Month: July 2016

Stock buybacks do nothing for most of us

Posted on by j.giglio

Economic inequality in the United States is at historic levels. In the wake of the Great Recession, the issue has captured the attention of the American public, but there is little consensus about its causes. One of the causes is clearly the rise in corporate stock buybacks and short-term thinking.

In the 1980s, the top 1 percent of Americans accounted for 10 percent of the income generated in the economy; by 2012 it was approaching 20 percent. The top 1 percent controlled nearly 42 percent of the wealth, a level not seen since the roaring ’20s.

This increased inequality does not support, and even inhibits, the consumer spending that drives economic growth in the United States because it leaves the middle class with less buying power.

Those who are supposedly smart on the issue point to a range of reasons for economic inequality, such as technological change, the decline of unions, globalization and trade agreements. Often overlooked is the expansion of the financial sector and corporate America’s Ahab-like obsession with short-term thinking.

According to the Bureau of Economic Analysis, in 1970 the finance and insurance industries accounted for 4.2 percent of gross domestic product, up from 2.8 percent in 1950. By 2012, the sector represented 6.6 percent.

The story with profits is similar: In 1970, finance and insurance industry profits made up about one quarter of the profits of all sectors, up from 8 percent in 1950. Despite the after effects of the financial crisis, that number had grown to 37 percent by 2013. Yet these industries create only 4 percent of all jobs, so profits go to a small minority.

The increase in the influence of financial sector extends to public corporations that face increased pressure to make immediate investor payouts through stock buybacks. According to Research Affiliates, S&P 500 companies spent $521 billion on stock buybacks in 2013 and $634 billion in 2014. More than

$6.9 trillion has been spent on share buybacks since 2004. Not one dime of this money has gone into expanding operations, hiring more employees, increasing wages, research and development, enhancing productivity, and improving the customer experience.

An important part of the appeal of stock buybacks is their ability to increase earnings per share. In theory, buybacks tend to jack up the share price, at least in the short term, by decreasing the number of shares outstanding while increasing earnings per share. Corporations frequently finance these buy backs by issuing debt, taking advantage of the Federal Reserve holding interest rates underwater and the fact that interest expense on the debt is tax deductible.

Underlying all this are two notions. First, the only responsibility of the corporation is to maximize shareholder value as reflected in the stock price, as opposed to getting sidetracked by talk about multiple stakeholders such as employees, customers and the community.

The second is that corporate management should be compensated in stock to align their interest with those of shareholders. Since managers’ pay is tied to the firm’s stock performance even at the expense of long-term shareholder wealth, the temptation to manage earnings to meet short-term investor expectations instead of long-term shareholder value is quite strong. For example, if the choice is between repairing the roof on the factory in Toledo this quarter or missing the quarterly earnings figure, which could cause earnings per share to tumble, corporate management might decide not to make the capital investment.

Stock-based compensation has also contributed to the sharp rise in CEO compensation. Between 1978 and 2013, CEO compensation increased by nearly 10-fold while workers experienced stagnant wages and increasing job insecurity.

While corporate and finance executives live in a second gilded age, stock buybacks and short-term thinking contribute to under investing in innovation and skilled workers, and ultimately to more economic inequality. But none of this troubles the 1 percenters, and they appear to be the only ones who really matter.

Originally Published: Jul 23, 2016

Aftermath of the Brexit vote will be long and uncertain

Posted on by j.giglio

Once again we are reminded that nothing is forever; not now, not ever, never. On June 23 Great Britain’s electorate voted to quit the 28-member European Union despite threats that economic Armageddon will follow. The Brexit vote represented the sort of populist victory over establishment politics that give elites, few of whom have the scars of the marketplace, agita.

The take-home message is that the British voted to be free to make their own decisions on issues from trade to immigration and free from burdensome one-size-fits-all E.U. regulations passed by unelected, know-it-all Eurocrats.

Like the Arab Spring, the result took many by surprise. Part of the shock came from the fact that pundits, pollsters, and bookmakers all got it spectacularly wrong. They were pretty sure that the British would reject Brexit, the clever name given to the decision to leave the E.U. Few people were surprised when there was a steep sell-off the following day, with shock and awe in financial markets around the globe.

Leadership in the country’s two major parties was in disarray following the vote and none of the British leaders had their hands on the wheel as the vehicle was careening off the cliff. Conservative Prime Minister David Cameron, an opponent of leaving, fell on his sword and announced the next day that he would resign his post but would linger as a lame duck for several months while leaving the divorce negotiations to his successor.

Labor was also in limbo with a leadership challenge being organized against Jeremy Corbyn, who was blamed for a half-hearted effort to keep Britain in the E.U. Perhaps they were thinking they would simply call Harry Potter and borrow his magic wand to deal with the aftermath of the vote.

Britain’s departure must be negotiated with the E.U. and should come at less economic and political cost than when America severed its relationships with an offshore power in 1776. The E.U. wants Britain to kick-start the legal process of quitting by immediately invoking the 250 words in a treaty that set guidelines for divorce and provide a two-year window for talks.

But there is no requirement that Britain invoke the article until it chooses to do so. Until then it remains a full member, with all privileges and obligations.

All this foot dragging contributes to a policy vacuum and heightens the uncertainty surrounding the divorce. If you are a British firm looking to expand, do you implement your plans or consider relocating somewhere where the relationship with the E.U. is more settled?

The vote also casts uncertainty over the future of the Union Jack. Scotland and Northern Ireland voted to remain in the E.U. Scotland is now considering a second independence referendum that would give its electorate the opportunity to leave the United Kingdom and stay in the E.U.

It will take years to sort through the economic impact of the vote as Great Britain and the E.U. negotiate post-Brexit relationships. Ideally the British want to work out trade agreements that maintain unfettered access to the single E.U. market, but without the requirement for the free movement of people. But it is hard to see why E.U. member states would agree to unravel rules on free movement that they regard as sacrosanct.

The loss of Great Britain raises fears that the E.U. will disintegrate into rival nation states. Other members such as the Netherlands may stage referendums on leaving. You can expect the E.U. to take a tough line on the terms of Britain’s departure to make it clear to any other nation that might try to ride British coattails out of the union that there is a considerable cost to doing so.

The only certainty is the cascade of commentary you will hear about this complicated story as the divorce papers are filed in the coming weeks and months.

Originally Published: Jul 9, 2016