Topic of Poor Management Overview:
The $11.8 billion Bed Bath & Beyond spent on its own stock since 2004 comes to more than twice the $5.2 billion in debt it had on its books in its most recent SEC filing, a debt load that proved crushing for the company. WHY???? If a management team is spending so much MONEY on Share BUYBACKS…is Failure INEVITABLE??
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INTRODUCTION/OVERVIEW:
The collapse of America’s middle class crushed department stores. Amazon and the pandemic are the Final Blows
In a New Jersey suburb seven miles west of Midtown Manhattan, the American Dream is on shaky ground.
The Dream in question isn’t the mythological notion that upward social mobility is within reach for all hardworking Americans. It’s a $5 billion, 3 million-square-foot shopping and entertainment complex in East Rutherford featuring an indoor ski slope, an ice-skating rink, and a Nickelodeon-branded amusement park. The complex finally opened last fall, but it’s now facing huge new challenges.
The development’s complicated 17-year history, marked by ownership changes, false starts, and broken promises, had already put American Dream in a precarious situation. The
Covid-19Links to an external site.
pandemic hitting in March made things much worse. Whether the mall makes it in the long term will hinge in part on how it deals with the collapse of three of the marquee department stores that were to anchor the complex and draw foot traffic — Barneys New York, Lord & Taylor, and Century 21 — which all have gone bankrupt and closed, or are planning to close all their stores in the US.
5 Reasons Why Even Profitable Retail Businesses Fail
(Hint: “Declining Sales” Is NOT One of Them!)
A dismal statistic: in the United States alone, on average 1 retailer fails every 12 minutes. Five failures per hour, 24 hours per day, 365 days per year. Whether or not there is a pandemic raging.
People who get their understanding about retailing from the popular press or from political rhetoric often believe that declining sales –“Comp store sales are down”– is the death knell of retailing. However, declining sales does NOT make the Top Five Killers list.
We will examine each of the Top Five Killers of Retail Businesses. While they all need the respect of you, the owner or CEO, your highest priority always must be the #1 slayer. And it just might surprise you to learn what it is.
(Here’s another hint of what it’s not: over one-third of the retail businesses that fail are actually “profitable.”)
Retail Failure Reason #5: Out-of-Control Balance Sheet
If you are considering expansion into new lines, new departments or new locations, you must not ignore the management of your Balance Sheet. Expansion is successful only when your balance sheet gets stronger.
What is your debt-to-worth ratio now?
What will it be a year or two from now?
Growth will be an affordable option only when it is the result of careful financial planning.
Growth of any kind means an increase in assets, which can be purchased either with excess profits or an increase in debt.
Projecting those changes will get a projected debt-to-worth ratio, the best measurement of financial strength that exists.
Note: If you must shrink your business, the same ratio should be your guide.
Retail Failure Reason #4: Out-of-Control Expenses
Productivity. Making each dollar count. Getting the greatest return on each dollar spent. Yes, we’re talking about expense management—the #4 killer of retail businesses.
Expense management may sound like an old idea, but today, it’s more important than ever. Ignore it at your business’ risk!
In retailing, your major expenses may seem fixed (i.e., premises, permanent staff salaries, etc.) These costs must be covered by margin dollars, whether sales are strong or weak.
But there are areas in your business with variable expenses where you likely can cut costs. Be creative! Ask your staff for help on cost-saving ideas. Put special attention on “the creepers”; what a menace those are!
Budgeting, of course, will be your main tool for keeping expenses down. Apro forma(projected) Income Statement is a necessity. You must forecast expenses and adhere to budget guidelines. Then tie that discipline to dealing with the #3 killer: Gross Margin.
Retail Failure Reason #3: Failing to Manage Gross Margin
The #3 “killer” of retail business is inadequate gross margin management.
As a retailer, you must not ignore the message of your gross margin.
Don’t ask,“How are my sales?”Rather, the more important question,“How are my Gross Margin dollars contributing to operating profit?”
By department, by vendor, even by SKU, what are the trends?
And what are my options?
