Thursday, 30 April 2015

The Danger of the Share-Buyback Epidemic

Paul Sweeney: The news that US companies will buy back over one Trillion dollars – that is $1,000,000,000,000 - worth of their own shares in 2015 is a warning of possible bad times.

When companies buy back their own shares instead of investing their money in the future, in jobs in plant and machinery, it means lower future growth for the company but also for the economy, especially when so many of them are doing it together.

It is estimated that this year US corporations will spend over 100% of net profits in share buybacks.

GE said it will sell-off most of its financial businesses to concentrate on its core industrial businesses and it will return $90bn to shareholders over the next three years. Apple which announced staggering profits this week, will also buy back $140,000,000,000 of its own shares. IBM has spent over 90% of its profits over the past ten years in share buybacks.

Here and in the UK, shareholders in Vodafone and Standard Life have seen big special dividends as both companies sold off US subsidiaries and gave the money back instead of re-investing it.

Irish company Ryanair has a cash pile of over $4 billion sitting on its books. It could return this to shareholders, cuts prices, or pay its workers more. It announced it would be buying back €400m of its own shares.

Cash returned to shareholders in the US was over $900bn in 2014, with $350bn paid out in dividends and a staggering $553bn in own share buybacks according to S&P Dow Jones Indices. US companies have cash of over 1.3 trillion and so it is argued it is best to hand it back to shareholders

Dividends have climbed on average 14 per cent annually over the past four years. This rate of increase is expected to continue in 2015. This is the seventh year of the Bull Market in the US.

It compares to wage stagnation in the US. While the U.S. economy added the largest number of jobs in 15 years in 2014 earnings grew just 1.7 percent last year, the lowest increase for any 12-month period since October 2012. Fed Chair Janet Yellen has frequently raised concerns over the slow pace of US wage growth. It iseems that QE in the US has benefited corporate America and shareholders but less so for workers.

Companies are making large profits, accumulating vast sums of cash and management, who are at the top for short periods, have a big incentive to buy back share to boost their share options and bonuses.

So even with large profits, huge cash piles and historically low interest rates companies are not still investing at the levels which these incentives would warrant. In the past, when unions were stronger and “shareholder value” was not the driving force for many companies, profits would be lower, wages higher and demand in the economy would be stronger. Most importantly, the level of inequality, which threaten not just social cohesion, but also economic progress would not be reaching such high levels in the US.

Some US companies have not been performing well, but still have bought back shares according to Merrill Lynch. These companies, like profitable ones, do this in order to boost the share price, to give shareholders a deceptive lift and also lift the executives’ remuneration.

Instead of raising money through the stock exchange from shareholders, companies are depleting their reserves and investing in shareholders.

The labour share of the national economy in most countries has been in serious decline for many years, as I have shown in this paper at the Statistical Society. The share buybacks are a major cause, though the high share of national income going to capital in profits is of course the kernel.

The boss of the biggest asset management firm in the world, BlackRock, Mr Larry Fink, is not impressed by what is happening. He said “More and more corporate leaders have responded with actions that can deliver immediate returns to shareholders . . . while underinvesting in innovation, skilled work-forces or essential capital expenditures necessary to sustain long-term growth.” He is dead right.

And Bill Lazonick, a leading critical economist in the US pointed out that over past 30 years, “corporate resource-allocation at many, if not most, major U.S. business corporations has transitioned from “retain-and-reinvest” to “downsize-and-distribute.”

Lazonick is contemptuous of the ideology of “maximizing shareholder value”, which is behind the buybacks. He calls for a decrease, or even a ban, in buybacks so that companies will be able to use these funds to finance capital expenditures and also to attract, train, retain, and motivate its career employees.

In summary - share buybacks:

  • Boost share price in short-run:
  • Increase the remuneration of top executives;
  • Executives focus on short-term financial performance - not the business;
  • Reduces investment in the firm’s future;
  • Can undermine the firm’s viability;
  • Is a form of the financialisation of economies;
  • Indicates that QE has benefited corporates and shareowners more than those in the real economy;
  • Share buybacks reduces the real economy (when so many firms doing it) by transferring wealth upwards to capital and
  • It adds to growing inequality.

Do these buyback transfers to capital spell the end of capitalism? Hardly, but the share buyback frenzy is a leading indicator of possible bad times to come for the US and perhaps for some other economies where it is occurring.

No comments: