How Stock Buybacks Can Influence Market Crashes

28 April 2025

Stock buybacks—two words that can spark heated debates in the world of finance. Some see them as a way for companies to reward shareholders and boost stock prices, while others argue they artificially inflate valuations and leave the market vulnerable. But can stock buybacks actually trigger a market crash? The short answer: they can absolutely play a role, and history has shown us some clear warning signs.

Let’s dive into how stock buybacks work, why companies use them, and how they can contribute to market instability.

What Are Stock Buybacks?

At its core, a stock buyback (also called a share repurchase) happens when a company buys back its own shares from the open market. This reduces the number of available shares, ideally increasing the value of the remaining ones.

Companies typically use buybacks for a few reasons:

- Boosting stock prices – Fewer shares mean higher earnings per share (EPS), which can make the company look more profitable.
- Rewarding shareholders – Buybacks distribute excess cash to shareholders indirectly by driving stock prices up.
- Offsetting dilution – When companies issue stock options to employees, they might buy back shares to prevent dilution.

Sounds good, right? Well, not so fast. Buybacks can have unintended consequences, especially when done irresponsibly.

The Hidden Risks of Stock Buybacks

Buying back shares isn't always based on solid financial footing. Sometimes, companies borrow money to fund these repurchases, inflating stock prices in an unsustainable way.

Here’s where things can go sideways:

1. Artificially Inflated Stock Prices

Stock buybacks create the illusion of strong financial performance. When a company repurchases shares, it decreases the number of outstanding shares, making earnings per share (EPS) look better—even if actual earnings haven’t improved.

Think about it like this: imagine a pizza with 8 slices. If 2 slices disappear, suddenly the remaining slices look more valuable. But did the pizza itself get any bigger? Nope. That’s what’s happening with buybacks—investors see the inflated numbers and assume the company is in great shape, even when it's not.

2. Short-Term Gains, Long-Term Problems

Many executives favor buybacks because they boost stock prices, and—surprise, surprise—their bonuses are often tied to stock performance. So, instead of reinvesting in business growth, research, or innovation, they use buybacks to juice the numbers.

This kind of short-term thinking can leave companies unprepared for economic downturns. When the market takes a hit, companies that spent billions on buybacks may find themselves strapped for cash, unable to weather the storm.

3. Increased Market Volatility

Buybacks can create a false sense of security in the market. Investors see rising stock prices, assume everything’s golden, and pour more money in. This fuels asset bubbles—situations where stock prices climb far beyond their actual value.

But when reality hits—whether through poor earnings, interest rate hikes, or economic downturns—those inflated stock prices come crashing down. And since so many companies participate in buybacks, the entire market can be affected when the bubble pops.

How Stock Buybacks Have Played a Role in Market Crashes

Stock buybacks aren’t the sole cause of market crashes, but they’ve often contributed to the underlying instability that led to major sell-offs. Let’s look at a few historical examples.

1. The 2008 Financial Crisis

Before the 2008 crash, financial institutions were huge fans of buybacks. From 2003 to 2007, major banks spent billions repurchasing their shares. Instead of safeguarding cash for potential economic downturns, they used it to boost stock prices.

When the housing market collapsed and financial giants like Lehman Brothers started to fall, these companies had little cash on hand to cover their losses. The result? A full-blown financial crisis.

2. The Dot-Com Bubble Burst (2000-2002)

During the late 1990s, tech companies were flush with cash and bought back shares aggressively. But when the bubble burst in 2000, these companies faced rapid declines in stock prices and lacked the financial flexibility to survive the downturn. Many folded, and the market took years to recover.

3. The 2020 COVID-19 Crash

In the years leading up to the 2020 crash, companies were spending record amounts on buybacks. In 2018 alone, S&P 500 companies spent over $800 billion repurchasing shares. But when COVID-19 suddenly halted the global economy, many companies were caught off guard.

Airline companies, for example, had spent almost 96% of their free cash flow on buybacks over the previous decade. When air travel came to a screeching halt, they were left begging for government bailouts.

Are Stock Buybacks Always Bad?

Not necessarily. When done wisely, share repurchases can benefit long-term investors. If a company has excess cash and few growth opportunities, buying back shares at a reasonable price can make sense.

But when buybacks are used recklessly—especially with borrowed money or at overinflated prices—they can set the stage for disaster.

Could Buybacks Trigger the Next Market Crash?

No one knows for certain when the next crash will happen, but the warning signs are there.

- Corporate debt is at record highs – Many companies are borrowing heavily to fund buybacks, just like they did before past crashes.
- Stock prices are soaring – If buybacks are inflating valuations above their true worth, we could see a sharp correction.
- Economic uncertainty remains high – Rising interest rates, inflation, and potential recessions could pop the illusion of market stability.

If stock buybacks continue at unsustainable levels, history suggests they could contribute to the next major sell-off.

The Bottom Line

Stock buybacks aren’t inherently evil, but they come with risks—especially when they’re used to prop up stock prices rather than support real growth. When companies prioritize short-term stock gains over long-term stability, they set themselves (and the market) up for trouble.

So, should investors be worried? Well, if history has taught us anything, it’s that when companies spend recklessly on buybacks, the market often pays the price. And when the tide goes out, we see who’s been swimming without a life vest.

Better buckle up.