As a general rule in retailing today, Gross Margins are dropping. (Just take a moment to look at the Gross Margin trends of the 53 Retail Segments found in
Store BenchmarksLinks to an external site.
here on The ROI site.) This is caused by the largest retailers incessantly cutting their operating expenses, then lowering their needed margins so they can lower their retail prices and better compete with the other retail monsters. Sadly, many independent retailers get caught in this spiral. You must not!
Specialty retailers who remain “special” can actually raise their margins in many cases. The key is,“Better buying for your better customers.”
Another key to managing Gross Margin is using a tool called GMROI – Gross Margin Return on (Inventory) Investment.
The ROI considers GMROI to be the #1 measurement of inventory productivity.
GMROI should be in every retailer’s arsenal. It is a powerful way to compare stores, departments, even vendors! Take a year’s gross margin dollars for a particular line of product and divide by the average cost value of inventory in that product line. Compare this dollar return with other product lines.
Retail Failure Reason #2: Out-of-Control Inventory
All retail businesses that carry inventory have special problems. Inventory is the “engine” of every retail business.
It generates all of the Gross Margin dollars.
It is responsible for customer satisfaction (or the lack of it.)
But inventory also soaks up cash, often lots of it.
Inventory has one more unique feature: the pressures to buy more and more of it. Just think about this: pressures to buy more and/or different stock come from…
your own well-intended sales associates
current and new vendors
offering what a competitor is carrying
customers asking for new or different items
and of course, from a disgruntled sometime customer you run into at a neighbor’s party!
How to offset all this pressure to over-buy or buy the wrong thing?
The pros always budget their inventory buying with an Open-to-Buy system set up by department or classification or by store.
Then, they follow the budget! The real pros in retailing respect their OTB plan as highly as any responsibility they have.
The #1 Reason Even Profitable Retail Businesses Fail: Being Out of Cash
“Profit cures a lot of ills, but cash flow pays the banker’s bills.”
Poor cash management is the #1 killer of retail businesses today. Producing profits may be the sign of a good business, but profits matter little if a business runs out of cash. What keeps retail businesses running is enough cash coming in so that purchases can be made and obligations met at all times.
Weakened relationships with suppliers when payments become irregular.
Loss of prompt payment discounts.
Increased borrowing with more finance charges and interest expense.
Bankers are hesitant to deal with retailers who cannot indicate a working knowledge, on paper, of their cash flow. These owners generally haven’t prepared and used a cash-flow budget, which is a plan for forecasting cash balances, cash receipts and cash disbursements.
It is simple, but essential.
It helps you anticipate how much money you will need to borrow, and when.
Most critically, it enables you to tell the lender when you will pay back the loan.
A cash-flow budget is the best tool for keeping a tight rein on the flow of funds into and out of your store. Unfortunately, many retailers don’t consider this budgeting a top priority for themselves. The consequence can be, and too often is, a business failure.
Around 100 storefronts in American Dream opened their doors to customers in October and November, but the complex’s future is not guaranteed. Its owners, Triple Five Group, missed several mortgage payments this summer, and it’s not clear who might fill the enormous holes left by the three fallen department store chains, or which other retail tenants will opt out of their leases now that the development is missing three of its anchors.
Across the US, department stores are shrinking or shuttering altogether. In 2011, US department stores employed 1.2 million employees across 8,600 stores, according to estimates from the research firm IBISWorld. But in 2020, there are now fewer than 700,000 employees in the sector, working across just over 6,000 locations.
The reasons for the struggles are both shared and unique. Since the Great Recession began in late 2007, the vast majority of income growth in the US has gone to high-income households, squeezing middle-class households and altering where they spend money. As a result, chains that sell brands at sharp discounts like TJ Maxx, Ross, and Dollar General have become more popular, siphoning away shoppers from full-price department stores like Macy’s and J.C. Penney that were designed to cater to a stronger middle class of yesteryear.
Department stores are also facing the reality that they are no longer the main way most shoppers discover or access new brands — which was once perhaps their main appeal as onetime innovators. Consumer brands have increasingly become focused on building connections with customers through their own stores, websites, social media platforms, and other online-only marketplaces.
