects of share repurchases on capital investment; (ii) to examine the interaction between stock-based CEO pay and the likelihood of share repurchases. We find that stock buybacks have a negative effect on capital investment with this effect being stronger among large firms, operating in non-competitive markets. Moreover, an increase in stock options make firms more likely to repurchase shares. Our findings suggest that stock-based compensation creates incentives for managers to focus on increasing shareholder value by repurchasing shares at the cost of declining real investment and long-run growth.

Keywords: Share repurchases, stock options, investment, shareholder value, firm data

JEL Classification: C23, D20, G11, G31, G35