Buybacks are the Symptom, Shareholder Power the Disease

Jeff Gordon –

People claim to be worried about stock buybacks. In fact, the buybacks are a stand-in for what we can all see: business in this country works for wealthy shareholders, not workers, customers, or communities.

Buybacks are in the news as policymakers contemplate a bailout of several major U.S. airlines, all of which have relatively little cash on hand to weather the current crisis. One reason the airlines have so little cash is that, as Bloomberg reports, they spent 96% of free cash flow buying back shares over the last decade. Senator Elizabeth Warren has proposed that no corporation receiving a government bailout should ever again be allowed to conduct buybacks. But the notion that, with fewer buybacks, the airlines would have saved enough to withstand a world-historic economic collapse is fanciful. To see this, we must recognize that the massive stock buybacks of the past decade are a symptom of heightened shareholder power. Efforts to limit or ban buybacks without addressing that power at its source would not lead to the higher wages, productive investments, or rainy-day savings that buyback critics hope for. Moreover, the narrow focus on buybacks distracts from the bigger opportunity presented by the crisis: to reclaim corporations for the public good.

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The Sociology of Markets: an Alternative Political Economy

This post is part of a series on the Methods of Political Economy.

Neil Fligstein – 

For the past 35 years (and certainly before that), scholars across disciplines have offered critiques of neoclassical theory and its variants of political economy. As a result, there is a great deal of theoretical work done on issues of the linkages between states and markets, the comparative study of capitalism across countries, and on understanding how markets are the product of social interactions between market actors—an approach known as the sociology of markets. All of these perspectives share the view that the economy is embedded in political, social, and cultural processes. The upshot of these perspectives is to counter neoclassical political economy’s claim that there is one best or “efficient” way to arrange markets. Instead, markets reflect the relative power of governments, firms, and workers to structure the production of goods and services. The outcome of these interactions produces stability for incumbent firms, a stability that reflects a resolution of these political conflicts. This perspective exposes theoretical arguments that assume efficiency as both incomplete and misleading. Such arguments miss that because there are multiple ways in which these arrangements can be negotiated, there are multiple paths to create stable markets.

These perspectives have been used to understand many empirical contexts including the rise of shareholder value capitalism in the U.S., the rise of finance in the U.S. and around the globe, and the implications of all of this for increasing income and wealth inequality. This literature is well known in political science, sociology, and business studies but less well known in the rest of the academy, particularly in parts of legal studies. My goal here is to introduce the perspective I have contributed by explaining a few of the key ideas and a couple of insights based on using those ideas to make sense of important features of markets.

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How Shareholder Primacy Hurts Jobs and Wages

Lenore Palladino— 

The debate around stagnant wages and job creation seems well-settled: scholars point to globalization, or skill-biased technical change, or the decline of union density.  Others point to the ‘rise of the robots’, claiming that automation and technology are driving us towards a jobless future. But few consider that the dominance of shareholder primacy within America’s public corporations has contributed just as much to economic inequality as these more commonly-cited factors.

I define shareholder primacy as the shift within public companies from investing corporate profits within the firm or its workers to instead sending corporate profits back to shareholders, and, in some cases, holding increasing amounts of financial assets. Companies today care more about their financial metrics than they do about producing goods and services more efficiently over time. That’s why corporations are on track to spend $1.2 trillion this year simply rewarding shareholders by purchasing back their own stock and paying dividends.

For a current example of the dominance of shareholder primacy, take the response to the big tax reform legislation of 2017, which lowered the corporate tax rate to twenty-one percent. According to Trump and the GOP, the legislation was meant to incentive companies to create jobs. What have companies done so far? $171 billion dollars have been spent on share buybacks, whereas only $6 billion has gone to workers’ bonuses and small wage bumps. When the point of corporate activity is to return money to shareholders, investing in productive workers who can grow the business over time is beside the point.

Much of the public still thinks that America’s largest businesses function as they did in the post-World War II era: they earn profits, use those profits in part to enrich their top CEOs, and also invest in their workforce, innovation, and in better prices for us all. But somewhere along the way, in the Reagan administration, government regulations and reforms in corporate governance broke this productive cycle. Some companies focused on shareholder payouts, while others focused on profiting more and more off of financial activity. This shift was led by our industrial mainstays: the paradigmatic American firm, General Electric, earned 43% of its profits in its banking arm, GE Capital, as recently as 2014.

Firms made these choices in direct response to rising pressure from capital markets to move money out of the firm and into the pockets of shareholders, and in order to keep share prices steadily rising—choices sweetened by the fact that CEOs were increasingly paid in company stock.

When investing in a stable and productive workforce is not essential, worker bargaining power declines. Before the 1970s, American corporations paid out 50% of profits to shareholders, while retaining the rest for investment. Now, shareholder payouts are over 100% of reported profits, because firms borrow in order to lift payouts even higher.

Thus the changing nature of work—the rise of the fissured workplace and the gig economy—is driven not just by a generic drive for profit or the attributes of the “knowledge economy,” but a structural shift within corporations from a productive to financialized use of corporate cash. The relentless search for short-term profits expresses itself through squeezing employees’ pay, transforming employees into independent contractors to avoid paying benefits or pensions, and outsourcing work to contracting firms that compete to pay lower and lower wages. If firms don’t count on their employees to come up with the next big productivity improvement or exciting product idea, there’s no reason to invest in employee efficiency or longevity with the firm.

Demands on firms intensified with the rise of ‘activist investors,’ formerly known as corporate raiders. As institutional investors became large shareholders of major corporations, they pressured firms to push up share prices by maximizing short-term profits. Since such institutional investors could move their investments around easily, firms grew more responsive to capital markets than to their customers. For public companies, key regulatory and legislative changes allowed for a greater focus on stock prices. In 1982, Congress passed the safe-harbor provision for buybacks, which formerly would have been considered market manipulation. Further, the shift to allow CEO ‘performance pay’ to be deducted from corporate tax incentivized corporations to pay CEOs in stock. On the private firm side, the rise of private equity and the increase in leveraged buyouts has led to extractive financial strategies in which private firms cut jobs and reduce wages in order to extract maximum wealth for the holders of equity.

Though the literature is still nascent, several scholars have examined the direct negative impact of corporate financialization on income inequality. One study found that financialization, net of other factors, could account for more than half of the decline in labor’s share of income in the nonfinancial sector of the economy, and is comparable to the effect of de-unionization, globalization, and technological shifts.  Others look directly at the impact of financialization on declining corporate investment, finding that the financial profit rate is correlated with a significant decline in investment, especially for large firms. Less investment can mean less to spend on improving the skills and productivity of one’s workforce.

Corporate financialization is not the only driver of labor market challenges. It has become impossible, though, to think about how to solve problems in the labor market without taking on the primacy of shareholders. It is not simply that firms want to spend less money on workers—it’s that they actually need them less, and so the incentive to invest in a high-quality workforce is much reduced. In order to have a stable and productive workforce, and for workers to have the bargaining power they need to take home a fair wage, the incentives that drive shareholder primacy must be reformed.

A modified version of this post will be published as part of the article, Eleven Things They Don’t Tell You About Law & Economics:  An Informal Introduction to Political Economy and Law, forthcoming in Volume XXXVII of Law and Inequality:  A Journal of Theory and Practice (Law & Ineq.) of the University of Minnesota.

Lenore Palladino is Senior Economist and Policy Counsel with the Roosevelt Institute, a Lecturer in Economics at Smith College, and Of Counsel with the Law Firm of Jason Wiener, p.c.