EXAMPLE I: The Demise of Bed, Bath & Beyond…and Bye, Bye Baby…(:()….
Bed Bath & Beyond was once a retail powerhouse and go-to destination for Americans in the market for home furnishings. But the big-box chain now finds itself on the doorstep to bankruptcy, another in a long line of once dominant retailers that failed to change with the times.
The company’s
revenue has plummetedLinks to an external site.
, its stock price has fallen nearly 70% year over year and management has scrambled to cut costs by
closing dozens of stores nationwideLinks to an external site.
. Things have gotten so rough that executives
saidLinks to an external site.
last week there’s “substantial doubt” Bed Bath & Beyond can continue in its present form.
A Bed Bath & Beyond spokesperson told CBS MoneyWatch that the company has “a team with proven experience helping companies successfully navigate difficult situations and become stronger.” Still, the company
said it’s mulling bankruptcyLinks to an external site.
, among other strategic options.
Experts point to three main reasons for the retailer’s steady decline over the years.
Slow to embrace the internet
Bed Bath & Beyond opened as a privately held business in 1971 and went public in 1992. As the U.S. economy boomed, the company then had a 15-year run of earnings that met or beat Wall Street expectations. Back then, Bed Bath & Beyond was one of the hottest stocks an investor could own, KeyBanc analyst Bradley Thomas said.
But momentum slowed once online shopping hit its stride. E-commerce was already taking off by the early 2000s, and consumers embraced online shopping for home goods starting around 2010, said University at Buffalo professor Charles Lindsey. Once products started arriving on their doorstep promptly and it became easier to return items purchased online, customers were sold, added Lindsey, an expert on consumer behavior.
During its heyday, Bed Bath & Beyond was led by former CEO Steven Temares, who Wedbush analyst Seth Basham described as an “old-school retail merchant” whose business model came down to “stack it high and let it fly.” By the early 2000s it had opened hundreds of stores across the U.S., including many large-footprint outlets that required a constant flow of customers and that characterized how many Americans preferred to shop at the time.
“He thought that was all they needed to do and he wasn’t willing to adjust,” Basham said of Temares. “So it was too late to catch up quickly when retail started going online.”
Bed Bath & Beyond finally hopped on the e-tailing bandwagon after naming Mark Tritton, a former top Target executive, CEO in 2019. But by then the company was nearly a decade behind leaders in the field, Basham said.
“They kept with the brick-and-mortar model and didn’t introduce a website quickly enough,” he said.
Key financial misstep
Experts said Tritton’s tenure at Bed Bath & Beyond was marked by two noteworthy moves. He redesigned the look of stores while shrinking the amount of merchandise on shelves. Under Tritton’s direction, Bed Bath & Beyond in 2021 also
spentLinks to an external site.
$625 million buying back shares in a move that later proved costly, Basham said.
Notably, that came at perhaps the worst possible time — the two years leading up to the
coronavirus pandemicLinks to an external site.
. By 2018 and 2019, consumers were relying more on companies like Amazon, Target, Walmart and Wayfair for home goods, Lindsey said.And once the pandemic hit, customers started thinking about ways to spruce up their home office.
“When they went to shop online, Bed Bath & Beyond wasn’t really the first thought in terms of most customers,” he said. “They weren’t positioned as strongly as other online retailers.”
Private-label fail
But the experiment failed because the products were low quality, exacerbated by a lackluster marketing push, Basham said. Bed Bath & Beyond
announcedLinks to an external site.
last August it would discontinue three of its private labels — Haven, Studio 3B and Wild Sage. Ultimately, that was “a misread of what demand was for their products,” Basham said.
Can Bed Bath & Beyond step back from the brink? Unlikely, the experts said.
“At the end of the day, Bed Bath & Beyond did not do enough from a merchandising standpoint and distribution standpoint in e-commerce,” Thomas said. “They didn’t evolve fast enough.”
