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Editor’s Note: On Monday, General Motors announced a $5 billion stock buyback. The beleaguered car-maker is appeasing grumbling shareholders by making their shares worth more.
Buying back stock limits its supply and therefore artificially drives up its value. To make those purchases, GM is reducing its cash reserves from $25 billion to $20 billion. (Recall that you, the taxpayer, helped prop up GM’s cash reserves with a $49.5 billion bailout in 2009.)
The stock buyback, combined with higher dividends, is expected to result in $10 billion for shareholders through 2016. It’s a grand time to be holding GM stock. And a bad time to have been behind the wheel of one of the thousands of defective vehicles for which GM is currently under investigation by the Department of Justice.
But GM’s not the only corporation throwing taxpayers under the bus. Almost all public companies do stock buybacks, writes plutocrat progressive Nick Hanauer in the following Making Sen$e column. He should know. The entrepreneur and original Amazon investor has done them too.
Hanauer authored the most popular post ever on this page last fall: on corporations not paying overtime and how doing so would address the crisis of growing economic inequality. He was also featured in a story of ours on the minimum wage and in Robert Reich’s film, “Inequality for All.”
The billionaire investor has used his high-profile platform to address his peers, most famously in the 2014 TED talk, “Beware, fellow plutocrats, the pitchforks are coming.” Today, he returns to Making Sen$e with another example of, to him, extravagant corporate overreach: stock buybacks. Fore more from Nick, follow him on Twitter.
— Simone Pathe, Making Sen$e Editor
Everybody is talking about income inequality these days. But even as politicians from both parties jockey to position themselves as champions of the American middle class, leaders from both sides seem terrified of acknowledging the trillion dollar elephant in the room: unsustainably high corporate profits.
Our crisis of income inequality wasn’t principally caused by the rich not paying enough tax, even though we don’t. Rather, it is largely the product of the $1 trillion a year that once went to wages, but now goes to corporate profits. And this demand and investment-killing trillion-dollar-a-year transfer of wealth from the bottom 80 percent of households to the top 1 percent is the direct result of the economic and regulatory policies both Republicans and Democrats have imposed since the dawn of the trickle down era.
As policy shifted economic power from workers to owners over the past 40 years, corporate profits’ take of the U.S. economy has doubled — from an average of 6 percent of GDP during America’s post-war economic heyday to more than 12 percent today. Yet despite this extra $1 trillion a year in corporate profits, job growth remains anemic, wages are flat, and our nation no longer seems able to afford even its most basic needs. A $3.6 trillion backlog has left our roads, bridges, dams and other public infrastructure in disrepair. Federal spending on economically crucial research and development has plummeted 40 percent, from 1.25 percent of GDP in 1977 to only 0.75 percent today. Adjusted for inflation, public university tuition — once mostly covered by the states — has more than doubled over the past 30 years, crushing recent graduates under $1.2 trillion in student debt, as of May 2013. Much of our public infrastructure, including public schools and our police and fire departments, is dangerously underfunded.
The core claim of the trickle down economics crowd is that high profits are the principal driver of growth. The higher profits are, the more money we have to “create jobs” and invest. So a fair question to ask is, where did this extra trillion dollars of profit go?
Much of the answer is as simple as it is depressing: Stock buybacks — more than $6.9 trillion worth since 2004, according to data compiled by Mustafa Erdem Sakinç of The Academic-Industry Research Network.
Between 2003 and 2012, the companies that make up the S&P 500 spent an astounding 54 percent of profits on stock buybacks. Last year alone, U.S. corporations spent about $700 billion, roughly 4 percent of GDP, simply propping up their share prices by repurchasing their own stock. And much of the rest of these profits has been paid to shareholders in the form of dividends.
In the past, this money flowed through the broader economy in the form of higher wages or increased investments in plants and equipment or in public investment. But today, trillions of dollars of windfall profits are being sucked out of the real economy and into a paper asset bubble, inflating share prices while producing nothing of tangible value. Of course, corporate managers have always felt pressure to grow earnings per share (EPS), but where once their only option was the hard work of actually growing earnings by building and selling better products and services, they can now simply manipulate their EPS by reducing the number of shares outstanding. Our epidemic of stock buybacks is the smoking gun that reveals just how dangerous bankrupt trickle-down economic theory is: it values profit above all else, and makes the sole responsibility of corporate managers the enrichment of shareholders.
