Authors: Aleksandar Adzic & Gemini

Aleksandar Adzic:

Who allowed stock buybacks and why?

Google Gemini:

The legalization of stock buybacks in the United States did not occur through a single law passed by Congress. Instead, it happened through a regulatory “about-face” by the Securities and Exchange Commission (SEC) in 1982.

The specific mechanism was SEC Rule 10b-18. It was adopted under the leadership of then-SEC Chairman John Shad, an appointee of President Ronald Reagan.

1. Who Allowed It?

• The Reagan Administration: As part of a broader push for deregulation, the administration sought to remove barriers to capital movement.
• John Shad: Before becoming SEC Chairman, Shad was a high-ranking executive at the Wall Street firm E.F. Hutton. He was the first person from Wall Street to lead the SEC in over 40 years. He brought a “free-market” philosophy to the agency.
• The SEC: The commission shifted its stance on buybacks. Initially, they were seen as a form of market manipulation (illegal under the Securities Exchange Act of 1934). Now, they are viewed as a “legitimate business tool.”

2. Why Was It Allowed? (The Official Rationale)

The SEC created a “Safe Harbor” for corporations. A company needed to follow specific rules regarding the timing, price, and volume of its repurchases. By doing so, it stayed safe from lawsuits. This ensured they would not be sued for manipulating their own stock price. The official reasons included:

• Market Liquidity: Proponents argued that the number of buyers in the market would increase. This could happen if companies were allowed to buy their own shares. This action could make the stock market more “liquid”. It would also enhance its stability.
• Efficiency of Capital: The prevailing economic theory at the time (and today) was different. If a company has “excess” cash, it is considered “inefficient.” This applies when the company cannot use the cash to grow. Letting it sit in a bank account is not advisable. It should be returned to shareholders so they can invest it in other, more promising parts of the economy.
• Flexibility Over Dividends: Unlike dividends, which investors expect to be paid consistently, buybacks offer a company flexibility. They return cash only when there is a surplus. This avoids committing to a permanent payout.

3. The Unintended (or Intended) Consequences

While the rule was framed as a technical “safe harbor,” it fundamentally changed the incentives for CEOs:

• Stock-Based Pay: Around the same time, executive compensation began shifting toward stock options. Buybacks reduce the number of shares. This increases the Earnings Per Share (EPS). Consequently, a CEO could use company cash to trigger their own performance bonuses.
• Short-Termism: Critics argue that the “why” was less about efficiency. It was more about “Financialisation”. They moved away from the 1965 model of long-term industrial investment. Instead, they adopted a model of short-term stock price management.

Comparison: Before vs. After 1982

Feature	Before 1982	After 1982 (Rule 10b-18)
Legal Status	Potentially Illegal (Manipulation)	Legal “Safe Harbor”
Corporate Priority	“Retain and Reinvest”	“Downsize and Distribute”
Main Payout Tool	Dividends	Stock Buybacks
CEO Incentive	Company Longevity	Stock Price Performance