Required:
The demise of the large department story clearly began prior to the COV ID-19 Pandemic….yet…..it appears as if many management teams FAILED to respond to the lack of demand and changing dynamics of retail….Prepare an analysis of what you and your team believes was the primary drivers of the demise…and whether this is a failure of the management teams of the these retailers who were forced to declare failure and declare bankruptcy…reorganize…and on the extreme end liquidate….Could these historic icons of retail have been saved if the management teams were innovative and responsive on. a timely basis once the consumer demands were on the verge of changing to a more on-line platform….which clearly upended these historic retailers who failed to transition to the 21st century retail marketplace….
International Journal of Accounting and Finance Studies
Vol. 6, No. 1, 2023
www.scholink.org/ojs/index.php/ijafs
ISSN 2576-2001 (Print) ISSN 2576-201X (Online)
Original Paper
How did a Previously Unscrupulous Tactic Become a Popular
Corporate Strategy?….. Time to Discuss the Impact of an Excise
Tax on Treasury Stock
Constance J Crawford1*, Corinne L Crawford2 & Glenn C. Vallach1
1
Business, Ramapo College of New Jersey, Mahwah, New Jersey, USA
2
Accounting, Borough of Manhattan Community College, New York, New York, USA *
Constance J Crawford, E-mail: ccrawfor@ramapo.edu
Received: March 1, 2023
doi:10.22158/ijafs.v6n1p1
Accepted: March 17, 2023
Online Published: March 23, 2023
URL: http://dx.doi.org/10.22158/ijafs.v6n1p1
Abstract
The problematic history of stock buybacks, known more familiarly as Treasury Stock acquisitions, has at
times been described as unscrupulous transactions resulting in stock manipulation tactics engaged in by
corporate America (Kotter, 1952). However, when the Securities and Exchange Commission (SEC)
passed rule 10b-18, the definition of share buybacks changed from problematic manipulative strategies
to brilliant corporate maneuvers (SEC Act 1934.). The SEC’s enactment of Rule 10b-18 opened
Pandora’s Box for corporations to engage in unfettered access of their own issued stock shares. The 10b18 SEC Rule provided a pathway for corporations to buyback their own previously sold stock shares
within an accepted legal framework. Unfortunately, the SEC Rule 10b-18 has been viewed as sanctioning
the use of corporate funds for valueless purchases depleting the liquidity of the corporate balance sheet.
But should these transactions, be subject to tax as a means to rectify the problematic buyback mania?
Keywords
treasury stock, excise tax earnings per share
1. Introduction
An interesting aspect of an accounting transaction identified as treasury stock is the fact, the transaction
has been viewed through multiple lenses for financial reporting purposes ranging from assets to contraequity accounts. Ironically, from a pure accounting viewpoint, both assets and contra-equity accounts
have debit balances but will result in the opposite impact on the balance sheet. An asset, viewed as an
expected future value or benefit, is an extremely beneficial account. The latter, a contra-equity account,
1
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International Journal of Accounting and Finance Studies
Vol. 6, No. 1, 2023
represents a financial negative resulting in a decrease in the net worth of the company. A reduction in
business value is an extremely problematic result for the future value of any entity. This opposing
viewpoint, commencing in 1720 was debated until the Securities and Exchange Commission issued the
SEC Act of 1934 along with the Internal Revenue Act of 1934 (Rueschhoff, N., 1978).
1.1 Impact of Legislation on Treasury Stock
The SEC ACT of 1934 stated: “S. E. C. Reg. S-X, Rule 3.16 provides: “Reacquired shares (treasury
stock), if significant in amount, shall be shown separately as a deduction from capital shares, or from the
total of capital shares and surplus, or from surplus, at either par or stated value, or cost, as circumstances
require.” Therefore, the current Generally Accepted Accounting Principles (GAAP) are consistent with
the SEC Act of 1934. GAAP Guidelines required that treasury stock is not to be reported as an asset but
as a deduction from equity at historical cost (SEC ACT 1934).
According to Harry Kotler, the author of Treasury Stock; A Corporate Anomaly stated: “Strictly speaking,
a corporation cannot become its shareholder. That is to say, it obviously cannot have a proprietary
interest in itself, and yet the corporation, upon the acquisition of its shares, must know the legal status of
such shares for a variety of purposes. Are they to be regarded as assets of the corporation, much as its
machinery and equipment? Or are they merely chooses in action, remaining in suspended animation until
the assertion of some corporate right which revitalizes them and gives them force and personality? That
issue has continued to plague the accounting community as they attempted to accurately report the status
of the account known as treasury stock (Kotler, H., 1952)”.
