Wednesday, August 23, 2023

Stock Buybacks: "The Scourge of Corporate Financialization: Income Inequity, Employment Instability, Productive Fragility"

As noted on a previous visit with Professor (emeritus, UMass.) Lazonik:

The first named author, Wm. Lazonick, has appeared on the blog a couple times, a very interesting guy....
From The Institute for New Economic Thinking, August 21:

Stock buybacks as a mode of predatory value extraction

After decades of worsening inequality, the United States has an extreme concentration of income and wealth among its super-rich, while most American workers live paycheck to paycheck. A Brookings study, using 2012-2016 data, found that 44% of all US workers ages 18-64 earned low hourly wages. In the last half of the 2010s, the US labor movement focused on the “fight for $15”—which, at $31,200 annually, still represents low-paid work. Oxfam reports that, in 2022, with inflation eroding real wages, 32% of the US labor force had hourly wages of $15 or less.

Even in the tech sector, which provides large numbers of high-paid jobs, employment has become very unstable. There were almost 225,000 tech layoffs in the first seven months of 2023, adding to and far surpassing the 165,000 tech layoffs in all of 2022. Meanwhile, as documented in studies by the Academic-Industry Research Network for the Institute of New Economic Thinking, leading US companies are finding themselves vulnerable to more innovative global competitors in sectors such as aviation, communications, semiconductors, and alternative energy that are critical to US productivity growth and national security.

My just-published book, Investing in Innovation: Confronting Predatory Value Extraction in the U.S. Corporation (currently available for free pdf download), exposes corporate financialization as a prime source of the nation’s extreme income inequity and diminished innovative capability. Central to corporate financialization is “predatory value extraction”: the power of senior corporate executives, Wall Street bankers, and hedge-fund managers to extract far more value from industrial corporations in which they have acquired shares than they have contributed to the creation of value by these corporations.

The main instrument of predatory value extraction is the open-market repurchase of the corporation’s own outstanding shares—aka stock buybacks—the overwhelming purpose of which is to manipulate the corporation’s stock price. In 2012-2021, the 474 corporations included in the S&P 500 Index in January 2022 that were listed throughout the decade funneled $5.7 trillion into the stock market as buybacks, equal to 55% of their combined net income, and paid $4.2 trillion to shareholders as dividends, another 41% of net income. When Joe Biden was vice president, he condemned buybacks. Yet, under the Biden administration, the $874 billion in buybacks by S&P 500 companies in 2021 easily outstripped the previous annual high of $806 billion in 2018, fueled by the Republican 2017 corporate tax cuts. In 2022, S&P 500 buybacks reached a new record of $923 billion, before declining in the first half of 2023.

Unlike dividends, which provide a yield to all shareholders, stock buybacks increase the realized gains of sharesellers, including senior corporate executives, with their copious stock-based pay, and hedge-fund managers, who are in the business of timing the buying and selling of shares on the stock market. Since buybacks became widespread in the mid-1980s, they have contributed to inequitable income distribution, unstable employment opportunities, and fragile productivity growth in the US economy. Within the business corporation, buybacks come at the expense of rewards to employees for prior contributions to successful value creation as well as the company’s investment in the productive capabilities to generate the innovative products on which a new round of value creation depends.

A company can grow through innovation by retaining a substantial proportion of corporate profits and reinvesting in the productive capabilities of its labor force. Indeed, an outsized proportion of stock buybacks are done by corporations that have become highly profitable through prior “retain-and-reinvest” allocation regimes. In 2021, 68% of all S&P 500 buybacks were done by the 50 largest repurchasers, which also had 34% of the S&P 500 revenues and 45% of the profits while paying out 28% of the dividends.

The 20 largest industrial corporate repurchasers

Investing in Innovation delves into the resource-allocation transitions of many of the foremost US-based industrial corporations from retain-and-reinvest to “dominate-and-distribute,” as the company continues to grow but prioritizes distributions to shareholders/sharesellers in corporate resource allocation; and possibly to “downsize and distribute,” as the company downsizes its labor force even as it distributes massive amounts of cash to the stock market. Once a business corporation engages in downsize-and-distribute, it is very difficult for it to return to a regime of retain-and-reinvest.

Table 1 shows the 20 largest share repurchasers among industrial corporations for the decade 2010-2019 and their distributions to shareholders/sharesellers during the Covid-19 pandemic (April 2020-June 2022). Coming into the pandemic, 11 companies on the list—Apple, Oracle, Microsoft, Cisco, Walmart, Intel, Home Depot, Johnson & Johnson, Amgen, Qualcomm, and Gilead—were in dominate-and-distribute mode, using the profits from their still-dominant market positions primarily to support their stock prices; while seven—ExxonMobil, IBM, Procter & Gamble, General Electric, Merck, McDonald’s, and Boeing—were in downsize-and-distribute mode, distributing corporate cash to shareholders/sharesellers as they downsized their labor forces. The other two companies, Pfizer and Disney, ceased doing buybacks in 2019 in attempts to return to retain-and-reinvest.

