Stock buybacks do nothing for most of us

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