Therefore, as the ambiguity of the treasury stock status remained unanswered, the argument related to
assets vs. contra-equity accounts continued to be discussed within the legal, tax, and accounting
regulatory authorities (Sheldahl, 1982). The SEC believed treasury stock could be viewed as a current
asset, investment, long-term asset, or as a deduction from capital stock. A very wide-ranging viewpoint
and, adding to this confusion, the IRS opined on the tax consequences of the treasury stock conundrum.
From 1920-1934 the IRS considered the sale of treasury stock a non-taxable event. Then, beginning in
1934, gains or losses were required to be reported on the corporate tax return (IRC SEC 1032).
So, it seemed, once the SEC Act of 1934 combined with the Internal revenue Act of 1934 was enacted,
the confusion regarding the financial reporting and taxation of treasury stock would finally be decided.
Unfortunately, the debate was not silenced and the confusion over the status of treasury stock transactions
remains a discussion point even in today’s dynamic world of commerce.
2. Impact of Treasury Stock Acquisitions on the Financial Statements
There are many reasons why a company would embark on repurchasing shares of their stock that had
been sold or issued in a prior period. Once the issued shares are repurchased by the corporation, they
become treasury stock and will transition from a positive value to a contra-equity designation. The
reacquired shares will remain issued or sold but will no longer be a part of the outstanding stock category.
Only outstanding shares are allowed to vote for corporate issues or to be able to share in dividends
declared. Additionally, treasury stock can no longer exercise any preemptive rights or receive assets in a
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Vol. 6, No. 1, 2023
corporate liquidation. Treasury stock falls into a category akin to a child’s “time-out” prohibiting the
shares from participating in any of the above-listed stockholder benefits.
Interestingly, the treasury shares will be reported as a deduction from the stockholder’s equity section of
the balance sheet at the price the company paid for the shares. This is in contrast to when the shares are
initially issued or sold and are recorded at par value. Par value is a value assigned by the corporation
during inception and will be stated in its corporate charter. Par value has no relationship to current market
value. The difference between the issue or market price and par or assigned value is reported in a “paidin capital in excess of par” account also included as part of the equity portion of the balance sheet.
According to GAAP guidelines, treasury shares are reported on the financial statements until they are
retired or resold at a later date. If the treasury shares are retired at a cost that exceeded the initial price,
the loss on retirement of treasury shares will buy-pass the income statement and be reported as a reduction
to either paid-in capital from the sale of treasury stock or retained earnings (GAAP, Topic 505-30, 2009).
If the shares are retired at a cost that was below the original issue price, the equity section will increase
by the amount of the gain on retirement of treasury stock (GAAP, Topic 505-30, 2009).
2.1 Impact of Treasury Stock on the Home Depot Financial Statements
The Home Depot financial statements detail a noteworthy financial statement storyline replete with the
consequential impact share buybacks have had on their financial results. On Jan 30, 2022, Home Depot
reported
the
following
data
according
to
their
2021
Annual
Report:
https://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/2022/2021_AnnualReport_IR_Site_FINAL.
pdf
The Home Depot Consolidated Income Statement reported the following selected data: (In
millions except per share data)
2021
2020
Net sales
$151,157
$132,110
Gross Profit
$50,832
$44,853
Net Income
$16,433
$12,866
Outstanding Shares
1,054
1,074
EPS
$15.59
$11.98
According to the fiscal year 2021 Annual Report, Home Depot had issued 1,792 shares with 1,035 shares
outstanding, which indicates that a 42% of the issued shares have been reacquired by the company leaving
a mere 58% still outstanding. Therefore, if the company had not engaged in a massive share buyback
program the earnings per share (EPS) would decline by 41% to $9.17 for 2021 along with a decline of
40% to $7.18 for the fiscal year-end 2020. A notable difference in EPS due to the share buyback activity.
