Profits Without Prosperity (2014)
hbr.org
hbr.org
This is the Harvard Business School Review. When HBR says something that increases CEO pay is a bad idea, it almost certainly is.
Stock buybacks are an incredibly inefficient way of increasing CEO pay. Especially if they involve taking on debt.
We need to tax corporate dividends, interest paid, and stock buybacks at the same rate. There's a bias against dividends and in favor of debt in tax law, and that's why companies take on so much debt. It's a subsidy program for the banking industry, which is why it's hard to change in the US. It doesn't particularly help non-financial corporations.
Also, "private equity" is mostly debt financing in disguise. It's not people putting up their own cash. There's usually a little cash, and a lot of debt.
Something worth realizing: relative tax rates between business alternatives have a large effect on corporate behavior. Absolute tax rates, not so much. As capital gains rates have gone up and down over the years, capital expenditures haven't followed.
Maybe it's late and I'm not getting it. What does this mean exactly. Like the point of pointing it out?
Animats was attempting to anticipate this argument with a counter argument: corporations don't seem to care what the absolute tax rate is; they only care what that rate is relative to the alternatives. So we should feel free to set all of those tax rates equal, raising taxes on interest paid.
All the ways businesses pay for their capital should be taxed at the same rate.
Would there be any other avenues available or would your solution be all that is needed?
But isn't this missing the forest for the trees anyway?
To use an aquatic metaphor, isn't this like plugging a leak in a dam with your finger when the entire structure is unsound and needs re-engineering?
I can only second your suggestion to stop penalizing dividends over interest on debt. There are even some good reasons to stop taxing capital returns at all.
The perennial favourites of alternative sources of funding for government are eg a carbon tax (where you explicitly don't mind the deadweight loss) and a land value tax (where there's no deadweight loss).
If those don't provide enough revenue, a consumption tax seems better placed than a tax on various forms of income.
See eg https://medium.com/basic-income/why-land-value-tax-and-unive... for how this could work.
But he makes no real case that buybacks are driving this. So if some politician wanted to go on a populist anti-buyback campaign, this article would be useful to him. But as an attempt to actually address the problems it highlights, it looks more like a distraction.
In America possibly.
But remember the missing part from this piece: globalism.
These are not 'American' companies anymore. They are global. Often with considerable ownership from overseas - and employment.
So - while the American lower-middle-class has not been doing as well - India, China, and big chunks of the developing world have been growing gangbusters.
They're all hiring in India.
For every middle-class American in stagnation, there's 2 Asians and 1 South American who are 'on the up'.
I'm not saying it's better, or needs to be this way, or making any kind of moral argument, rather just pointing out that most companies post-2000 simply can't be spoken of entirely in the American context anymore - and the story looks different when you look at it more from a globalist perspective.
Conventional theory suggests this would occur under conditions of increasing market power. Most of the symptoms of this (of which decreasing investment is one) can already be witnessed. [2]
It seems therefore that the increase in share buybacks is simply one of the symptoms of the overarching market concentration narrative. Monopolists have little need to invest/innovate due to lack of competition and are therefore free to commit resources to price manipulation or further increasing their market power.
In this context any anti-buyback campaign would prove ineffective unless carried out alongside policies designed to limit market concentration and increase competition.
[1] https://promarket.org/responsible-declining-labor-share-outp...
[2] http://noahpinionblog.blogspot.co.uk/2017/08/the-market-powe...
What am I missing here. I thought "profit" simply was a shorthand for "captial's share of revenue". I tried to understand the definitions at the promarket.org link but couldn't make sense of them.
I think what you are saying is that profits are being increasingly being derived by barriers to entry. That makes sense, but still those extra profits are going to be counted as captal's share of revenue.
That's shocking, is this is a case of lying with statistics somehow? That paints such an ugly picture that I can't believe it's the first time I've heard anything about it.
Edit:
Also, I think there's a bit of funny math here possibly contributing to a misunderstanding when the article says things like this:
> During that period those companies 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 productive capabilities or higher incomes for employees.
By definition, wages don't come out of profits. A company could increase wages by $1 billion, have $1 million profit, do a $1 million buyback, and then a journalist could write an article saying "company spends 100% of profit on buyback, giving none of it to workers."
In reality, many companies have a large cash hoard which is not going to employees or investors. Doing a buyback in those circumstances (notable recent examples include Apple and Facebook) doesn't have any effect on employee wages.
Done correctly, it’s a synthetic dividend without the immediate tax burden on the shareholders. Those that want to cash out, can sell a portion of their higher priced shares.
To be explicit, there is a decision tree where a company can decide whether to have wages increase or profit, then decide what to do with the profit, and the rise of stock buybacks vs. dividends is an answer to the second question, not the first.
The corporation pays corporate taxes on the money used for the buyback. The investors taxed are avoided because they haven’t realized their gains. When they eventually sell their shares they pay taxes.
In the stepped-up basis case I mentioned, the investor may never pay taxes on the gains.
If you cash out you're still potentially paying taxes on capital gains.
The only way to avoid taxes while still profiting from the increased price of the shares (it seems to me) is to take a loan against your portfolio (possibly deduct that interest) and re-invest the money.
Retail Joe six-pack investor probably won't be able to do that; but it seems like the sort of thing a professional money manager might do?
The article directly addresses this argument. Search it for the word "tax".
I think the claim is that reinvestment causes the company to trickle down wealth to workers more than the alternatives. It's not an absurd claim, though not an obviously true one either.
https://www.wsj.com/amp/articles/amazon-takes-over-the-world...
