How Corporations Scam Their Shareholders and Screw over Workers
newrepublic.com
newrepublic.com
> Over time, share repurchases became a substitute for dividends. Managers rationalized the practice by saying they were doing shareholders a favor: Dividends were taxed as ordinary income, whereas capital gains were taxed much more lightly. Moreover, capital gains taxes weren’t payable until shares were sold, while taxes on dividends had to be paid annually. Assuming a share repurchase raised share prices by the same amount as would be the case if the money were paid out as a cash dividend, taxable shareholders would prefer share buybacks.
Dividends are taxed as ordinary income and the top marginal income tax rate was incredibly high at various points in history (94% in 1944 and more than 50% till 1986). Capital gains taxes are lower so the government has given corporations a massive incentive to pay less dividends.
The article is very critical of corporations, which is fine, but let's not forget about the bizarre incentives that governments give, for no apparent reason. "Managers rationalized the practice by saying they were doing shareholders a favor" could easily be rephrased as "Corporations were pressured to change shareholder payouts due to tax laws...".
Angelo Mozilo's story is a great example of misaligned incentives and minimal consequences: https://en.wikipedia.org/wiki/Angelo_Mozilo
Buffett has a great criticism of stock option compensation: https://www.nytimes.com/2002/03/11/business/stock-options-ar...
Also, much of the investment in the stock market is in non-taxable accounts and not subject to capital gains or ordinary income taxes until funds are paid out.
The truly rich receive most of their income through capital gains rather than wage labor, so when the rich lobby for tax cuts for themselves, they lobby for reductions in capital gains taxes.
If capital gains rates were required to be equal to the rates on dividends, the incentive toward buybacks and other earnings bypass measures would go away.
To pay no tax, a capitalist simply pays themselves no income, not even dividends.
What if they need cash, you ask? Easy peasy: just borrow against the capital holdings. How to service that debt, you ask? Easy too: just borrow more! As long as you don't consume too much of your capital, so that it continues to accumulate, you win the privilege of paying $0 in taxes. If your capital's value collapses, you'll have a problem (or, rather, your creditors will), so make sure that doesn't happen.
I don't see how workers are getting screwed. The main charge in the article is that executives take advantage of positive signalling around share buybacks to boost share price prior to selling shares. If this claim is true, the share price should go back down once more material public information is released that suggests a lower valuation. The losers in this scenario are shareholders who purchased in the short period following the buyback. Although some workers may fall into this group, the vast majority do not.
Also, the article implies that companies should go back to issuing dividends over share buybacks. This doesn't make sense. The tax advantage nature of share buybacks far outweighs the ill-gotten gains executives reap from this strategy.
On average, share price increases ~2% following a buyback announcement. So, while execs can 'scam their shareholders' with this scheme, the loss to shareholders is nowhere near the ~10-20% benefit shareholders get by realizing gains as capital gains instead of income.
Management often has poor/ short term motivations based on short term share price which can be devastating to companies.
Many companies also issue dividends when it doesn’t really make sense.
The overall level of shareholder compensation (dividends + buybacks) has not increased over the last couple decades.
FTFA:
> "Pressure to maintain corporate payouts may also be responsible for larger-than-necessary layoffs during the COVID-19 crisis." (only common employees get laid off)
> "...reduce or postpone investment spending for new projects, research and development, advertising and maintenance" (less money to employees, more to executives)
> "Buybacks also tend to raise corporate indebtedness and leverage, which can increase bankruptcies..." (borne by common employees, not executives)
also, employees other than executives cannot execute this sort of pump'n'dump.
and that's just the immediately obvious stuff.
If you compare the dividend yield of the s&p500 from 1980 to today, it dropped by around 3%. Based on today’s market cap, that 3% equates to around $900b. In the last year, we’ve had around $700b in share buybacks for s&p 500 companies. These data suggest that the shift to buybacks did not negatively impact liquidity, r&d, or overall ability to maintain employment levels.
no, adverse incentives (like here, where buybacks preferentially benefit executives) create moral hazards, which economic research has shown time and again. there's even a specific name for this particular issue: the principal-agent problem[0].
in the idealized case, you don't return money to investors if you have positive npv projects on the table (meaning more capital and less risk directed toward common employees as a side effect), but you will if you can enrich yourself regardless of those projects. dividends don't create these perverse incentives but buybacks in the current environment do.
[0]: https://wikipedia.org/wiki/Principal%E2%80%93agent_problem
I agree buybacks create adverse incentives. As I’ve stated elsewhere in this thread, the damages of these adverse incentives are outweighed by the tax advantages buybacks have over dividends.
> But shareholders don’t benefit a great deal from all this paper revenue because shares are constantly being diluted by stock options granted to corporate executives, which were given a tax preference in 1981. The net benefit to shareholders is much less since much of the share buybacks simply offsets the dilution.
While I think the tax preference for stock options is probably misguided overall, this is clearly hyperbole, because we could see the dilution effect on the actual stock price. That is to say, if stock buybacks didn't actually raise the stock price... they wouldn't raise the stockprice? This logic doesn't really make sense.