The impact of share buybacks positively increases the EPS by merely reducing the shares outstanding
not by increasing the net income sending a confusing message to the investor.
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The Home Depot Consolidated Balance Sheet reported the following selected balances: (In
millions except for per-share data)
2021
2020
Current Assets
Total Assets
$29,055
$71,876
$28,477
$70,581
Current Liabilities
$28,693
$23,166
Total Liabilities
$73,572
$67,282
Retained Earnings
$67,580
$58,134
Treasury Stock, at cost
($80,794) ($65,793)
Total Equity (Deficit)
($1,696)
$3,299
As the balance sheet indicates, for January 30, 2022, Home Depot’s Current Ratio = Current Assets
/Current Liabilities, demonstrates an extremely problematic liquidity issue:
$29,055 / $28,693 = 1.01% vs. an industry norm for the retail-hardware industry of 1.68% according to
Credit Guru Inc. Additionally, for fiscal year-end (FYE) January 30, 2022, Home Depot’s Total
Liabilities of $73,572 exceeded the Total Assets of $71,876, a further indication of a liquidity crisis.
Another interesting fact, embedded within the Home Depot Balance Sheet, concerns the treasury stock
balance for FYE January 30, 2022. The share buybacks aggregated $80,794 which exceeded the retained
earnings balance of $67,580, and as such, triggered a stockholder’s equity deficit of ($1,696) indicative
of extreme business problems. Furthermore, the financial statements of Home Depot report a 22.80%
increase in the treasury stock balance from $65,793 in FYE January 31, 2021, to $80,794 in FYE January
30, 2022, resulting in an erosion of both liquidity and net worth.
Ironically, in May 2021 the Home Depot Annual Report included the following note:
“In May 2021, our Board of Directors approved a $20.0 billion share repurchase authorization that
replaced the previous authorization. This new authorization does not have a prescribed expiration date.”
Therefore, it is obvious Home Depot intends to continue engaging in massive share buybacks in the future
regardless of the problematic liquidity issues that the financial statements detail along with a growth in
EPS driven by the substantial corporate buyback activity.
3. The Top 20 Corporations Engaging in Share BUYBACKS
According to the S & P 500 statics, the first quarter of 2022 set records with a total of $281.0 billion in
buybacks as compared to the previous record-breaking amount of $270.1 billion in the fourth quarter of
2021 (S & P 500 Indices, 2022). As the chart below indicates that for the 12 months ending Sept 30 th,
2022, the top 20 firms engaging in buybacks aggregated $392.146 B. The entire S & P 500 buybacks
totaled $981.953 B, indicating the top 20 entities engaged in 40% of total buybacks for a 12 month period,
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as indicated below. In 2021, the total share buybacks for the same period aggregated $742.21 B indicating
a 32.25% increase over the prior period (S & P 500 Indices, 2022).
The buybacks for year-end Sept 24, 2022, represented an average cost of $159.31 (S & P 500 Indices,
2022). Unfortunately, the year-end Dec 31st, 2022, stock price was $128.61, or a 23.87% price decline.
Interestingly, the treasury stock will remain reported at the higher cost on the balance sheet essentially
obscuring a holding loss of $15.51 B.
