I've mentioned SEC Rule 10b-18 a few times, some links after the jump. A lifetime of looking at this stuff has led me to the conclusion that in the U.S. stock buybacks are nothing more than a tax-avoidance scam with the added benefit of rewarding managers for things they didn't do by, well, managing the company rather than the stock price....
(there's an icebreaker for tonight's festivities: "Say, what's your take on SEC Rule 10b-18?")
A repost from October 2019:
In the U.S. stock buybacks are just a straight-up tax dodge with the
added attraction of boosting shares-based management compensation. If
interested see "The Real Reason Stock Buybacks Are a Problem"
The smart kids, members of Phi Scamma Jamma, are still pitching a
differential between tax on earned income and tax on capital gains even
though the efficacy of capital gains tax breaks in performing their
original purposes, investment and job creation, has been declining since
the 1970's and is now just an excuse for a loophole. See "TAXES, CAPITAL AND JOBS" for an exceptionally lucid discussion, again, if interested.
And today's headliner, from American Affairs Journal:
In the jargon of finance, America is suffering from a capital allocation problem. The country seems incapable of making the necessary investments to fuel future productivity and growth, or to ensure widespread prosperity. At the government level, public spending on basic research and development as well as infrastructure investment has declined significantly over the past several decades. This trend, of course, should not be surprising, as reducing government spending has been a conscious policy objective for many years, especially (though not exclusively) for conservatives.
Over the same period, however, business investment has also declined. As a percentage of GDP, corporate investment has been in a long-term downward trend since 1980. And this trend is much more pronounced when viewed as a percentage of corporate profits or market capitalization.
This latter fact is particularly problematic for advocates of “free market” policies: if “getting government out of the way” does not lead to more entrepreneurial investment in the private sector, then what’s the point? Indeed, the entire neoliberal/libertarian economic policy toolkit has essentially been discredited by its failure to generate increased business investment in recent decades.
To take the most recent examples, the 2017 corporate tax cut was sold in large part with claims that it would increase private-sector investment, thus driving growth. Yet although there was some uptick in investment in early 2018, capital spending has stalled out in recent months, and growth estimates have been revised downward. In fact, in the second and third quarters of this year, S&P 500 companies spent more money buying back their own shares than on capital investment. For the foreseeable future, the prospects for any major boom in investment—certainly one matching the magnitude of the tax cut—are dim. Apparently the Trump administration’s vaunted deregulatory agenda has not worked either.
Looking back further, the Fed’s uniquely accommodative monetary policy in the aftermath of the financial crisis did lead to extraordinary asset-price inflation, but it did not produce anything approaching extraordinary investment growth. Meanwhile, the much-lauded “gains from trade”—really increases in corporate profits from tax and labor arbitrage—were never reinvested in the domestic economy. Nor were increased monopoly rents resulting from relaxed anti-trust, nor the labor cost savings resulting from de-unionization.
In short, neoliberal policies—from tax cuts, to deregulation, to trade liberalization, and so on—have produced massive increases in corporate profits, but these profits have not been reinvested in productive, entrepreneurial activity as promised (nor, of course, have they gone to labor). Instead, they have simply flowed into financial markets and remained there. But without sufficient investment into productivity-enhancing technologies, facilities, equipment, and the like, productivity has inevitably stagnated, and the economic prospects for future generations have deteriorated. In addition, given the highly unequal distribution of stock ownership (50 percent of Americans own no stocks; the top 10 percent own over 80 percent of equities, and the top 1 percent owns almost 40 percent), more capital flowing into financial markets has led to and will only continue to exacerbate gaping inequality, apparently with no compensating benefit that was supposed to come from increased investment.
The net result, as William Lazonick has argued, has been the construction of a “value extraction” economy rather than a system that rewards “value creation.” In other words, the financial markets are rewarding corporate behavior that extracts value from capital assets in order to convert it into liquid financial assets, rather than incentivizing the investment of financial assets into the real economy.
