Wednesday, May 6, 2015

Where the Money Goes

As some readers know, I have lamented the dominance of Wall before. I and certainly many others, have expressed disgust over the way Wall Street sucks money out of the economy. This is not mere rhetoric spewed from that swirling cacophony called the Internet. Let me provide a very specific example of what I mean when the Wall Street feeding frenzy is damaging America: the current practice of stock buybacks. It is a simple enough to understand, and why corporations might want to do it when warranted. What is not as obvious is the broader ramifications.

As you should know, publicly-traded companies become public by issuing stock, shares of which are available to anyone who cares to buy them. Said companies often issue additional shares from time to time as a way to raise capital, which is not debt, and in lieu of borrowing, which is. Over time, a company, call it Acme Widget, may have raised a great deal of capital by issuing a flood of stock. Companies like Acme may or may not have grown as a result.

However, Wall Street doesn't just want to see Acme make profits; what it really wants is for the stock price to rise and it cares little about how it is done. Rising stock prices are harder to come by if Acme has gazillions of shares floating around. On a per-share basis, earnings look better if Acme has, say, 300 million shares instead of three billion. Obviously they are not better, they only look better.

What to do? Acme could use its profits on R&D, or on new equipment, two mainstays of stable growth. Or Acme could buy back shares of its stock. This has some ramifications. Apologists will tell you Acme is investing in its future, and buybacks should be seen as a mark of confidence. That is risible nonsense. What does Acme get by blowing its earnings on its own stock? Companies like Acme are now spending big money, billions of dollars in some cases, buying (back) something that is not a productive asset. Cash spent on buybacks is cash not spent on increased wages, new technologies, or something corporate America could really use; higher quality products and processes. But buybacks enrich the investor class, which insists that maximizing shareholder value should be a corporation's overriding objective. If they get rich, then, well, that's it.

There is, finally, a growing recognition that American capitalism, with its obsession of stock buybacks, is toxic to this country's long-term health. At MarketWatch, not exactly the New Left Review, Rex Nutting writes:
Many factors have been blamed for the plummeting fortunes of the American middle class: globalization, technology, deregulation, easy credit, the winner-take-all economy, and even the inevitable tide of history. 
But one under-appreciated factor is a pervasive business model that encourages top managers of American corporations to loot their company for short-term gains, depriving those companies of the funds they need to build and enlarge, and invest in their workers for the long haul. 
How do they loot their company? By using large stock buybacks to manage the short-term objectives that trigger higher compensation for themselves. By using those stock buybacks to manipulate the share price, which allows them to use inside information to time their own stock sales. By using buybacks to funnel most of the company’s profits back to shareholders (including themselves).
Upper management at publicly traded companies is highly incentivized to enrich the already rich, most of whom are passive investors and have nothing to do with those companies except that they own shares. CEOs have garnered enormous wealth in recent decades because they also own many shares. Their role helps explain the corporate America's felt need to aggressively engage in stock buybacks. CEOs generally don't get multi-million dollar paychecks; that's for professional athletes. They get big paychecks, to be sure, but the really big money comes from stock options, though with a catch. Generally the stock has to appreciate in value up to a pre-determined amount, and within a certain time frame. Therein lies the short-term thinking in so many American companies that focus on their stock instead of on their products, customers, and employees.

This unproductive but highly addictive practice plays out as such: CEOs know that if they can get or keep the stock price at a certain level, their previously awarded stock options can be exercised. He, or occasionally she, sell those shares on the open market. The result is a windfall of cash, sometimes many millions of dollars. And this is an ongoing process: stock options awarded, work the stock, cash in, fresh stock options, repeat and enrich yourself.

Most shares the CEOs care to sell end up in the open market, where they tend to weigh down the price of the stock. That won't make investors happy, nor the CEO, who hopes for more stock options in the future. That's where the stock buybacks come in. CEOs and compliant corporate boards are only too happy to accommodate them, for they, CEOs, others in upper management, boards and investors alike stand to benefit.

The situation is complicated only somewhat by dividends. CEOs and investors alike are more inclined to keep their shares if the company pays a dividend. Fine, you say, except that dividends can get very expensive. Again, this is cash that could have been plowed into productive assets. But once dividends are paid, they are gone forever and they go mostly to the hedge funds, investment banks, and the rest of Wall Street, as well as the CEOs.

It is essential that voters understand the damage being done. Corporate America extracts profits from the working- and middle-class. That is as it always has been. And that is not the problem since customers, that's us, get something in return. The difference now is that those profits are not finding their way back, in the form of increased wages, to middle America. To reiterate, corporate America is on a buyback frenzy to please investors, and it is using money that in the past went to increased wages and capital improvements.  Instead, the use of stock options and buybacks ensures that an ever-increasing portion of capital sifts upward to the very top, where it remains in control of the .01%. Even the rich are beginning to recognize the recklessness.

It is the antithesis of the intellectual asininity called "trickle-down." Indeed, it is an ongoing debate whether neoliberalism's warriors were ever ideologically naive enough to buy into the trickle-down argument, or they simply figured we were.


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