Table 1. Top 20 S & P 500 Dow Jones Indices Share Buyback Companies (S & P 500 Indices,
2022)
Corp Name
Stock Symbol
Buybacks 12 Mos
Change prior 12
Sept 2022
Mos Sep 2021
% Increase
Apple
AAPL
$95.625 B
$92.527 B
+3.35%
Alphabet
GOOGLE
$57.362 B
$44.705 B
+28.31%
Meta
META
$45.600 B
$31.532 B
+44.61%
Microsoft
MSFT
$30.585 B
$28.326 B
+8%
Exxon Mobile
XOM
$10.634 B
$101 M
+893.71%
Proctor & Gamble
PG
$11.253 B
$11.759 B
-4.30%
Lowe’s
LOW
$ 16.140 B
$12.422 B
+30%
Marathon
MPC
$9.496 B
$1.912 B
+396.65%
NVIDIA
NVDA
$10.579 B
$1.508 B
+601.53%
Chevron
CVX
$5.386 B
$618 M
+771.52%
Comcast
CMCSA
$11.868 B
$2.722 B
+336%
Cigna
CI
$7.295 B
$8.011 B
-8.93%
Walmart
WMT
$11.127 B
$8.807 B
+263.43%
Conoco Phillips
COP
$7.928 B
$2.390 B
+231.72%
Morgan Stanley
MS
$11.973 B
$9.278 B
+29.05%
S & P Global
SPGI
$11.091 B
$60 M
+1,738.5%
Charter Comm
CHTR
$13.842 B
$15.183 B
-9%
& JNJ
$5.711 B
$2.781 B
+105.36%
Visa
V
$11.709 B
$8.820 B
+32.76%
Union Pacific
UNP
$6.942 B
$6.595 B
+.05%
Johnson
Johnson
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Top 20 Total
$981.953 B
International Journal of Accounting and Finance Studies
$392.146 B
$290.077 B
$742.209 B
+32.30%
Vol. 6, No. 1, 2023
+35.19% S & P 500 Total
Based on the analysis provided by the S & P Dow Jones Indices presented above, seventeen of the top
twenty largest companies increased their buybacks from the prior twelve-month period (S & P 500
Indices, 2022). Nine of the twenty companies more than doubled their share buybacks and one in
particular, S & P Global increased their buybacks by 1,738% (S & p 500, 2022).
3.1 Impact of Treasury Stock on Corporate Ratio Analysis
Given the data presented in Table 1, it is apparent that many of the most successful corporations engaged
in the share buyback frenzy. The primary reasons are rooted in the fact that once shares are reacquired
they are no longer included as part of the outstanding share population and, the financial value of the
earnings per share (EPS), the return on equity (ROE), and the return on assets (ROA) all increase as the
number of shares outstanding decrease (Bargerstock, 2022). This positive financial maneuver has
increased over the past few years and has now culminated in more than $500 billion in acquisitions
according to the S & P 500 data (Bargerstock, 2022). Additionally, despite the discussion above of Home
Depot’s massive share buybacks, they are not even in the top 20 of the S&P 500 companies engaging in
the most share buybacks for 2022.
The impact on a corporation’s return on equity ratio (ROE) can also be positively improved through an
aggressive share buyback strategy. The interesting market reaction is that as earnings per share (EPS)
increase in direct correlation to stock buyback activity, the stock price of the shares will also increase.
Unfortunately, the stock price increase is merely in response to a perception of earnings growth driven
merely by the EPS increase. Unfortunately, many investors fail to understand that the increase in EPS is
not driven by profit growth but rather a decline in the shares the earnings are being allocated toward. In
other words, the EPS formula = Net Income / Outstanding Shares, will increase as the outstanding shares
decline due to the share buybacks not because the company has reported greater net income. In the chart
presented below, the top ten companies with extremely high ROE presented as of May 2022 by
Schwab.com is as follows (Bargerstock, 2022):
Table 2. Companies with High ROE
COMPANY
ROE
Oracle Corp.
7412.75%
North European Royalty Trust
3213.35%
Permian Basin Royalty Trust
2915.23%
First Physicians Capital Group Corp.
2635.44%
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The Home Depot
DJSP Enterprises, Inc.
2050.28%
1864.19%
Amerisourcebergen Corp.
1286.11%
Dell Technologies
1246.35%
DAVIDsTeas Inc.
917.23%
First Hartford Realty Corp.
907.66%
Vol. 6, No. 1, 2023
Unfortunately, the ROE calculation (Net Income/Common Shareholder’s Equity) will increase as
common shareholder’s equity decreases due to share buyback activity. Once again, the increase in ROE
will not be driven by increased net income but rather by a decline in equity due to the contra-equity
treasury stock deduction. Ironically, as equity declines, the ROE ratio will increase providing
misinformation regarding the impact of the share buyback activity on the future value of the entity. A
rising ROE would appear to indicate a positive in the company’s future outlook, but this is an example
of how numbers can lie. Additionally, as the chart illustrates, Home Depot’s ROE is 2050.28% driven by
the massive amount of treasury shares that are no longer a part of the calculation and as discussed above,
the equity section of the balance sheet depicts a much more problematic story than this ratio reflects.
