Bad for Business: Make Stock Buybacks Illegal Again
Back when I worked in banking I read a book on my commute that felt like I was carrying a rebellion in my bag: it was called The Myth of Capitalism. The book demonstrates how, while built on capitalist principles, the United States economy has descended into something more resembling an oligarchy, or erstaz capitalism; that is, economic gains are privatized and losses are socialized.
The book demonstrates that, given free market competition is integral to the definition of capitalism, since there is little actual competition among firms today, America has a monopoly problem.
American capitalism no longer boasts competitive markets. Authors Jonathan Tepper and Denise Hearn employ some real life examples in demonstration: when you move do you have options to choose from for your new electricity or cable provider? Most people do not; more than 75% of households with high speed internet access are served by a single provider. Five banks control 50% of the commercial banking industry in this country, and the finance industry receives a quarter of all corporate profits. Most hospitals are local monopolies, and in many states the top two insurers service 80–90% of the market.
Over the past decades, the percentage of GDP growth going to wages has fallen, while the percentage of GDP to corporate profits has risen. The rise of monopolies has contributed directly to income inequality. While workers have helped to create vast wealth for corporations, wages have not kept up. In the meantime, the ratio of CEO to worker pay has risen, from 20:1 in 1965, to 361:1 today. While managers and executives should certainly be compensated for the complexity of their jobs, it’s hard to make the case that they are nearly twenty times more valuable than they were fifty years ago…
As I read through the proposed solutions in the book, it became clear to me that one of the main contributors to this disparity is stock buybacks. Illegal in the US until 1982, because they were seen as a form of market manipulation, buybacks have experienced a renaissance in the years since the Great Recession: since 2008 at least $5.6 trillion in buybacks have been announced. A stock buyback occurs when companies use extra shareholder cash from corporate profits to buy their own shares off the market. Those shares effectively disappear, thereby reducing the amount of shares in circulation and increasing the price and earnings per share.
Before stock buybacks existed as a viable option for executives, extra cash was used to reinvest in the company: to increase salaries, benefits, and training for employees, or to invest in new infrastructure and equipment, as well as in innovation, research and development (R&D). These reinvestments would pay off over the long term, raising the overall value of the corporation over through increased worker productivity and market share. The legalization of stock buybacks, however, gave executives a quick way to immediately increase the value of their company, and long term corporate investments suffered as a result. Buybacks also affect on executive compensation, since executives are often paid a portion of their salary in company stock, while the average worker is not. Stock buybacks are a main cause of the outsized ratio of executive to worker pay.
Remember the 2017 Tax Bill that was promised to do so much to boost wages, create jobs, and help the economy? Most of the companies who received a tax break used the majority of the cash to buy up their own shares. Companies chose not to invest in their workers, instead using the tax savings to line executives’ and shareholders’ pockets; according to Bloomberg, 60% went to shareholders and 15% went to workers. While 50% of Americans do own stocks — usually in the form of an IRA or 401(k) — the wealth is not evenly distributed: the richest 10 percent of Americans own 80 percent of all stock shares. The bottom 80 percent of earners own just 8 percent of all stock shares. It’s infuriating, right? But none of this news is recent; in fact, most of us just haven’t been paying attention…
When companies choose not to invest in R&D or innovation, they miss out on future earnings potential. Much of today’s technological innovation in the United States was developed in corporate labs and venture initiatives, spending on which has stagnated, especially in the early, riskier stages of technology development. Tepper and Hearn write that such investment averaged 20% of corporate revenues between 1959 and 2001, but fell to 10% between 2002 and 2015. US companies have now taken an extremely short term view on profits, and, coupled with a decrease in government funding for innovation, research, and technology development, it poses a significant risk to the United States’s position as the hub of global innovation.
By not investing in innovation, companies risk losing market share and profitability over the long run. In 2018, only 43% of companies in the S&P 500 Index recorded any R&D expenses, with just 38 companies accounting for 75% of the R&D spending of all 500 companies.
Stock buybacks can also be attributed to corporations’ inability to weather the current economic crisis. Those in support of buybacks contend that executives who decide to buyback their stock do so after exhausting all other firm investment opportunities. But over the past twelve years of record corporate profits — instead of solidifying their business operations by investing further in business operations or saving cash — companies were constantly thinking short term: a Bloomberg study shows that, from 2010–2019, 96% of U.S. airlines’ free cash went to buybacks. American Airlines led the pack, spending $12.5B buying back their own stock despite having negative cash flow. Given they were named the worst airline in the United States earlier this year, it’s clear they weren’t even thinking about reinvesting in their operating business.
Stock buybacks have irked Democratic legislators for years. But right now they be even more under the microscope given the wide amount of government bailout money that has been made available to U.S. corporations. Despite plenty of predictions pre-COVID-19 about the inevitability of an economic downturn, corporations actively chose not to prepare and are now lining up for government support. A video of billionaire CEO Chamath Palihapitiya calling out corporations for this behavior went viral. And even President Trump is against buybacks now.
The abuse of stock buybacks demonstrate just how imperative it is that companies move from a shareholder profit model to a stakeholder profit model. Member companies of the Business Roundtable agreed to this idea in principle last year, but we as shareholders, employees, and voters need to hold corporations accountable in order to force an end this corrupt practice. The short term effects on the market would result in a slower growth in share prices, but as we have seen from the current economic crisis, the stock market does not reflect the real economy: share prices are rising while millions of workers have lost their jobs. And in the long term, the growth would be more sustainable and its positive effects more widespread — worker salaries and benefits would have to increase. It’s one change that could make a big difference.
