Share buybacks..quantitative easing, secular stagnation and the risks of Myopic Share Virus..

The point about share buybacks is that they sit uncomfortably in a widening narrative of increasing inequality, weak income growth (worse at lower income levels), falling economic growth rates and disturbing trends in both human and capital investment. The backdrop to the narrative and one that threatens to envelop it as one are the burgeoning asset and debt markets, whose rise is at odds with the weakening fundamental growth prospects of many developed economies. Asset markets and hence debt are being supported, yet the fundamental underpinning to their longer term valuation, investment and growth in real incomes is being weakened. At some point the two, economic reality and asset market capitalisation will need to meet.

I posted on share buybacks and their relationship with wages and capital investment a while back.  But “share buybacks” per se are being seen as an increasingly important agitator in our long running financial and economic crisis…and this crisis has deep roots.

In a recent article in the Harvard Business Review, Profits Without Prosperity (which is thoroughly good read I must add), William Lazonick discussed what he felt was a strong relationship between share buybacks and inequality, which he ascribed to, in essence, an untoward focus on executive compensation and dilution of capital investment in favour of directing borrowing and earnings towards share buybacks and share appreciation. 

“From the end of World War II until the late 1970s, a retain-and-reinvest approach to resource allocation prevailed at major U.S. corporations. They retained earnings and reinvested them in increasing their capabilities, first and foremost in the employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth—what I call “sustainable prosperity.”

This pattern began to break down in the late 1970s, giving way to a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders. By favoring value extraction over value creation, this approach has contributed to employment instability and income inequality”

…Exxon Mobil, while receiving about $600 million a year in U.S. government subsidies for oil exploration (according to the Center for American Progress), spends about $21 billion a year on buybacks. It spends virtually no money on alternative energy research……top executives of Microsoft, GE, and other companies have lobbied the U.S. government to triple its investment in alternative energy research and subsidies, to $16 billion a year. Yet these companies had plenty of funds they could have invested in alternative energy on their own. Over the past decade Microsoft and GE, combined, have spent about that amount annually on buybacks.

This theme of the “subversive” tendencies of the Maximising Shareholder Value ideology was also picked up on by a CFA Institute blog

Rather than enriching themselves by buying back stock at prices near all-time highs, CEOs should instead reinvest in their businesses, including their employees. Doing so will drive long-term growth and sustainability for corporations and the economy at large, better balancing the interests of all stakeholders.

Additionally, QE has also conspired to facilitate corporate borrowing to finance share buybacks as low interest rates and high demand for yield offer a much easier environment for financial engineering:

Bondholders pay price of share buybacks  FT

According to a more recent FT article, The short-sighted US buyback boom,”In 2012, the 500 highest paid US executives made on average $30.3m each, according to Prof Lazonick. More than 80 per cent of it came in the form of stock options or stock awards.”

Equity bulls face slowing share buybacks FT

“Andrew Lapthorne at Société Générale says companies have exploited the generosity of financial markets to fund their share buybacks and as that fades, the equity bull market faces losing a key source of support”

The short-sighted US buyback boom FT

And I also unearthed discussion of the subject in a blog by Steve Roth, Do Businesses Borrow to Invest in Productive Assets? Does the Business-Interest Tax Deduction Encourage That?, and a Slackwire post, What is Business Borrowing For, from which much of it was derived:

Fun fact: Regressing nonfinancial corporate borrowing on stock buybacks for the period 2005-2010 yields a coefficient not significantly different from 1.0, with an r-squared of 0.98. In other words, it seems that the marginal dollar borrowed by a nonfinancial business in this period was simply handed on to shareholders, without funding any productive expenditure at all.

And finally Andrew Smithers who runs a blog at the FT has penned a couple of posts on the issue “US equities: more buyers than sellers”, all of which are well worth reading.

The point about share buybacks is that they sit uncomfortably in a widening narrative of increasing inequality, weak income growth (worse at lower income levels), falling economic growth rates and disturbing trends in both human and capital investment.   The backdrop to the narrative and one that threatens to envelop it as one are the burgeoning asset and debt markets, whose rise is at odds with the weakening fundamental growth prospects of many developed economies.   Asset markets are being supported, debt is being supported yet the fundamental underpinning to their longer term valuation, investment and growth in real incomes is being weakened.   At some point the two, economic reality and asset market capitalisation will need to meet.

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