> Something is deeply amiss when a company can ascend to almost a half trillion dollars in market value—becoming the fifth most valuable firm in the world—without paying any meaningful income tax. Does Amazon really owe so little to support public revenue and public needs? If a giant firm pays less than the average 24% in income taxes that the companies of the S&P 500 pay, it logically means that less-successful firms pay more. In this way, Amazon further adds to the winner-take-all tendencies plaguing our economy.
(I know, I know, "The poor embattled multinationals...")
Companies can also reinvest profits in the business. The textbook example is building more lemonade stands.
A genuine robber baron capitalist who intended to hang onto her own shares long term would generally just shitcan managers who behaved that way. But 401k investors don't have the option.
I'm ignoring workers here. I'm only talking about morality between owners and managers.
The point of the stock market is to efficiently let investors re-deploy capital from mature companies (earned through capital gains and dividends) to growing companies. If all the lemonade stands that need to be built have been built, your research dollars will be less effective than others’, then constraining capital to the incumbents, by dissuading dividends or buybacks, results in (a) bad investments and (b) rent seeking by the agents overseeing this restricted capital.
(Possible point of confusion: earnings means profits earned, not revenues earned.)
That's a false dichotomy. The article specifically mentions other alternatives, such as raising employee's wages or raising the number of employees (both of those examples result in more tax revenue for the government as well).
For example, suppose my company earns $100 in profit in 2017. I choose to pay out $90 in dividends to the owners. That means 90% of earnings have been given to shareholders.
Now suppose I decide to pay an extra $50 in wages. My 2017 profits are now $50. I choose to pay out $45 in dividends to the owners. Again, 90% of earnings went to shareholders despite 50% of 'profits' going to wages.
Talking about using 'profits' to pay costs is somewhat nebulous, since 'profits' are defined as revenues after costs.
I was thinking along the lines of using last year's profits to pay for this year's wage raises and new hires.
If you have a $100 profit in 2017 you can't retroactively pay it out as wages, like your example suggests. You would have to pay 20-40% taxes on the profit (depending on where the company is domiciled) and then you can choose to pay it out during 2018.
many fortune 500 companies offer some mechanism for employees to own stock, such as ESPP.
Granted, much of this slowdown is due to Apple waiting for tax law changes before moving money around. But an article that uses six-year-old statistics as its lede, but doesn't even reference recent trends, should raise red flags about its impartiality.
[0] http://www.marketwatch.com/story/sp-500-buybacks-have-droppe...
Let’s go back to paying CEO’s purely in cash with an annual performance bonus decided by the board.
The responsible thing to do is give it back to shareholders who can invest it in countries and enterprises that generate a better risk adjusted return. Boards invent the CEOs to do this rather than waste capital.
From personal experience, let's add: rewriting a memo a dozen times because the corporate VP had to approve a fax machine that wasn't on the "Deployable Technology List." (This from a company currently in a high profile proxy fight)
But I find the idea of short-term-ism in managing profits a little counter to the goals of managers. Presumably, managers are motivated to stay in the job and make more money for themselves, and would do a calculation between short term and long term investment.
>>> “It concerns us that, in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies,” Laurence Fink, the chairman and CEO of BlackRock
This may be related to the complexity of driving returns that exceed the cost of capital by a sufficient amount, one that would be within the range that the company and their shareholders find palatable.
If people think that these companies should not be buying back their stock and instead invest them in growth opportunities, maybe this means that these opportunities exist for others to take advantage of. But the author does not mention that other companies do that. It somehow places the risk and responsibility of investing in the company that has the cash.
I think the issue is researches who spend too much time [2] sitting at their fancy desks and protected by grants or tenure. Maybe they should leave and actually go out there and start a company.
[1] http://www.scielo.org.za/img/revistas/sajems/v19n1/02f01.jpg
I thought the broader point was that successful companies are amassing profits, derived, presumably, from overall increased productivity.
But instead of sharing this surplus equitably amongst all the employees, by, for example, raising wages, executives are engaging in strategies that increase their share of the surplus, and possibly the shareholders share, at the expense of the lower level workers.
How long do top level managers stay at the same company? I would expect places with lower rotativity to think more long-term.
As a Canadian, US dividends get taxed like full-income. Capital gains get taxed just like Canadian capital gains: at one-half the income tax rate.
In one of our tax-free savings vehicles: the tax-free savings account, capital gains would be tax free, but dividends are still stuck with IRS withholding taxes of 15-30% of dividends.
With dividends, your tax bill each year is at the mercy of the board of directors.
With only capital gains... a stock practically functions like a retirement fund: you can defer taxes until low-tax years.
B) Companies reinvest in themselves through buyback and lobbying congress for subsidies. They freeze wages and reduce their workforces.
C) Congress subsidizes their research and development through tax payer funding. Costing a higher tax burden during which wage rates are falling / stagnant.
If B relies on C, and C relies on A, but A is destroyed by B - then what happens?
I understand that it's still peanuts compared to the structural imbalances at play here. More of a first step.
Or maybe mandate that PLCs can distribute a certain amount stock tax free to employees say $2000 per anum
Is what the article is actually about. "Profits Without Prosperity" is by comparison cryptic and uninformitive.
> Otherwise please use the original title, unless it is misleading or linkbait.
The author admits he wants to force companies to invest their profits in expansion instead of paying back shareholders, because he claims they have an obligation to maximize their wages and taxes paid.
If stockholders were never allowed to realize a profit, why would anyone ever buy stock at an offering?
The author sneers at icahn for not buying at the IPO, ignoring that icahn is making good on the implied promise that IPO investors would get to eventually cash out.