One doesn’t have to look very far to answer the question of why the fortunes of ordinary American workers continue to stagnate while corporate profits and the stock market are doing so well. Just check out the latest figures on corporate stock buybacks: They’re booming.
Since buybacks are how companies steer profits to their shareholders instead of reinvesting them to make themselves stronger--in part by investing in their workforce through hiring and pay increases--there’s your answer.
The latest statistics on buybacks, assembled by the economics firm Birinyi Associates, are stunning. Announcements of new buyback programs by U.S. companies reached a record $141 billion in April, a 121% increase from a year earlier. Birinyi calculated that the authorizations put 2015 on track to reach $1.2 trillion. According to the Wall Street Journal, that means they’ll be “shattering the 2007 record of $863 billion.”
Economists tend to be unhappy with surges in buybacks, often seeing them as distorting influences in the stock market. During the current bull market, economist Edward Yardeni wrote in March, “bearish strategists... couldn’t fathom why stock prices were rising when there were no obvious buyers among retail, institutional, and foreign buyers. They obviously missed corporate buyers.”
The consequence of steering corporate resources into buybacks is what economist William Lazonick calls “profits without prosperity,” which is a pretty good definition of the corporate-driven U.S. economy today.
Examining the nearly 450 companies in the S&P 500 index that were publicly listed from 2003 through 2012, Lazonick wrote last year in the Harvard Business Review that “during that period those companies used 54% of their earnings — a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37% of their earnings.
“That left very little for investments in productive capabilities or higher incomes for employees.”
Why do corporate executives pursue such a nearsighted strategy? Lazonick cites a “simple truth”: Their pay depends on their stock price, and a buyback program is a sure way of turbocharging that price, if only for the short term.
But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices. In 2012, he wrote, top executives at the biggest U.S. companies were paid an average $30.3 million each, with 83% of their compensation coming from stock options and stock awards.
Many companies don’t even pretend that fattening their shareholders this way isn’t their chief goal. In February, Hewlett-Packard disclosed that it had spent $1.6 billion on share buybacks in its first quarter. Capital investment in its business? That came to only $947 million.
The buybacks were part of a $10-billion authorization approved by the Hewlett-Packard board in 2011, just before Meg Whitman became chief executive. While she was implementing the buybacks, she was also cutting Hewlett-Packard’s workforce by more than 44,000 employees. Is this a formula for sustainable long-term growth? So far, the answer appears to be no.
The same upside-down growth prescription appears to prevail at IBM, where Chief Executive Virginia Rometty last year received a big bonus, a big stock award, and a 6.7% bump in her base salary even though IBM’s revenue declined by nearly 6%, and net income by 27%. The board did praise Rometty, however, for having “returned significant value to shareholders through $14 billion in share buybacks,” and through increased dividends of $300 million.
Fueling the buyback craze are low interest rates, which allow companies to borrow money cheaply. It’s the use to which they’re putting their borrowed funds that’s perverse. “Whereas firms once borrowed to invest and improve their long-term performance,” observed J.W. Mason of the Roosevelt Institute in February, “they now borrow to enrich their investors in the short-run.”
Lazonick proposed a few simple suggestions for putting an end to this shift of corporate strategy from value creation to value extraction. Corporate purchases of their own shares on the open market should be banned, he wrote--or at least the Securities and Exchange Commission’s “safe-harbor” regulations that exempt them from being viewed as stock manipulation should be lifted. Stock-based compensation should be ratcheted back to discourage executives from driving up their share price to fatten their own paychecks.
And shareholders should take a closer look at whether they’re really getting value when their companies spend billions to pay them off. Over the last two years, both IBM and Hewlett-Packard have underperformed the S&P 500 index--IBM by a huge margin. Can shareholders really believe these companies are being managed for growth?