Consumer-oriented companies such as Disney, Home Depot, McDonald’s, Procter & Gamble, and Walmart employ large numbers of low-paid workers who, in the absence of buybacks, could have had substantial raises. Gains in the wages and benefits of low-paid workers at the most profitable companies help to lift the incomes of low-paid workers throughout the US economy. In 2015, for the first time, the labor movement focused on the adverse impacts of stock buybacks when a campaign was launched to support wage increases for McDonald’s employees. Recently, unions representing flight attendants, mine workers, and freight-rail workers have called for a cessation of buybacks. Labor organizations such as United for Respect make the case for a company such as Walmart to prioritize wage increases for employees over buybacks for sharesellers....


Additionally, buybacks are a straight-up tax dodge vs. dividends which are taxed at a higher rate and at the time of their occurrence.

And if I hear one more person raise the argument that the lower tax rate for capital gains is justified by their original goals, I'm going to sic Mason Gaffney on them.


Over the last few years I've come to believe that all income, earned and unearned, should be taxed at the same rate, that preferential taxation of capital no longer leads to the intended policy effects of job creation and increasing capital investment in plant. property and equipment but rather is a bought-and-paid-for scam perpetrated by the financier class.

On a related point, it's time to get rid of the carried interest loophole which taxes income at cap gains rates for private equity and hedge funds.
That carried interest should not be treated as a capital gain can be proven quite easily.
Show me one tax return where a carried interest capital loss was allowed.
[you won't be invited to any of the meetings ever again -ed]

At the lower end of the income scale there should be some minimum tax. Everyone should have some skin in the game.

I'll be coming back to all these topics throughout 2012, in the meantime here's the granddaddy of Econ papers for folks interested in this stuff, sincere thanks to the reader who turned my vague recollection of the thesis into an actual PDF copy. It is as pertinent and fresh today as the day it was written, 34 years ago.
By Mason Gaffney
A paper delivered to the National Tax Association, Chicago, August, 1978.
Adapted for use in a course in Macro-economics, Winter, 1996.

We hear a lot these days about the need for more capital to make jobs. Some of what we hear and read we may discount as self-serving, lobbying for more preferential tax treatment of profits. Yet there is a case argued by sincere and public-minded people on objective grounds which we must take seriously.

It had better be a good case, because it goes far toward destroying the progressivity case, the one on which the American public has bought the income tax concept. Preferential income tax treatment of property income cuts off the top brackets of income receivers from tax liability, especially when we exempt capital gains. Preferential treatment exempts or favors the unearned increment to land values, especially again when we favor capital gains. The thrust of proposals being seriously advanced today is to convert the income tax into simply another payroll tax, socializing a large share of personal effort while eliminating the public equity in the land and capital resources of the nation.

Preferential tax treatment for property also destroys the neutrality or uniformity argument for income taxation. It encourages substituting capital and land for labor. It forces higher rates on personal effort, thus weakening the incentive to work while maximizing the incentive to lobby in legislatures and the Congress for public works and other federal outlays which create unearned increments to land values....MUCH MORE
And back to Lazonick: 
From Forbes:
Good news: Harvard Business Review has announced that Bill Lazonick is the 2014 HBR McKinsey Award winner for the best HBR article in 2014 for his brilliant, hard-hitting piece, “Profits Without Prosperity” (September 2014 HBR). Lazonick is a professor of economics at the University of Massachusetts Lowell, where he directs the Center for Industrial Competitiveness.

In the article, Lazonick described the horrifying impact of massive stock buybacks: net disinvestment, loss of shareholder value, crippled capacity to innovate, destruction of jobs, exploitation of workers, runaway executive compensation, windfall gains for activist insiders, rapidly increasing inequality and sustained economic stagnation. Lazonick’s article explained with quantitative detail why buybacks are an economic, social and moral disaster.

The article revealed for instance that share buybacks weren’t done for the most part when stock prices were low: astonishingly, most of the big purchases came when the stock price was high. Why? “Because stock-based instruments make up the majority of executives’ pay, and buybacks drive up short-term stock prices.” These firms are engaged, the article said, in “what is effectively stock-price manipulation.” In September 2014, The Economist called them the “corporate cocaine.”...MORE

Here is Profits Without Prosperity, HBR, September 2014.

There are a few more but I have to run and the good Professor has laid out quite a bit to chew on as it is.  

Okay, one more, from last December:

"Share Buybacks and the Contradictions of 'Shareholder Capitalism'” (it's a racket)

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?")