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rampant capitalism and unintended outcomes/incentives
"....the S&P 500 corporations last year spent all but 2 percent of their profits on buybacks and dividends...." Ethics? What ethics? We don't need no stinking ethics.
Thank you for the referenced article and the discussion. It adds further fuel to a fire that is likely to burn for a long time.
How a company should spend its profits is a perennial issue that couples short-term/long-term tradeoffs, perverse incentive programs, and the unintended consequences of laws and regulations.
For planning purposes, these tradeoffs and considerations are made more complicated by the spiky nature of annual profits, even for the composite S&P 500 much less for individual companies. Just review the graph that closes the Boston Globe article.
You might be interested in a supplemental Wall Street Journal article that appeared a few days earlier. It addresses the same topic with a slightly different perspective. Here is the Link to the piece:
I mentioned earlier that journalist seem to have a herd instinct. Once a subject is published, it is almost a certainty that it will be followed by a rampaging run of similar works. They often quote the same sources like the references to BlackRock’s Laurence Fink in both these articles.
There is much to be said supporting Fink’s quote: “While delivering immediate shareholder returns, executives are ‘underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
The impacts of the various tradeoffs are difficult to project. As the WSJ authors concluded: “The answer is far from settled. If the activists are right, they are stopping companies from throwing good money after bad.” Of course, these activists have their own set of incentives, and just might be wrong. In investing, never easy answers.
Enjoy the reference. It contributes to information diversity just a little.
There's an interesting question as to whether share buybacks are even good for long term investors because: 1. Buybacks decrease the amount of equity on a company's balance sheet and thus cause the debt to equity ratio level to go up. This ratio can prove dangerous if the company can violate its covenants which require a certain ratio during periods of stress and possibly have to repay the debt early or even go into default. 2. Companies borrowing money to do share buybacks seem particularly stupid as that further increases their leverage basically exchanging equity for debt. And what if their stock isn't particularly cheap? What is the point of taking on more debt and buying back stock if your stock is grossly overpriced as many experts say most stocks are today. 3. Companies that don't reinvest in their businesses ultimately stagnate from a growth perspective. So why do executives buyback stock? Because they want a short-term bump in their company's share price. That short-term bump is it all it takes for them to hit the right level to execute their options incentive package for a quarter and cash out their bonuses. They end up treating the company as an ATM machine as a result. And the irony is the share buybacks may just be a bit of a shell game as the options issuance dilutes the effects of the repurchased shares. For long-term investors this is not particularly beneficial unless the company's stock is particularly cheap. Then a buyback can make sense.
There seem to be three different issues getting smooshed together. From the specific to the broader, encompassing issues, they are:
1. Buybacks vs. dividends - the original article spends most of its space talking about the problems with buybacks (they inflate executive compensation, consequently management tends to support buybacks over reinvesting cash in the company, etc.)
2. Use of excess cash - return to shareholders (in the form of higher stock prices or as dividends) vs. reinvest in company. The free market perspective (given in the article) is that the shareholders can best decide what to do with the company earnings. Lewis gave some counter arguments.
3. How to treat a corporation's stakeholders - its shareholders, its employees, its customers, and the government (since a corporation is a creation of the government that grants it certain rights like limited liability of shareholders). This question is implied by the article's lead (that a cash-rich company is laying off employees), but not developed.
An interesting read on this issue is a paper by one of the people quoted in the article: Lynn Stout's "Why We Should Stop Teaching Dodge v Ford" The paper discusses the purpose of a corporation (it's not just to make money for stockholders).
If you're just interested in a brief introduction and history, stick with the abstract (link is above). If you like legal concepts, and are wondering where the idea comes from that corporations' objective is to maximize profits, the full article may be worth a look. It is not all legalize (though it will help to know that "dicta" are essentially commentaries by a judge that don't affect a ruling). The pdf with the full article also contains a rebuttal paper.
@MSF Actually, my counter-arguments weren't really against shareholders but talking about different kinds of shareholders. From a hedge fund shareholder point of view, buybacks are good because most hedge funds are very short-term oriented and will dump the stock as soon as the buyback has sufficiently increased its price. The same goes for the buyback company's CEO which is short-term focused because of his incentive package. But from the long-term investor's point of view I think the buyback can actually be harmful. This is why someone like Larry Fink of Blackrock which manages all those index funds/ETFs has spoken out against buybacks. Index funds buy and hold stocks forever so if the buyback increases debt levels or causes the company to overpay for its repurchased shares when it should be reinvesting in its business for long-term growth, then the buy and hold investor may suffer down the road. It comes down to the distinction between a long-term investor and a short-term speculator. Buybacks benefit speculators but hurt long-term investors unless the stock is sufficiently cheap to warrant a buyback. The cheaper the stock is, the more a buyback can make sense, which is ironic if you think about it. Because companies are gaga for buybacks now when stocks are expensive when they should've been buying back the most stock in 2008 and 2009. Instead most just sat there back then and did nothing. Arguably when stocks are expensive companies should be issuing more stock and using their stock as a currency to grow their businesses. So companies are doing the opposite right now of what a good long-term steward of capital should do. They are buying back overpriced stock. Interesting article, by the way, MSF. Everyone who has the time should read it.
@davidrmoran Excellent article. When the Boston Globe gives their reporters a little extra time, they usually get a good result. Kudos to Michael Kranish for a job well done.
Well, I have a couple more on the subject, but I think I'll put the head to pillow so I can give it a better go tomorrow. You know, as an "Everyday American."
Longer-form investigation is indeed what the Globe sometimes does extremely well as to news; God knows it's not editing or 'normal' newspaper news coverage.
Know Lazonick et alia at HBR pretty well, just did not want to post of additional material. The Cisco story was outrageous enough, theories about corporations apart.
