“They made their money despite the government. They should be rewarded for creating so much value with the federal bureaucracy all over them like a cheap suit.”
His eyes fluttered with involuntary uncertainty as he spoke. If he played poker, I wanted in on the game.
“Sheeple” he’d called people like me who disagreed with him. I recalled a South African proverb: Tshwene ga e ipone lekopo. A baboon laughs at another baboon’s face … which, of course, is identical to his own.
We were discussing the stratospheric incomes of top executives at U.S. corporations. My interlocutor felt they earned every penny, and would earn even more were it not for the thieves in Washington, D.C. They were the Masters of the Universe.
“What if I told you that what they’re doing was illegal until 1982?” I replied.
That gave him pause.
I seized it. “And it’s cost the U.S. economy over $7 trillion over the last 15 years,” I replied. “$7 trillion that could have been invested in capital and jobs … and would have been, a generation ago.”
I had his attention now.
Profits Without Prosperity
Some months ago, an unknown author managed to get her debut novella onto the New York Times best-seller list. The problem was that nobody had heard of her book, or had seen it in stores.
She’d been buying all the copies herself to game the system. Once her book was in the Top 10, she schemed people would start buying it just because of its rank.
That’s essentially the same strategy on which U.S. corporate executives spent that $7 trillion.
Starting in the early 1990s, hundreds of publicly traded U.S. corporations have used cash reserves and borrowed funds to purchase their own stock. This does two things:
- The large stock repurchases increase the demand for the shares, and thus their price.
- By reducing the number of outstanding shares, stock repurchases artificially increase earnings per share, making them more valuable in the stock market … at least temporarily.
Yes, Blame the Bureaucrats
My conversation partner had an almost religious faith that government bureaucrats always intervene to hurt productive capitalists. He blamed it on jealousy.
It’s true that government typically constrains business — for example, by imposing rules against pollution or deceptive advertising, or antitrust actions.
But occasionally the tables are turned … when the wolves are running the henhouse.
Such was the case in 1982, when Securities and Exchange Commission (SEC) Chairman John Shad, a former Wall Street CEO, redefined unlawful “stock manipulation” to exclude stock buybacks.
Before then, it had been illegal for a company to buy its own stock.
Shad’s action set the stage, but it was President Bill Clinton’s $1 million cap on tax-deductible CEO pay that raised the curtain on Wall Street’s stock buyback performance.
Perverse Incentives
Faced with limits on the tax-deductibility of CEO salaries, corporate boards decided to reduce direct remuneration in favor of stock options.
That opened Pandora’s Box.
With their earnings now driven mainly by share prices, top executives had an incentive to inflate those prices by any means necessary.
Before the SEC rule change and the Clinton tax bill, corporations would use excess cash or borrowings to invest in research and development, productive plants and equipment, raising worker pay (and thereby consumer demand), shoring up shaky pension fund reserves, or increasing dividends to shareholders.
That led to a more gradual but sustainable increase in share prices. Companies became more valuable because they were … albeit in economic, not just financial, terms.
The rule changes created a massive conflict of interest between top U.S. corporate executives and their own companies.
By buying back company shares to boost their prices, and thus their own compensation, executives effectively extracted capital from their corporations instead of using it for investment and growth.
$7 trillion shifted from the real economy into the unproductive world of financial speculation.
CEOs: Vampires of the U.S. Economy
A new study from Insead (the European Institute of Business Administration) shows that since 2005, IBM has spent $125 billion on stock buybacks. Simultaneously, it invested only $69.9 billion in research and development — its supposed core business — and laid off large numbers of workers.
Here is IBM’s share price (red) versus Amazon, Apple and Facebook this year:
The same study found that 64 U.S. companies — including dying retailers J.C. Penney and Macy’s — spent more on stock buybacks over the last decade than their businesses are currently worth in market value.
Winners and Losers
The CEOs and other executives of U.S. corporations get to keep the money they make when they exercise their stock options, even if their companies die.
If you’re an investor in firms like IBM, General Electric, J.C. Penney or Macy’s, however, you lose.
After all, government isn’t the only thing that can destroy value. Private enterprise can do that perfectly well too.
Kind regards,
Ted Bauman
Editor, The Bauman Letter
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