4. Time to Tax the Share Buyback Strategy
According to the Cornell Law School Legal Information Institute, an analysis of IRC section 26 CFR
Sec1.1032-1, indicates there are no tax consequences when shares of treasury stock are sold. Therefore,
a taxpayer will not recognize a taxable gain or a deductible loss on their tax returns.
If the treasury shares selling price exceed the initial cost of the shares, the excess would be reported as
an increase to the equity section of the balance sheet. The paid-in capital from the sale of treasury stock
would be increased by the amount of the excess or gain. However, if the treasury stock was sold below
cost, that loss would be initially deducted from any balance in the paid-in capital from the sale of treasury
stock and, once the paid-in capital from the sale of treasury stock was eliminated, any remaining loss
would be charged to the retained earnings account balance. As a result of this IRC Sec 26 guidance, a
taxpayer could increase their corporate net worth without any tax consequences.
4.1 Unintended Consequences of a Tax Reduction Policy
As the Trump era 2017 TCJA tax cuts became law, it become apparent, that as corporate tax rates declined
from a 15-39% range to a flat 21% rate, many of these tax savings were being used to buy back shares of
treasury stock (Remely, 2021). In 2018, the first year of the tax reduction act, share buybacks exceeded
$1 trillion (Shaw, 2022). These activities of massive share buybacks have resulted in skewed data
resulting in increases to EPS and ROE along with a lack of enthusiasm in additional research and
development (R & D) expenditures as had been anticipated since R & D investment was already a major
part of corporate strategy prior to the tax cuts (Knott, 2019).
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In response to both the nontaxable nature of the treasury stock transactions and the excessive share
buyback activity exhibited by a plethora of corporate decision-makers, the federal government has
proposed a 1% excise tax to dampen the enthusiasm of the treasury stock buying spree (Friedlich, 2022).
The Inflation Reduction Act of 2022 (H.R. 5376) includes this last-minute provision of a 1% excise tax
aimed at diluting the tax reduction incentives the Trump era 2017 tax cuts provided (Friedlich, 2022).
The imposition of the nondeductible excise tax effective beginning after 2022, is intended to serve as an
incentive for the corporate decision-makers to invest their excess cash in areas other than share buybacks
(Shaw, 2022). Additionally, the Biden Administration has recently proposed a quadrupling of the excise
tax to 4% in an attempt to further dampen the aggressive nature of many corporate buyback activities.
Now returning to the Home Depot FYE January 30, 2022, financial reports, the increase of $15.001 billion
in treasury stock from the prior year would now trigger an excise tax of $600 million assuming the excise
rate enacted is 4% as the Biden Administration has proposed resulting in a further erosion the liquidity
of the entity. Whether this additional cost would change the Home Depot management’s buyback strategy
in the future remains to be seen.
5. Conclusion
Corporations have historically engaged in share buybacks dating back to the 1700s (Harry, 1952).
Corporate stock buybacks have increased following the lowering of corporate income tax rates and in
response, new excise taxes are being implemented currently. Just recently, share buybacks have become
the preferential corporate strategy instead of dividends (Bargerstock, 2022). Whether the share buyback
preferential tax treatment is the cause of the current buying frenzy remains an unanswered query (Shaw,
2022). Interestingly, dividends are taxed as ordinary income, however, share buybacks are taxed to the
holder at a lower preferential capital gains tax rate (Remely, 2021). Therefore, both the nontaxable
treasury stock impact on the corporate level along with the capital gain tax rate preferences on the
individual level provides a double tax benefit for any share buyback transaction.
A 4% excise tax has been floated by the current Biden Administration as a response to the perceived tax
inequity of the current share buyback tax landscape (Bogage, 2022). Whether this additional excise tax
will reduce the current share buyback activities remains to be seen. In addition, whether tax consequences
are critical to the share buyback decision-making of corporate America is another question that will
remain unanswered until the excise tax is imposed. The stock buyback journey continues to evolve as a
fascinating corporate strategy.
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