Stock Buybacks: The Good, the Bad, and the Ugly

The Great Recession is long since over, company profits are high, and the stock market is booming. Yet most Americans are not feeling good about the “recovery”. While many corporate executives have received large pay packages --- almost none of company profits has “trickled down” to the average employee.  And this is at a time when employee productivity is at an all-time high.   Profitability is simply not translating into widespread economic prosperity.

Why?  Well probably everyone has their own belief about this, but I’m going to focus on the use of company profits to fund stock buybacks.  Some people believe it has created a lot of damage --- both for companies and the economy in general. 

The 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012 used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37% of their earnings. That left very little for investments in R&D or higher incomes for employees.

From the end of World War II until the late 1970s, a retain-and-reinvest approach was the norm at major U.S. companies. They retained earnings and plowed them back into the company. They provided workers with higher incomes and greater job security and economic growth.

A turning point was the wave of hostile takeovers that occurred in the 1980s. Corporate raiders often claimed that CEOs of the targeted companies were failing to maximize shareholder returns. That criticism prompted Boards to align the interests of management and shareholders by making stock-based pay a much bigger component of executive compensation.  Result:  In 2012, the 500 highest-paid executives of America’s S&P 500 corporations averaged $30.3 million each in total pay, with stock-based rewards making up 83 percent of their pay package.

To increase stock prices top executives made massive stock repurchases, which helped them “manage” (read manipulate) stock prices.  That enabled them to maximize shareholder value and to meet Wall Street’s expectations for higher and higher quarterly EPS.  It also provided them with good-sized compensation packages.  The result: Trillions of dollars that could have been spent on innovation and long-term growth in the U.S. economy were lost.

Let’s look at this notion that a CEO’s main obligation is to shareholders.  It’s based on a misconception of the shareholders’ role in companies.  The majority of shareholders are  investors who sell their stock when it reaches a pre-determined price. They care about a company only in terms of its stock. They’re not value creators --- they’re value extractors.

But this is the real point I want to make.  The bulk of buybacks have come at a time when U.S. companies face new global competitive challenges.  Gary P. Pisano and Willy C. Shih of Harvard Business School have warned that if U.S. companies don’t start investing much more in research and manufacturing capabilities, they cannot expect to remain competitive in many advanced technology industries.  Example:  Cisco has focused on buybacks.  Its competitors --- China’s Huawei Technologies and Sweden’s Ericsson --- don’t do buybacks. They’ve been investing in innovation instead and improving their competitive posture. 

Top managements of U.S. companies don’t appear to be concerned about the impact of lack of value creation on the economy.  In fact an Apple executive once said a couple of years ago:  “We don’t have an obligation to solve America’s problems.”

It’s time for the U.S. corporate governance system to enter the 21st century.  If the U.S. is to achieve growth that distributes income equitably and provides stable employment, government and business leaders must take steps to bring both stock buybacks and executive pay under control. The nation’s economic health depends on it.

On a parting note, think about this.  No one would argue that the U.S. economy has always had a major impact on compensation.  But could it be that we are now at a point when compensation is having a major impact on the U.S. economy?

Jacque Vilet, President of Vilet International, has over 20 years’ experience in Global Human Resources with major multinationals such as Intel, National Semiconductor and Seagate Technology. She has managed both local/ in-country national and expatriate programs and has been an expat twice during her career.   Her true love is working with local national issues.  Jacque has the following certifications:  CCP, GPHR, HCS and SWP as well as a B.S. and M.S in Psychology and an MBA.    She belongs to SHRM, Human Capital Institute and World at Work.   Jacque has been a speaker in the U.S., Asia and Europe, and is a regular contributor to various HR and talent management publications. 

Comments

[Chris Dobyns]

On most of these equity-based issues - I always feel like what I know would just about fill a thimble.

On the assumption that a company is profitable, and it has excess cash, I thought that companies principally undertook stock repurchase programs to achieve one (or more) of maybe three goals.
■ when a company's stock price is low, a buyback is an opportunity to retire the shares permanently, or retain the shares as treasury stock - both of which increases earnings per share.
■ a company will also initiate a stock buyback, in order to keep excess cash off its books, to avoid becoming a takeover target

However, I've never heard of initiating a buyback, simply to bolster the existing stock price - to benefit organizational insiders. Thi s also may be where the "needle" showing empty on my thimble of knowledge begins to glow red.

That said, I would agree that depending on the business, some amount of profits necessarily need to be invested in new products and innovation for the future. Usually (but that may be Jacque's point . . .).

[Jacque Vilet]

Chris ---- I think the industries affected are the ones that are needed to fuel our competitiveness for the future. Buybacks may make companies look profitable with increased stock price and EPS --- but if you peel the layers back these companies may not be as healthy as they seem. The short-term focus on stock price and EPS satisfies analysts/shareholders ---- but does nothing to ensure continued investment in innovation/R&D that will fuel both company growth and our economy. And I think most people acknowledge that using stock price/EPS as criteria for judging CEO performance --- emphasizes the short-term at the expense of the long-term.

[Scott]

Jacque,
What is your take on the part that the government is playing in corporations investment strategies? Seems to me that a lot of the policies and tax regulations that are in place are leading employers to invest less in it's employee's. My experience with equity and the stock market is limited. Is there a tax benefit to companies to follow a more agressive stock buyback strategy vs. investing in R&D?

[Jacque Vilet]

Scott thanks for your comment. I'm not a tax expert and the short answer is I don't know. But with all the talk government is doing about needing to be competitive in the future and for businesses to grow ---- it would be unlikely there would be laws to benefit companies that buyback rather than invest in innovation.

Buybacks have exploded in the past few years and it is understandable due to low interest rates. However company debt has also increased and some analysts worry about that.

If you look at Apple for example (and this is just one company and my opinion) since Tim Allen has taken the reins there have been several large buybacks and Icahn has battered Allen to do more. Look at their technology innovation since he took control. Not much . . .

China/Korea on the other hand pour money into companies/industries they have identified as key. That makes it easier to innovate and grow. I was talking to a friend yesterday about her new SMART phone. She purchased a Samsung and commented that we wouldn't even be talking about Samsung as a competitor to iPhone 5 years ago. So who as innovated and who has not?

Now I don't think our country would stomach government getting involved in investing in key industries to help them. That is why it is up to industries/companies themselves to take this up. And apparently reinvestment in company R&D, etc. meant more before the advent of stock based awards. And tax legislation was partly responsible for that.

And by by increasing the percentage of stock in CEO pay packages to align closer to shareholder interests, we have ended up with a classic example of "Be careful what you wish for".

Yes we have stock price increases due to buybacks and shareholders are thrilled, but should that be the primary responsibility of CEOs? My opinion is that if should not.

[Jacque Vilet]

Sorry for the lengthy response. I've almost written another post!