Last month, the top executives of KFC, Wendy’s, Papa John’s and other large restaurant chains held an urgent call with President Trump about the coronavirus crisis.
The companies needed billions of dollars in aid to avoid mass layoffs, the executives said. The next day, their trade group asked government leaders, including Mr. Trump, for $145 billion in relief.
These companies had been highly profitable in recent years, yet they were seeking help from the federal government. Where had all their money gone? Like much of corporate America, the restaurant chains had spent a large chunk on buying back their own stock, a practice aimed at bolstering its price. Some were even more vulnerable to the economic shock because they had previously increased their borrowing — including to fund buybacks or pay dividends — and strained their credit in the process.
Few, if any, corporations could have been adequately prepared for this pandemic, and efforts to stem the spread of Covid-19 have hit certain industries particularly hard — especially restaurant companies that have been forced to close most of their locations.
Still, the crisis has exposed the potential failings of a strategy embraced by many big companies: aligning their priorities with the interests of shareholders, many of whom are narrowly focused on the performance of a company’s shares. Shareholders, wanting stock prices to go higher, pushed management to use up cash on buybacks and dividends. And senior executives, paid largely in stock and on the basis of how the stock performed, were happy to oblige. The result was that companies often didn’t have much spare cash, leaving them even more exposed to economic downturns.
“They should have built up some buffers against such sudden shocks and risk,” said Willi Semmler, an economics professor at the New School for Social Research in New York.
In the three years through 2019, spurred on by Mr. Trump’s tax cuts, companies in the S&P 500 stock index spent $2 trillion on buybacks, 30 percent more than what they spent over the previous three years, according to an analysis of data from CapitalIQ. Including dividend payments, S&P 500 companies spent $3.5 trillion in the most recent three years — an amount that was equal to their net income for the period.
Regulatory requirements prescribe how much cash banks and insurers need to hold, but there are few such rules for other companies.
They spend their cash as they see fit — on acquisitions, capital expenditures, payroll and, of course, buybacks and dividends. The more money a company spends buying back its shares, the less it has for other uses, making the practice controversial. Some giants, including Apple and Facebook, are sitting on mountains of cash despite intense criticism from investors who say the companies have a responsibility to return that cash to shareholders. But most don’t need to be prodded.
Over all, S&P 500 companies now have a smaller cash buffer to support their borrowing than they did nine years ago, according to one widely used measure: net debt to EBITDA, which stands for earnings before interest, taxes, depreciation and amortization. The higher the ratio, the less cash the company has on hand and coming in to pay its debts. It was 1.8 as of March 30, according to FactSet, significantly higher than it was a year before the 2008 financial crisis.
The big-business trade group, the Business Roundtable, has long argued that distributing cash through buybacks helps improve the general economy by giving money to enterprising investors who can put it to use elsewhere.
“People act like buying back stock is a bad use of capital. No, it’s not,” JPMorgan Chase’s chief executive, Jamie Dimon, said at a Business Roundtable event in Washington in December 2018. “You buy back stock, that’s a redeployment of capital to a better and higher use.” He added that it was “beneficial for all of America.”
The investor Warren E. Buffett, whose company, Berkshire Hathaway, is known for its enormous cash pile, has also said stock repurchases are fine as long as a company “has ample funds to take care of the operational and liquidity needs of its business.”
Zion Research, which analyzes stocks for investors, recently ranked companies that pushed their stock buybacks to a point where any financial weakness might limit their ability to continue those programs. American Airlines and Boeing — both in line for taxpayer bailouts — were at the top.
“You look at some of the companies that are struggling and are potentially in need of the most help — they’d love to have some of that capital right now,” said David Zion, founder of the firm.
In the past five years, American Airlines spent $13 billion on stock buybacks and dividends, and Boeing nearly $53 billion. American could receive as much as $10.6 billion in grants and loans from the Treasury. The stimulus bill that Congress passed last month provides as much as $17 billion for companies considered crucial to national security, a category dominated by Boeing.
The restaurant industry lived particularly close to the edge.
During the five years that ended in 2019, McDonald’s and Yum Brands, which operates KFC and Taco Bell, made payments to shareholders that were equivalent to a third of the $145 billion in pandemic relief that the industry requested, an analysis by Hindenburg Research for The New York Times found. The industry did not secure the money it sought, but individual restaurant owners are expected to get funds from government programs.
Well before the pandemic, Yum repeatedly flagged the mass spread of diseases as a top “risk factor” in its annual reports, warning over a year ago that such outbreaks could “severely disrupt” operations and harm its business and finances.
Yum also returned cash to its shareholders, paying $15 billion to investors in buybacks and dividends over the past five years. And it didn’t just spend profits to make the payments; it borrowed to finance them. At the end of last year, Yum’s debt was more than twice the size of its assets, according to Hindenburg — a huge leap from 40 percent of assets five years earlier. During the same period, the compensation of Greg Creed, its recently retired chief executive, totaled $66 million.
Virginia Ferguson, a representative for Yum, said a change in the structure of its business and the strong performance of its restaurants had provided much of the cash to pay for buybacks. The use of extra debt to fund the purchases was “measured,” she said in an email.
Yum, which said last month that it had suspended its buyback program, did not request government funds for itself, Ms. Ferguson said. She added that the small businesses that run Yum franchises would qualify for government relief. Owners of franchises in chains like Yum’s and McDonald’s can apply for aid made available through the legislation passed last month in response to the pandemic.
“McDonald’s Corporation has not, and will not, ask for assistance from any government entity, nor seek any deferral of our tax payments,” said Michael Gonda, a company spokesman. He said the company had halted share buybacks, cut spending by $1 billion and borrowed more money.
The situation is dire for some restaurant companies that pushed the financial envelope.
Dave & Buster’s, a chain of game-filled restaurants, warned this month that with all its locations closed, there was “substantial doubt” that it could remain a going concern. The company spent $627 million on stock buybacks and dividends in its last three fiscal years, nearly twice its net income for the period.
At the start of February, Dave & Buster’s had 15,908 employees. Because of the pandemic, all but 165 are on furloughs. In the annual report from a year ago, the company flagged the risk of illnesses, though it was not identified as a prominent risk factor.
Last week, Dave & Buster’s issued new stock to help it absorb the shock of the pandemic but did not disclose how much it had raised. The company declined to comment.
Investors, especially large asset managers, like BlackRock and Vanguard, that own big stakes in companies, could prod management to prepare for future pandemics. BlackRock’s chief executive, Laurence D. Fink, has warned about “short-termism,” writing in 2015 and 2017 annual letters that too many companies were failing to put money into research or expand their work forces for long-term growth. But Mr. Fink’s concern was limited to whether companies were leaving themselves enough cash to grow, and not whether they were prepared for unforeseen calamities.