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.
Given the amount of money circulating is actually debt generated with fractional reserve banking, how would significantly changing private equity ~= debt effect the economy? (i.e. without appropriate transition wouldn't this lead to massive deflation?)
It would disincentive companies from taking long ter loans, thus reducing the amount of fractional reserve lending. (That thing is finite, despite what some textbooks say, and it's finitness is relevant on the US.)
> 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?
When people raise Animats' argument, the beneficiaries of the relative tax rate imbalance typically make an argument like: "Oh, you couldn't possibly increase the tax rate on interest paid. Any absolute increase in the tax rate will make corporations refuse to borrow, ruining the economy."
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.
I'd argue that we need to tax corporate dividends, interest paid, and stock buybacks at the same rate. That rate could be set to be revenue neutral. Dividends taxed less, interest and stock buybacks are taxed more.
All the ways businesses pay for their capital should be taxed at the same rate.
The instability comes from piles of biases created by rules, exactly like this. Addressing these biases and correcting clearly ridiculous incentives will slowly correct overall behaviour, if enough rules/rates/whatever are tweaked in a better direction.
Absolute tax rate do have an effect on eg how much corporate behaviour you get in the first place.
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.
How exactly would you tax stock buybacks? When a company purchases its own stock someone is selling, and the seller will already have to pay capital gains tax.
I did some back of the envelope calculations on Boeing in 2015. The spent about $86,000 per employee on buybacks and dividends. Just a year after strong arming the union out of their pension out of a supposed desperate need to compete with airbus. I really doubt airbus has lower employee overhead than Boeing.
To boot, they are the beneficiaries are massive, pork-laden propped up government defence contracts - and massive 'investment incentives' from states/municipalities like Seattle etc. who give them massive tax incentives etc. to build plants in their state.
Well the article's fundamental worry is right: labour's share of revenue has shrunk compared to the share taken by capital (and also high-level executive type employees). And this causes, or is at least related to, problems with society as a whole.
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.
"labour's share of revenue has shrunk compared to the share taken by capital (and also high-level executive type employees). And this causes, or is at least related to, problems with society as a whole."
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.
Actually, both capital and labour shares of output have seen a relative decline at the expense of profits. [1]
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.
Actually, both capital and labour shares of output have seen a relative decline at the expense of profits. [1]
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.
"Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. 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'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.
What do you find shocking about it? There is a big moral question about corporate profits vs. wages. But given that some portion of revenues become profits, they are either going to turn into a corporate cash hoard, dividends, or buybacks. I don't see anything shocking about choosing a buyback over the other two choices. After all, when a company takes investor money in a public offering, the idea is that the money will eventually be returned to investors, plus a profit if possible. A buyback is one way to close out the deal with some of those investors and return that money.
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.
Stock buybacks have a distinct advantage over dividends: they're not taxable
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.
IMO, there's an injustice here when things like stepped-up basis result in these gains never being taxed, but that seems like a separate issue from the question of wages vs. profits.
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.
If the company made the money from selling beer, it was triple taxed due to the alcohol tax! Wait, if the customer paid for the beer with earned income, the beer was quadruple taxed. But if he paid for the beer with dividend income, it was quintuple taxed!
In the stepped-up basis case I mentioned, the investor may never pay taxes on the gains.
> 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.
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?
That's assuming that the buy back actually increases the stock price by the amount spent and for those of us that hold stocks in an ISA (tax free) id much rather have a dividend
a journalist could write an article saying "company spends 100% of profit on buyback, giving none of it to workers."
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.
> 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...")
But there is no reason why it is better or somehow more moral for a business to invest more and more in expanding its own operations vs. making that capital available for other kinds of investments.
There is a reason why it can be more moral. If managers are just running the share price up to inflate the value of their options, that costs the owners (shareholders) money. (The managers might keep exercising options, then spending the owners' money to buy back shares. Long term you end up with the same number of shares outstanding. Where did all the money for those buybacks go? To people who exercised stock options.)
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.
> Companies can also reinvest profits in the business
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.
You have to identify a demand for lemonade before you can reasonably invest in more lemonade stand. In a lot of industries the demand just hasn't been there, and in that case it doesn't make sense to increase capacity no matter how much money you're making.
Sure, reinvestment could be a bad idea. But it's really not correct to say that retaining profits as cash or paying them out are the only possible options for a business. That's what I was responding to.
Agreed, the "cash hoard" option should also include assets, and we should also talk about debt and depreciation in that case. I don't think it conflicts with my original assertion wrt. wages.
Profits are either returned to shareholders or accumulated (and returned later). Returning 91% of profits to shareholders does not seem particularly odd to me.
(Possible point of confusion: earnings means profits earned, not revenues earned.)
> Profits are either returned to shareholders or accumulated (and returned later).
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).
If the money is paid as wages, then it wasn't profit.
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.