This issue is also not mutually exclusive, and has nothing really to do with stock buybacks themselves.
Avoiding the shananigans that management play with the buybacks alone is a laudable reason to eliminate them. But the more important reason is they are long term detrimental to the well being of most companies. Funds used to finance a buyback could be otherwise spent on r&d, new products and/or services, hiring better talent, etc.
If the IRR of such activities is so low that a buyback is better, management is very poor or the company has no growth prospects (and possibly entering an end of life period).
It's not a given that every profitable company should spend all the money they earn and try to grow at the maximum rate possible.
There is no change in the value of the company. There are fewer shares outstanding though which means each existing share is worth more.
Share buybacks are absolutely a good deal for shareholders when a company is undervalued. When a company is overvalued, dividends reward shareholders better. If a company is fairly valued, it largely depends on tax rates and whether the shareholder funds are in a tax sheltered account. [1]
The problem comes in when executive compensation is based on share-price. Executives have massive motivation to buyback shares even when the company is overvalued. So long as share buybacks are on the table as an option, share value should never affect executive compensation or there is an inherent conflict of interest.
Ideally, the company would hire a third party with no conflict of interest to determine best ways to return money to shareholders.
[1] Tax incentives around dividends and buybacks are overdue for some reform.
The company's value decreases by the buyback amount. Share price (ignoring positive signalling impact) remains unchanged.
E.g. Company has $100 market cap with 10 outstanding shares at $10/share. Company does $10 buyback. Afterwards, company has $90 market cap with 9 outstanding shares at $10/share.
If the company is overvalued, the shareholders just get screwed as the company is buying back shares which are already worth less than the future value of the companies earnings.
That worth has been reduced by the cash paid for the retired shares. So yes, each shareowner has a slightly larger percentage ownership but of a slightly smaller company. The way this can change is if future profitability exceeds that which is already expected and part of the current price.
It doesn't work this way. Companies aren't valued based on how much cash they have on hand. They are valued based on the future value of their returns which should be several orders of magnitude more than whatever cash they are spending on buybacks.
Apple has spent over $500b on buybacks over the past 10 years. By your logic, they should be smaller than they were when they started. A healthy company spending money on a buyback doesn't affect their ability to earn money in the future which is the basis for the companies valuation.
Likewise, dividends don't devalue a company. A company is valued based on their future earning capacity, not based on how much cash they have on hand.
Uh, yea they are. A company’s valuation is based on both the cash they have on hand AND future discounted cash flows.
Once you correct your understanding of this, you will see that GP is explaining things correctly.
If a companies liquid assets are more than a small fraction of the companies value, then management is doing something seriously wrong. Some valuation formulas punish companies who have excessive cash on hand.
Going to quote my original reply because I'm tired of repeating this point.
> Share buybacks are absolutely a good deal for shareholders when a company is undervalued.
If a company is undervalued, then the share price is less than the future earnings of the company. The value of their future earnings might be $1.01. If they buy back shares, they are paying $1 for $1.01 worth of future earnings which are realized by existing shareholders.
A classic example of this is Apple buying back shares over the past 5-10 years or so (less clear now with share prices being so high).
If a company is valued higher than the companies future earnings or the company needs to take on debt to buyback shares then it doesn't make any sense.
> It’s not obvious to me that buyback tax reform is something we should obviously do.
The big reason I think it should be reformed it creates lopsided incentives which reward some shareholders more than others. As I said above, I do think it could be better, but I'm not super passionate about it.
1. remove these tax preferences.
if we wanted to retain some of the incentive for startups, we could phase out the tax benefits based on the valuation of the company at time of grant. so a grant of stock options for a $1MM startup might grant you a tax preference, but not for a (mid-sized) $100MM company. (however, phase-outs need to be continuous functions to remove the gaming potential, and politicians hate that.)
2. remove the tax advantage of debt
3. remove carry-forward/-back losses
4. remove the separate capital gains/carried interest rates and all related exemptions (like 409's)
5. remove accelerated depreciation/amortization
and more. in short, remove tax loopholes, thereby dramatically simplifying the tax code.
it's pretty easy to slip in such small, innocuous-seeming riders without much pushback because it takes more than cursory economic knowledge and real interest to work out the first-order effect, nevermind the higher order ones, or even pick them out of huge, drab appropriations bills in the first place. there doesn't seem to be a valued constituency on the other side to push through counteracting legislation however.