Many serious voices on the left have been calling attention to these problems for some time, unfortunately to little apparent effect even within the Democratic Party. But the situation has gotten so bad that critiques of the current system and new policy proposals to address its problems are starting to come from some unexpected quarters. Larry Fink, the CEO of BlackRock, recently called on companies to focus more on long-term capital investment rather than the short-term boosts of financial engineering (though there is no indication that BlackRock has used its considerable power as a massive institutional investor to force changes in corporate behavior). Moreover, today, Senator Marco Rubio proposed amending the tax code such that corporate share buybacks would be deemed dividends and taxed accordingly. This would remove the tax advantage/deferral that buybacks currently enjoy versus other forms of capital return, and aims to reduce the warped incentives that reward financial engineering at the expense of productive investment as well as labor compensation.
Needless to say, this tax change, even if implemented, would not itself solve all the problems related to counterproductive corporate behavior and financialized “shareholder capitalism.” Yet it is certainly the first serious attempt to address these issues—and one that goes beyond the conventional policy toolkit—to emerge from a Republican.
If discouraging financial engineering is now a bipartisan cause, it seems likely that a new and perhaps more concrete public debate around these issues will have to occur. And while the basic positions on these matters are fairly well defined, many delusions persist, so it is worth investigating in particular the issues around share buybacks.
At this point, the only remaining intellectual defenders of share buybacks or financial engineering more broadly fall into two groups. First, there are the salaried salesmen of “free market” think tanks, who typically have no practical knowledge of financial markets or the business world (indeed it is shocking—though probably not accidental—how few libertarian think tank commentators have any real-world business or Wall Street experience). On the other hand, the second group is mostly comprised of a few mediocre stock-pickers with academic pretensions like Cliff Asness who are basically talking their own book. Their main argument is that returning capital to shareholders does not reduce investment but simply allows for the reallocation of cash from one company to another which could deploy that cash more efficiently.
As an aside, some still argue that buybacks serve a bona fide business purpose, like “restructuring,” but anyone with any experience in institutional investing recognizes these arguments as utterly frivolous. In almost all cases, companies do buybacks in order to return capital to shareholders and boost their stock price by reducing the number of shares outstanding and thus improving earnings-per-share (EPS) metrics. Buybacks have also come to be preferred over dividends because they enjoy a tax advantage: shareholders who do not sell immediately receive a tax deferral on the price appreciation resulting from the stock’s increased EPS, whereas dividends are subject to tax immediately upon payment.
Returning to the main question, however, defenders of buybacks argue that returning capital to shareholders does not come at the expense of productive investment but rather represents the best use of capital available and allows shareholders to allocate capital to other companies more in need of it. Like most neoliberal economic arguments, this claim benefits from a certain logical simplicity, but it totally breaks down when applied to the real world.
First, the statistics simply do not support this argument. According to data from the Peterson Institute for International Economics and Bloomberg, in 1980 total capital return (buybacks plus dividends) represented about 2 percent of U.S. GDP, while investment was close to 15 percent of GDP. In 2016, investment represented around 12 percent of GDP while capital return was about 6 percent of GDP. To be sure, there is some variation in these numbers year over year, but the long-term trends are obvious....
....MUCH MORE
There is an interesting little wrinkle in that last paragraph's 1980
start date for the comparison but I'll have to leave that for another
post.
"The Real Reason Stock Buybacks Are a Problem"
This argument is a corollary of the fact that the preferential taxation of capital does not seem to deliver on the policy goals with which it is rationalized.
More on that after the jump.
(I'm going to get kicked out of the club aren't I?)
Related, the post where I first used the 10b-18 intro: Taibbi: "The S.E.C. Rule That Destroyed The Universe"
And just to refresh memories:
...II. Overview of Current Rule 10b-18
A. Rule 10b-18 as a "Safe Harbor"
In 1982, the Commission adopted Rule 10b-18,4 which provides that an issuer will not be deemed to have violated Sections 9(a)(2) and 10(b) of the Exchange Act, and Rule 10b-5 under the Exchange Act, solely by reason of the manner, timing, price, or volume of its repurchases, if the issuer repurchases its common stock in the market in accordance with the safe harbor conditions.5 Rule 10b-18's safe harbor conditions are designed to minimize the market impact of the issuer's repurchases, thereby allowing the market to establish a security's price based on independent market forces without undue influence by the issuer....
For many, many years corporations have been the marginal buyer, meaning their actions are what sets stock prices, which is directly at odds with the original intent of the rule change.
