You’ve hopefully heard about, if not read, this revealing analysis by William Lazonick on the sharp rise in public corporations using their profits to boost their share price through stock buybacks as opposed to re-investment.
I won’t summarize the findings, as Harold Meyerson amply does so here. As he writes:
From the end of World War II through the late 1970s major U.S. corporations retained most of their earnings and reinvested them in business expansions, new or improved technologies, worker training and pay increases. Beginning in the early ’80s, however, they have devoted a steadily higher share of their profits to shareholders.
Lazonick looked at the 449 companies listed every year on the S&P 500 from 2003 to 2012. He found that they devoted 54 percent of their net earnings to buying back their stock on the open market…they devoted another 37 percent of those earnings to dividends. That’s a total of 91 percent of their profits that America’s leading corporations targeted to their shareholders, leaving a scant 9 percent for investments, research and development, expansions, cash reserves or, God forbid, raises.
What I wanted to tackle here is a question someone asked me the other day: what could be done about this significant problem of underinvestment in the long-term in the interest of boosting near-term share prices, stock options, and stock-based CEO pay?
Lazonick offers three ideas.
First, change back the SEC rule that facilitated the growth of stock repurchases. Back in the early 1980s the SEC gave corporate leaders the permission to repurchase large amounts of their companies’ outstanding shares, with only nominal oversight against stock price manipulation. Lazonick suggests the SEC change the rule back to sharply limit allowable repurchases.
Second, put some restrictions on stock-based compensation. For example, implement a six-month holding period for exercised stock options so executives can’t immediately flip shares when a buyback spikes the price.
Third, implement corporate governance changes that give some different stakeholders seats on the board, like worker representatives. This is a common German practice, and their corporations certainly plough more profits back into their companies than ours do (though this is but one of many difference in governance and corporate culture).
I’d add: do not provide government subsidies and tax breaks to companies that engage in large scale and frequent open market repurchases (as opposed to “tender offers,” which tend to be smaller, less frequent, and more benign). If the best use you can think of for your retained earnings is dividend payouts and share buybacks, why should the taxpayer subsidize your R&D or equipment purchases?
Pfizer and other American drug companies defend their patents and profits by saying how essential they are for research. Yet from 2003-12, they spent 146% (!) of their net income on dividends and buybacks. I should also note here that Pfizer paid 3% of its worldwide income in taxes in 2012. If reading that makes you feel like a tax-paying chump who neglected to get lawyered up, join the club.
Finally, the fact that tax rates on dividends and capital gains are lower than those on ordinary income exacerbates this problem.
And no, none of these sorts of changes are likely to occur anytime soon. But when you think about how these regulatory and tax issues have facilitated this short-sighted trend—one which exacerbates inequality and slows investment-led growth—you get an important insight into ways policy changes shape economic outcomes.