To reduce inequality, end buyback 'binge': Study
Root causes of massive wealth disparity come down to one issue: Companies would rather use cash to buy back their own stock than to grow their businesses, a study in Harvard Business Review says.
Share repurchases have soared since the Great Recession ended, totaling more than $950 billion just in the past two years, according to data from FactSet and S&P Capital IQ. Capital spending, though, has essentially flatlined during the recovery, remaining at anemic levels when compared to the total economy.
The net result has been an economy that has grown historically slow when compared to previous periods following a recession, even as the gap between the rich and poor swells.
A recent Federal Reserve report highlighted the problem, stating that most of the gains in income and family wealth went to top earners, while those at the bottom of the scale actually saw "continued substantial declines in real net worth."
In an article titled "Profits Without Prosperity," Harvard Business Review's William Lazonick, an economist at the University of Massachusetts in Lowell, identifies the buyback culture as the wealth divide culprit:
Corporate profitability is not translating into widespread economic prosperity. The allocation of corporate profits to stock buybacks deserves much of the blame.
According to the Review's calculations, S&P 500 (INDEX:^GSPC - News) companies devoted 54 percent of their total earnings to share buybacks from 2003 to 2012. Dividends took up another 37 percent.
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Shareholders most often benefit from buybacks, particularly when those repurchases reduce total share count in circulation. Share count reduction in turn boosts earnings per share and expands market multiples.
Perhaps more importantly, the Review argues, company executives reap the biggest benefits:
Why are such massive resources being devoted to stock repurchases? Corporate executives give several reasons. ... But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices. In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42 percent of their compensation came from stock options and 41 percent from stock awards.
Demonizing corporations and their executives is easy, but the real dynamic is more complicated.
Consumer demand and confidence, while recovering, is just now getting back around precrisis levels. Faced with levels of revenue growth that have lagged profit gains, companies have used cheap money to keep their bottom lines healthy and please shareholders.
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Fed policies, ironically, have helped grease the buyback mechanism through cheap money that companies can borrow to buy their shares.
Until that cycle breaks, it will be hard to persuade companies to put money to work on growing their businesses through capex and hiring.
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"There's room for further improvement in business investment, and if we start to see signs of a healthier recovery here in the U.S. and globally, businesses should respond to that favorably with greater investment," said Michelle Meyer, senior U.S. economist at Bank of America Merrill Lynch. "But it has been abnormally slow."
Meyer said the current condition "is the nature of recoveries," even though wealth disparity is at historic levels.
For the corporations, Lazonick muses that CEOs "may actually get satisfaction" from lower compensation if it means a stronger economy and a growing business. That may not be a particularly pragmatic way of thinking, but he sees it as the only way out of the current spiral:
The corporate resource allocation process is America's source of economic security or insecurity, as the case may be. If Americans want an economy in which corporate profits result in shared prosperity, the buyback and executive compensation binges will have to end.
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