Profits Without Prosperity
Five years after the official end of the
Great Recession, corporate profits are high, and the stock market is
booming. Yet most Americans are not sharing in the recovery. While the
top 0.1% of income recipients—which include most of the highest-ranking
corporate executives—reap almost all the income gains, good jobs keep
disappearing, and new employment opportunities tend to be insecure and
underpaid. Corporate profitability is not translating into widespread
economic prosperity.
The allocation of corporate profits to stock buybacks deserves much of the blame. 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 left very little for investments in productive capabilities or higher incomes for employees.
The buyback wave has gotten so big, in fact, that even shareholders—the presumed beneficiaries of all this corporate largesse—are getting worried. “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, the world’s largest asset manager, wrote in an open letter to corporate America in March. “Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks.”
Why are such massive resources being devoted to stock repurchases? Corporate executives give several reasons, which I will discuss later. But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices. In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets.
As a result, the very people we rely on to make investments in the productive capabilities that will increase our shared prosperity are instead devoting most of their companies’ profits to uses that will increase their own prosperity—with unsurprising results. Even when adjusted for inflation, the compensation of top U.S. executives has doubled or tripled since the first half of the 1990s, when it was already widely viewed as excessive. Meanwhile, overall U.S. economic performance has faltered.
If the U.S. is to achieve growth that distributes income equitably and provides stable employment, government and business leaders must take steps to bring both stock buybacks and executive pay under control. The nation’s economic health depends on it.
From Value Creation to Value Extraction
The allocation of corporate profits to stock buybacks deserves much of the blame. 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 left very little for investments in productive capabilities or higher incomes for employees.
The buyback wave has gotten so big, in fact, that even shareholders—the presumed beneficiaries of all this corporate largesse—are getting worried. “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, the world’s largest asset manager, wrote in an open letter to corporate America in March. “Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks.”
Why are such massive resources being devoted to stock repurchases? Corporate executives give several reasons, which I will discuss later. But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices. In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets.
As a result, the very people we rely on to make investments in the productive capabilities that will increase our shared prosperity are instead devoting most of their companies’ profits to uses that will increase their own prosperity—with unsurprising results. Even when adjusted for inflation, the compensation of top U.S. executives has doubled or tripled since the first half of the 1990s, when it was already widely viewed as excessive. Meanwhile, overall U.S. economic performance has faltered.
If the U.S. is to achieve growth that distributes income equitably and provides stable employment, government and business leaders must take steps to bring both stock buybacks and executive pay under control. The nation’s economic health depends on it.
From Value Creation to Value Extraction
For
three decades I’ve been studying how the resource allocation decisions
of major U.S. corporations influence the relationship between value creation and value extraction, and how that relationship affects the U.S. economy. 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.
Here ends the free taster written by William Lazonick, a professor of economics at the University of Massachusetts Lowell, the remainder has to be paid for here.
As to value creation, value extraction, capital expenditure, sustainable prosperity and other such terms this writer has no intention of attempting to discuss these aspects of the article. What strikes me, a non-academic, are the column inches devoted here and elsewhere, whole books even, to explaining where the profits are being channeled followed by calls for justice and fair pay and conditions for workers, as if it will make a blind bit of difference. What I and many others see quite clearly and simply is that what's happening is working just as it's meant to for those who are benefiting, those at the very top of the pyramid. Workers are disposable. There's a huge reserve of unemployed growing fast. Outsourcing is just another option. Equality will only come to us when the 99.9% decide enough is enough and remove the 0.1% from their perch.
JS
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.
Here ends the free taster written by William Lazonick, a professor of economics at the University of Massachusetts Lowell, the remainder has to be paid for here.
As to value creation, value extraction, capital expenditure, sustainable prosperity and other such terms this writer has no intention of attempting to discuss these aspects of the article. What strikes me, a non-academic, are the column inches devoted here and elsewhere, whole books even, to explaining where the profits are being channeled followed by calls for justice and fair pay and conditions for workers, as if it will make a blind bit of difference. What I and many others see quite clearly and simply is that what's happening is working just as it's meant to for those who are benefiting, those at the very top of the pyramid. Workers are disposable. There's a huge reserve of unemployed growing fast. Outsourcing is just another option. Equality will only come to us when the 99.9% decide enough is enough and remove the 0.1% from their perch.
JS
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