Take, for example, Wal-Mart, which recently made headlines by announcing it would spend a billion dollars a year raising the wages of its lowest paid employees — a minor tweak to its low-wage business model. Over the past 10 years, according to data compiled from its public filings, Wal-Mart has spent more than $65.4 billion on stock buybacks — about 47 percent of its profits. That’s an average of more than $6.5 billion a year in stock buybacks, enough to give each of its 1.4 million U.S. workers a $4,670-a-year raise. It is also, coincidentally, an amount roughly equivalent to the estimated $6.2 billion Wal-Mart costs U.S. taxpayers every year in food stamps, Medicaid, subsidized housing, and other public assistance to its many impoverished employees. In this context, how can stock buybacks be either morally or economically justified?
They can’t, for the practice is not only unfair to the American middle class, it is also demonstrably harmful to both individual companies and the American economy as a whole. In a recent white paper titled “The World’s Dumbest Idea,” GMO asset allocation manager James Montier absolutely shreds our 40-year obsession with “shareholder value maximization,” or SVM, documenting the many ways that stock buybacks and excessive dividends have reduced business investment and boosted inequality. Almost all investment carried out by firms is financed by retained earnings, Montier points out, so the diversion of cash flow to stock buybacks has inevitably resulted in lower rates of business investment. Defenders of SVM argue that investors efficiently reallocate the profits they reap from repurchased shares by investing the proceeds into more promising enterprises. But Montier shows that since the 1980s, public corporations have actually bought back more equity than they’ve issued, representing a net negative equity flow. Shareholders today aren’t providing capital to the corporate sector, they’re extracting it.
So what’s changed? Stock buybacks were once considered a form of illegal stock manipulation, until 1982, when President Ronald Reagan’s Securities and Exchange Commission chair John Shad (a former Wall Street CEO) loosened the rules. It was this rule change that made possible the shift toward stock-based compensation that has driven the dramatic rise in the ratio of CEO-to-worker pay, from 20-to-one in 1965 to about 300-to-one today. Before 1982, such massive stock grants would have diluted the number of shares outstanding, causing both EPS and share prices to tumble. But armed with the SEC’s seal of approval, CEOs can now prop up EPS by diverting profits into stock buybacks, making their own previously unimaginable compensation packages possible.
The result has essentially been the creation of a gigantic game of financial “keep away,” with CEOs and shareholders tossing a $700-billion ball back and forth over the heads of American workers, whose wages as a share of GDP have fallen in almost exact proportion to profit’s rise. And as wages fall, so does consumer demand, resulting in slower economic growth: A new study from the Organization for Economic Co-operation and Development finds that rising inequality knocked six points off U.S. GDP growth between 1990 and 2010 alone. Stock buybacks are hurting the U.S. economy.
To be clear: I’ve done stock buybacks too. Virtually all public companies do it. In this era of short-term-focused activist investors, it is nearly impossible to avoid. And I have nothing against profit. I love profit. Profit is absolutely necessary to incentivize both innovation and investment. But if we truly want to address our crisis of income inequality, we must have the courage and common sense to question whether too much profit can be too much of a good a thing.
During Seattle’s successful campaign for a $15 an hour minimum wage, our opponents would sometimes roll their eyes and snort, “If $15 is so good, why not $50?” It was a straw man argument: Nobody was proposing a $50 minimum wage; it would have been too high and we said so. Yet Americans have been taught to unquestioningly celebrate record profits as if the sky is the limit, and that more is always better for the broader economy. So if 12 percent of GDP is so good, why not 25 percent? Why not 50 percent? Or, wouldn’t it be reasonable to suggest that the optimal and sensible balance might not call for profits to return to the same 6 percent of GDP that, between 1950 and 1980, fueled the greatest economic expansion in human history — an economy that benefited all Americans, not just the top 1 percent? If our true goal is to grow and sustain a prosperous middle class, isn’t it reasonable to suggest that this $1 trillion a year in excess profits might be better spent raising wages or building roads and schools rather than buying back stock?
This is not just a moral question of fairness. It is simply mathematically impossible to make the public and private sector investments necessary to sustain our nation’s global economic competitiveness while flushing away 4 percent of GDP, year after year after year manipulating stock prices. That is why we must reorient our policies from promoting personal enrichment to promoting national growth. That is why we must discourage this sort of stock price manipulation by returning to the pre-1982 stock buyback rules.
If we business leaders hope to maintain broad public support for market capitalism, we must acknowledge that the purpose of the corporation is not to enrich the few, but to benefit the many; we must acknowledge the trillion dollar elephant in the room. Once America’s CEOs get back to the business of growing their companies rather than growing their share prices, shareholder value will take care of itself, and all Americans will share in the higher wages and other benefits of a renewed era of economic growth.
Hanauer’s brand of “middle-out” economics was the subject of a Making Sen$e segment last summer:
Nick Hanauer is a Seattle-based entrepreneur, venture capitalist, philanthropist and author.
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