Think Debt-Funded Stock-Buybacks are Pernicious? Here’s Why You’re Right
I’ve ranted about this phenomenon for a long time:
Do Businesses Borrow to Invest in Productive Assets?
Quoting JW Mason: “the marginal dollar borrowed by a nonfinancial business in this period was simply handed on to shareholders, without funding any productive expenditure at all.”
We Need to Spur Business Investment. Yeah, Right.
Quoting Floyd Norris: “From the fourth quarter of 2004 through the third quarter of 2008, the companies in the S.& P. 500 — generally the largest companies in the country — reported net earnings of $2.4 trillion. They paid $900 billion in dividends, but they also repurchased $1.7 trillion in shares. As a group, shareholders were paid about $200 billion more than their companies earned.”
It just seems wrong. But I haven’t been able to enunciate, in economic terms, exactly why it’s wrong
I find that William Lazonick has done so for me:
Profits Without Prosperity – Harvard Business Review
Brief summary, in my words:
The “safe-harbor” stock-buyback provisions of Rule 10b-18 of the Securities Exchange Act, passed in 1982, gave C-suite executives carte blanche to extract rents for their own benefit via stock-price manipulation.
This of course gave them the incentive to do so. And they have done so. The rule turned real business managers who “think like owners” into financial prestidigitators who manage their businesses for their own extractive enrichment, not for the good of the business.
Read the whole thing.
One thing that Lazonick doesn’t discuss (but Mason and Norris do) that seems huge to me: interest payments are tax-deductible for corporations. Dividend payments aren’t. This gives them yet another huge incentive to fund their activities through debt rather than equity issuance — and to borrow money for stock buybacks.
Economists almost universally bemoan the mortgage-interest deduction on efficiency grounds (and equality grounds). I really wonder why they don’t vilify all interest deductions, (especially) including the corporate interest deduction. Given the destructive effect on prosperity of the debt-fueled stock-buyback dynamic, it’s arguably even more pernicious.
We should make Rule 10b-18 much more restrictive or repeal it entirely, and we should remove all interest deductions from the tax code.
Cross-posted at Asymptosis.
I’ve wondered that as well. Especially coming off the financial crisis, why favor debt at all? The rational seems really weak. Insofar as the purpose is to help someone that needs to take on debt compete against a more established entity that can finance expansion with cash it doesn’t seem that hard to think of alternatives for an interested government to pursue. Debt serves an extremely important purpose but for anything debt could be used for that has a public interest reason to subsidize it, it would seem far more logical to directly subsidize that public purpose itself rather than the debt used to finance it.
This one is at least as old as Thorstein Veblen. In both Absentee Ownership and The Theory of the Business Enterprise he discussed the idea that business no longer cared about production and would, in fact, undermine production if necessary. The goal of business was to create credit flows from which profits could be extracted.
If you want another reason to eliminate the interest deduction, not that the above isn’t good enough, the use of credit to extract assets out of companies is the modus operandi of private equity. Strip a company’s assets, load it up with debt, drive it into bankruptcy, break the union contracts, and loot the pension funds. Robert Kuttner has a good discussion of this in Debtor’s Prison.
This also hits on another problem, the need for two sets of books, one based on GAAP and another for taxes. It’s an invitation for obfuscation and abuse.
Watching successive CEOs practice this thumb-on-the-scale accounting for success via stock price is why I largely quit participating in my Fortune 100 employers ESOP years ago.
Getting “bonuses” for returns to shareholders while borrowing money to buy your own stock: Nice work if you can get it!
So many of our fellow Americans can’t even balance their check book and have no clue about how to handle their own debt, let alone get into the minutia of corporate debt. The corporations that contribute to the 501(c)(4)s and (c)3s like it that way, because it helps them continue to buy the legislation that assures they can continue – you’ll pardon the expression – “business as usual.”
Back when the private equity biz was called the junk bond biz, Joe and Jill Six-pack may have had a slightly better inkling that something was rotten in Manhattan. But the name change made it sound, not only less odious, but the term “private” gave the average Joe the idea that he had no right to question what they were about.
We are well and truly screwed. Unless and until the revolution comes.