Caterpillar, the world’s leading manufacturer of construction and mining equipment, is on a roll. It recently announced a US$1 billion stock buyback this year, and hopes to continue on a $10 billion spree beginning 2019. Meanwhile, it’s laying-off hundreds of workers. Is there a connection between buybacks and lay-offs?
In stock buybacks companies purchase their own shares with profits, cash reserves, or borrowed money. It used to be illegal in the US until 1982 because of its power to unduly influence stock prices. But then the reasoning that “companies should be able to do whatever they want with their money” prevailed under the Reagan administration. Using company funds to buy equity is part of the freedom of enterprise and legitimate managerial discretion. No one, not the least government regulators, should be second-guessing executive decisions on what is best for firms.
A study by Tung and Milani in the restaurant, retail, and food sectors in the US between 2015 and 2017, however, establishes a negative correlation between buybacks and worker compensation. Apparently, funds are being diverted from possible increases in employee wages.
Buybacks represent 140 percent of restaurant, 80 percent of retail, and 60 percent of the food sector profits. So although firms claim not being able to afford higher salaries, nevertheless, they go in debt just to finance buybacks, which mainly benefit executives with options. Tung and Milani’s report is especially striking given the notoriously low wages in these sectors. Thus corporate buybacks may contribute to greater social inequality. Moreover, stock repurchases may not only hurt employee compensation, but also defer long-term capital investments in R&D and infrastructure, which make firms more sustainable and competitive.
At a CEO conference in late 2017, presidential economic adviser Gary Cohn discovered that executives were ear-marking 40-60 percent of savings from the announced tax-cuts to buybacks. By some estimates, that was 10 times what they intended to apportion to employee wages and benefits. From this perspective stock repurchases seem to be getting out of hand.
Further, in June 2018, SEC Commissioner Robert Jackson acknowledged that more and more executives cash in their stock holdings a month after buybacks, taking advantage of a 2.5 percent price hike at a minimum. For this reason he thinks 2013 SEC rulings need an update, as they egregiously fail in incentivizing sustainable, long-term value creation.
Nevertheless, because S&P 500 companies are nearing record-levels of investment in absolute terms, dedicating 40 percent to buybacks seemed to Fried and Wang in an HBR article a reasonable, and even modest figure. Apple, for instance, the first company to break the $1 trillion barrier in market capitalization, has distributed around $288 billion to equity holders through buybacks in the past six years. (Some consider this a slow-motion buyout.) Stockholders, then, could reinvest in other businesses, creating more wealth and generating more employment, so the theory goes.
However, the main ethical objection against buybacks still hasn’t gone away. Although legal, buybacks are a fool-proof method to boost stock price without creating sustainable value. They disproportionately benefit stockholders, especially executives with options, who engage in double-dipping. First, buybacks allow managers to meet quarterly share price goals, earning them more options. And second, buybacks ensure that their holdings and options, in turn, increase in value. Meanwhile, as if wage-stagnation for non-equity holding workers weren’t bad enough (the company cannot “afford increases” and lose competitiveness), they now have to contend with the threat of losing their jobs.
Buybacks, especially those financed through loans, may signal management’s unwavering faith in a company’s future. But that belief is tenuous, not based on any long-term capital investments. Through buybacks the company does not create better products and services more efficiently; it only jacks up stock prices. To counterbalance this, perhaps executives should simply be obliged to hold on to their shares much longer.
So what to do in companies with so much money, hard-pressed to find suitable investments? Perhaps issuing dividends would be preferable, as a McKinsey report suggests. That would still reward equity holders, without distorting stock prices and earnings per share as much. Lastly, they could always pay their workers higher wages. There’s nothing wrong with that. Consider it a human capital investment. And it may even increase social equity, which indeed benefits everyone in the long run.
Alejo José G. Sison teaches at the School of Economics and Business at the University of Navarre and investigates issues at the juncture of ethics, economics and politics from the perspective of the virtues and the common good. For the academic year 2018-2019, he is a visiting professor at the Busch School of Business at the Catholic University of America. He is an editor of the recently published “Business Ethics: A Virtue Ethics and Common Good Approach” (Routledge 2018). He blogs at Work, Virtues, and Flourishing from which this article has been republished with permission.