https://en.m.wikipedia.org/wiki/111th_United_States_Congress
and yet
January 29, 2009: Lilly Ledbetter Fair Pay Act of 2009, Pub.L. 111–2
February 4, 2009: Children's Health Insurance Program Reauthorization Act (SCHIP), Pub.L. 111–3
February 17, 2009: American Recovery and Reinvestment Act of 2009 (ARRA), Pub.L. 111–5
March 11, 2009: Omnibus Appropriations Act, 2009, Pub.L. 111–8
March 30, 2009: Omnibus Public Land Management Act of 2009, Pub.L. 111–11
April 21, 2009: Edward M. Kennedy Serve America Act, Pub.L. 111–13
May 20, 2009: Fraud Enforcement and Recovery Act of 2009, Pub.L. 111–21
May 20, 2009: Helping Families Save Their Homes Act of 2009, Pub.L. 111–22
May 22, 2009: Weapon Systems Acquisition Reform Act of 2009, Pub.L. 111–23
May 22, 2009: Credit CARD Act of 2009, Pub.L. 111–24
June 22, 2009: Family Smoking Prevention and Tobacco Control Act, as Division A of Pub.L. 111–31
June 24, 2009: Supplemental Appropriations Act of 2009 including the Car Allowance Rebate System (Cash for Clunkers), Pub.L. 111–32
October 28, 2009: National Defense Authorization Act for Fiscal Year 2010, including the Matthew Shepard and James Byrd, Jr. Hate Crimes Prevention Act, Pub.L. 111–84
November 6, 2009: Worker, Homeownership, and Business Assistance Act of 2009, Pub.L. 111–92
December 16, 2009: Consolidated Appropriations Act, 2010, Pub.L. 111–117
Read this, "The Big Change" published in 1952 by Frederick Lewis Allen. http://gutenberg.net.au/ebooks05/0500881h.html
Looking at this segment of American business, we would almost find it appropriate to call our present economic system "managementism" rather than "capitalism."
It's very popular for Americans to portray capitalism in a negative light these days but in my experience if you get these people to define how they are using the word capitalism it has almost zero overlap with a traditional text book definition of the word relating to open capital markets and the ability to exchange goods in markets with money, and what they are angry about is something more like your "managementism", financialization, or crony capitalism.
There is a contrarian money manger who does some good blogging on this topic which shows up on HN from time to time who has written extensively on this topic:
https://www.epsilontheory.com/this-is-water/
His style can be off putting sometimes but I think his underlying messages are usually pretty astute.
But Capitalism is about the private ownership of capital and means-of-production as opposed to state-owned. And if the state is actually run democratically, then that non-capitalist approach could be a democratic economy. That has its own set of issues, but it's not exclusive of the free exchange of goods in markets with money. See, e.g. Market Socialism.
Capitalism does not equal markets. Markets predate capitalism. Capitalism can well have totally non-free dysfunctional markets controlled entirely by monopolists. That's today's situation. See https://mattstoller.substack.com for great reporting on this.
It's just as much a mistake to assert that Capitalism is synonymous with markets as to assert that it's synonymous with today's crony-capitalism with regulatory-capture etc.
"The means of production" is not a relevant idea outside of marxism. It's just called capital, assets or money to everyone else. Defining capitalism in terms of the "means of production" is part of a dishonest attempt to reframe the discussion in Marxist terms which is not taken seriously by anyone that is not Richard Wolff in academic economics and not by anyone who is involved in economic analysis professionally.
Check out the wiki for the "means of production". It's part of the series on marxism (ie economics used by essentially no one in practice): https://en.wikipedia.org/wiki/Means_of_production
Focusing on the word private is not untrue, it's just dishonest in the sense that it is used to imply that any other meaningful framework exists and again to try to highlight the comparison to Marxism as primary which is not a debate that exists on any meaningful implementation level. Out of over 200 countries in existence, as far as I know North Korea is the only one potentially that doesn't acknowledge private ownership of goods (on paper only) and that only exists for unrelated complex international political reasons, not because it is a tenable system economically.
You don't own things privately if there is no market to trade them in because markets are an emergent phenomenon of people owning things privately. The only way there wouldn't be this market is if you legally restricted private ownership. So market's and private ownership are meaningless without each other.
And even then you are failing to understand the difference between markets as a concept and capital markets.
So no, it is not a mistake to equate markets with capitalism, especially the existence of capital markets and this does not preclude markets existing before we thought of things in terms of capitalism.
Also Matt Stoller is not an economist, he's a partisan author of popular media. He's not authority on any of this.
I wasn't describing the abolition of private property. The emphasis is on major capital. That I can own my own computer and chair and even car is not comparable to the idea of organized capital owning massive factories and land etc. Yes, of course there's no clear defining line. If I own a car, I can use it to run a delivery business etc etc, and other than legal distinctions, there's a continuum from that to a massive factory. I don't happen to support any extreme position on these things. Absolute free-market capitalism and Marxist socialism both are simplistic if you try to just force the real world into these models.
I'm more sympathetic to Georgism FWIW, but I'm much more agnostic than certain about any of this.
I didn't say Matt Stoller was an economist. He's a journalist. And I mention him because he's done a great job of investigating and writing about the specific topic of monopoly in today's society. I don't just mean rhetorically but in terms of discussing specific examples and evidence.
More importantly, I wasn't using the mention of Stoller to ask for deference to him as authority, I was suggesting his work as worth reading. Appeal to authority isn't the point at all. What critiques do you have of his work?
It shows that corporations themselves are engaged in a planned economy. It's not just American thing, but it's the way things work.
Paul Graham in his essay http://www.paulgraham.com/opensource.html also calls corporations "communist states".