The article makes some great points, and more people should read about Piketty's research on wealth concentration. But it buries the fact that buybacks have actually been decreasing by certain metrics [0].
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.
Worth noting: article is from 2014. It's unfair to ask it to cite trends that started after the date of publication (and likely after the finalization of the research, which probably dates closer to 2012, the cited end date in the article).
Ah! I've been so spoiled by the moderation on HN that when I see an article that doesn't have e.g. (2014) in the title, I assume it's recent! You're absolutely right.
It seems there is an uptick in news stories in general about stock buybacks. With the Bush tax holiday, corps bought back $70B in stock out of the $223B that was repatriated. Even a rookie accountant would see the value of holding offshore profits until another tax holiday (now estimated to be $2T). Thus starting a cycle that is the biggest tax shelter in corporate tax history. The odds are pretty good that of the 3 goals of the trump tax plan, only the tax holiday will pass. So we can expect to see around $700B in stock buyback and the rest will pay dividends to keep stock prices from correcting the current %25 over inflated stock price caused by the tax holiday plan.
Paying CEO’s most of their compensation in stock was a theoretically sound idea when it was made— after all, shouldn’t their pay be linked to performance?— but one that should be abandoned now that the empirical results have shown what it mess it has really been. It encourages tax and stock shenanigans like this in favor of real investment, further prioritizes short-term thinking, and is just generally useless since there connection between CEO performance and stock price has been shown to be tenuous even without the manipulation.
Let’s go back to paying CEO’s purely in cash with an annual performance bonus decided by the board.
The person you replied to is just trying to get a conversation and some potential pressure started. No need to instead be so aggressive and expect them to become a rich CEO.
Here's another explanation. After companies get to a certain size, they can't deploy capital as efficiently. The low hanging fruit is gone, they have more principal-agent problems, and lots of waste.
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.
I know what you mean but I'm not sure I'd throw "waste" around so casually. Wages are not waste, from the employee's point of view. From a utilitarian point of view, it's not at all clear that the money would be less "wasted" if given to stockholders.
Of course wages are not waste. Corporate mergers for purposes of CV building and vanity are waste, and are the hallmarks of a company sitting on too much cash. Run your business properly and give any surplus profits to the owners.
The trend has been to both squeeze wages and engage in corporate buybacks, usually with the justification that the company can't afford to raise wages (which is obviously bullshit given how wastefully profits are used)
I'm not thinking wages. I'm thinking corporate jets, M&A that feeds ego while costing shareholders ($) and employees (jobs), and pet R&D projects that go nowhere due to corporate bureaucracy.
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)
It is true that earnings management is an issue. The histogram of earnings % shows a discontinuity when earnings are negative but approaching zero, [1] which shows that managers will artificially inflate earnings to show a positive earnings per share.
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.
Maybe I’m missing something amid all the technocratilly minded discussions on the virtues of paying dividends vs stock buybacks vs the issue of whether the profits of a company are more efficiently used to fund new investment compared to returning profits to shareholders (one way or another) so they can reinvest.
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.
Nope. Stock buy backs are a tax efficient way of giving dividends. The stock rises in price instead of issuing the dividend. So for me the owner of the stock I don’t have a tax event for holding. The whole reason to own stocks, is to realize profit from ownership.
The author does address this. "Some people used to argue that buybacks were a more tax-efficient means of distributing money to shareholders than dividends. But that has not been the case since 2003, when the tax rates on long-term capital gains and qualified dividends were made the same."
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.
That addresses the objection but doesn't fully satisfy it. First, not all shareholders are taxed the same way, as the other commenter noted. Second, the tax rate of long-term gains might change before the stock is sold; a fraction of shareholders in the US probably believe that will happen. Third, the dividend tax is collected immediately (on the next tax return), so it reduces how much the shareholder can reinvest unless they take money from elsewhere. Buybacks compound in the stock more easily than dividends.
A) So, wages are stagnant or falling and unemployment (real unemployment) is at 10%.
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?
The lack of prosperity is due to only top management receiving compensation in stock. What if legislation existed that mandated some percent of an employees pay must (if said employee chooses that is) be in the form of stock for publicly traded employers?
I understand that it's still peanuts compared to the structural imbalances at play here. More of a first step.
Well you mandate the all employees must have access to the same share option plan on the same terms that the executives do would be a start - this would stop the abuse complex LTIP for the board.
Or maybe mandate that PLCs can distribute a certain amount stock tax free to employees say $2000 per anum
How about changing the HN title to match the page (“Profits Without Prosperity”), rather than 0x4f3759df’s editorialized version (currently “Stock buybacks as a mechanism to depress wages and increase CEO pay”).
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.
AMZN is a pretty good counter example of a company that invests in itself and it's workers rather than spend on stock buybacks or dividends. Surely someday in the future shareholders of AMZN will realize a profit!!!
The simple argument is that you can buy back shareholders and not increase wages or pay people more in the pursuit of greater innovation and/or productivity.
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.