Comments
Ethics? What ethics? We don't need no stinking ethics.
I would have liked to have seen a reference to confirm this. The author throws out statistics with no source to back them up.
Thank you for the referenced article and the discussion. It adds further fuel to a fire that is likely to burn for a long time.
How a company should spend its profits is a perennial issue that couples short-term/long-term tradeoffs, perverse incentive programs, and the unintended consequences of laws and regulations.
For planning purposes, these tradeoffs and considerations are made more complicated by the spiky nature of annual profits, even for the composite S&P 500 much less for individual companies. Just review the graph that closes the Boston Globe article.
You might be interested in a supplemental Wall Street Journal article that appeared a few days earlier. It addresses the same topic with a slightly different perspective. Here is the Link to the piece:
http://www.wsj.com/articles/companies-send-more-cash-back-to-shareholders-1432693805
I mentioned earlier that journalist seem to have a herd instinct. Once a subject is published, it is almost a certainty that it will be followed by a rampaging run of similar works. They often quote the same sources like the references to BlackRock’s Laurence Fink in both these articles.
There is much to be said supporting Fink’s quote: “While delivering immediate shareholder returns, executives are ‘underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”
The impacts of the various tradeoffs are difficult to project. As the WSJ authors concluded: “The answer is far from settled. If the activists are right, they are stopping companies from throwing good money after bad.” Of course, these activists have their own set of incentives, and just might be wrong. In investing, never easy answers.
Enjoy the reference. It contributes to information diversity just a little.
Best Wishes.
Regards,
Ted
Stock Buybacks: Innovation Boon or Middle-Class Doom?
http://www.usnews.com/news/articles/2015/06/01/stock-buybacks-innovation-boon-or-middle-class-doom
1. Buybacks decrease the amount of equity on a company's balance sheet and thus cause the debt to equity ratio level to go up. This ratio can prove dangerous if the company can violate its covenants which require a certain ratio during periods of stress and possibly have to repay the debt early or even go into default.
2. Companies borrowing money to do share buybacks seem particularly stupid as that further increases their leverage basically exchanging equity for debt. And what if their stock isn't particularly cheap? What is the point of taking on more debt and buying back stock if your stock is grossly overpriced as many experts say most stocks are today.
3. Companies that don't reinvest in their businesses ultimately stagnate from a growth perspective.
So why do executives buyback stock? Because they want a short-term bump in their company's share price. That short-term bump is it all it takes for them to hit the right level to execute their options incentive package for a quarter and cash out their bonuses. They end up treating the company as an ATM machine as a result. And the irony is the share buybacks may just be a bit of a shell game as the options issuance dilutes the effects of the repurchased shares. For long-term investors this is not particularly beneficial unless the company's stock is particularly cheap. Then a buyback can make sense.
1. Buybacks vs. dividends - the original article spends most of its space talking about the problems with buybacks (they inflate executive compensation, consequently management tends to support buybacks over reinvesting cash in the company, etc.)
2. Use of excess cash - return to shareholders (in the form of higher stock prices or as dividends) vs. reinvest in company. The free market perspective (given in the article) is that the shareholders can best decide what to do with the company earnings. Lewis gave some counter arguments.
3. How to treat a corporation's stakeholders - its shareholders, its employees, its customers, and the government (since a corporation is a creation of the government that grants it certain rights like limited liability of shareholders). This question is implied by the article's lead (that a cash-rich company is laying off employees), but not developed.
An interesting read on this issue is a paper by one of the people quoted in the article: Lynn Stout's "Why We Should Stop Teaching Dodge v Ford" The paper discusses the purpose of a corporation (it's not just to make money for stockholders).
If you're just interested in a brief introduction and history, stick with the abstract (link is above). If you like legal concepts, and are wondering where the idea comes from that corporations' objective is to maximize profits, the full article may be worth a look. It is not all legalize (though it will help to know that "dicta" are essentially commentaries by a judge that don't affect a ruling). The pdf with the full article also contains a rebuttal paper.
Re. William Lazonick and the article he wrote in the HBR, I posted this to the discussion board early last Fall. After about a day, for some reason, someone "with the keys to the car" disappeared it, along with some comments that had come its way. That was an unfortunate call; since then, it has been frequently referenced by financial writers when discussing buybacks, and I suspect HBR got a lot of hits because they eventually made his entire essay accessible without requiring registration. So I'll try it again. You're a data-driven kinda guy, so you probably will enjoy it, now that the Globe article has piqued your full attention:
William Lazonick "Profits without Prosperity" Harvard Business Review, September 2014
https://hbr.org/2014/09/profits-without-prosperity
also, a more recent HBR article by William Lazonick and Matt Hopkins re. GM stock buyback:
https://hbr.org/2015/03/gms-stock-buyback-is-bad-for-america-and-the-company/?utm_source=newsletter_finance&utm_medium=email&utm_campaign=finance050611&[email protected]&cm_mmc=email-_-newsletter-_-finance-_-finance050611&referral=00209&cm_ven=spop-email&cm_ite=finance-031215+(1) (you may have to register for this one; I may have a cookie somewhere that allows me access w/o signing in)
@msf That be a good read. For your viewing pleasure, here is Lynn Stout in action at the Aspen Ideas Festival in 2012, discussing this same topic with others:
http://www.aspenideas.org/session/does-maximizing-shareholder-value-endanger-americas-great-companies
Well, I have a couple more on the subject, but I think I'll put the head to pillow so I can give it a better go tomorrow. You know, as an "Everyday American."
Longer-form investigation is indeed what the Globe sometimes does extremely well as to news; God knows it's not editing or 'normal' newspaper news coverage.
Know Lazonick et alia at HBR pretty well, just did not want to post of additional material. The Cisco story was outrageous enough, theories about corporations apart.