Americans often decry the high rate of executive pay in this country. It is certainly true that American CEO’s are being paid more than they were in the past – about 940% more than the late 1970s. But the much more interesting, and perhaps dangerous, aspect of corporate governance is the expansion of stock buybacks. A stock buyback is the practice by which a corporation repurchases publicly offered shares of its own stock. The general basis of such a move is that by reducing the number of shares available, the value of each share will increase. Despite the technicalities involved in the process, our current weak regulation of stock buybacks is causing a profound harm to the everyday American people, and more need to be aware of the need to address this issue.
Until 1983, the SEC heavily regulated the practice of stock buybacks, creating what was essentially a soft ban. Under Reagan’s deregulatory policies, these restrictions were lifted, and replaced with a 25% cap on the value of stock that could be repurchased per day, as well as quarterly reporting rules. In 1993, another fateful decision was made in which Clinton’s Securities and Exchange Commission (SEC) ruled that corporate executives could use their knowledge about the timing of buybacks to determine when to execute their stock options. Because stock buybacks are done anonymously through a broker and only disclosed on a quarterly basis, the general public would have no knowledge of why a stock’s price was rising, yet corporate executives would. In essence, a CEO could order a buyback to inflate the value of a stock, and then execute their stock options for maximum profit.
Since the SEC’s 1993 ruling, this practice continues to be utilized by corporate executives. Between the years of 2003 and 2012, the ten companies who repurchased the most stock had corporate executives who received 68 percent of their total pay in stock options. Unsurprisingly, stock options as a percentage of corporate executive pay continues to increase. The median salary of a CEO of a S&P 500 company has changed almost nothing since 2011, yet the median pay in equity for those same companies has increased by over 60 percent. As an example, Jeff Bewkes, the CEO of Time Warner Cable – one of the largest companies in America – was paid only 2 million dollars in salary. Yet, tellingly, his pay in stock options was over 15 million dollars. In 2013 Mark Zuckerberg received a mere 1 dollar salary as CEO of Facebook. Of course, in that same year he received 3.3 billion dollars’ worth of stock options.
Now, it deserves mention that stock options are a valid way to reward an employee. Many companies reward even low-level workers with equity. In many ways, paying employees, including corporate executives, in equity is a good way to create an incentive to help the company perform well. However, in a time of increasing income inequality, most American’s might be shocked to learn that what seems like a clear conflict of interest is not only allowed, but is so prevalent. On a basic level, it is unfair that executives should be allowed to use their inside knowledge for personal profit. Essentially, this is another avenue for those at the top with connections to make money, one which those at the bottom have probably never heard of, or even have the ability to use.
The potential ramifications of stock buybacks do not stop at income inequality, however. As companies spend more and more on stock buybacks, they spend less and less on worker’s wages, expansion and research and development. In 2005 alone, Hewlett-Packard laid off 10 percent of its staff. Yet, between 1999 and 2005 it had spent 14 billion on buybacks. 3M, IBM and Pfizer, all once seen as great American innovators, are now spending more on stock buybacks than they are on the invention and development of new products and ideas – products and ideas that benefit all Americans. Every dollar that a company like Pfizer spends on stock buybacks represents one less dollar going towards the development of possibly lifesaving pharmaceuticals.
This lack of innovation might also be doing real damage to the U.S. economy as well. Evidence suggests companies who frequently repurchase large amounts of their stock tend to underperform those who did not practice buybacks. A FactSet analysis of last year looked at the performance of companies in the S&P 1500 who had bought back stock against those who had not. Those companies that had not repurchased stock performed best, even better than the average company. Those who had not repurchased stock saw a median return of -5.1%, an improvement on the -6.4% median return for those who had repurchased stock. The 100 companies who had repurchased the most stock relative to market cap performed worst, having a median return of -9.5%, far below the average company. All this suggests that the gains offered by stock buybacks are artificial; short-term benefits to shareholders and corporate executives at the cost of long-run returns. Long run returns that might actually create new jobs and opportunities for the American public.
All of this is of course not to say that there isn’t an argument for stock buybacks. But the evidence is mounting that stock buybacks are being abused by corporate executives for their personal gain. The economic consequences of stock buybacks must be explored, and any attempt to address the issue of CEO pay must include the examination of stock buybacks. For the sake of Americans everywhere, and our economic systems, we must explore a ban on, or heavy regulation of, stock buybacks.
What would such a ban look like? One possibility is a return to the pre-1983 rules. These strong limits would work as a soft ban on the financial mechanism. A more business-friendly maneuver might simply be a return to the pre-1993 ban on executives using their knowledge of buybacks to time the execution of stock options. Though it wouldn’t prevent buybacks and the economic harms they cause, it might discourage executives from abusing the mechanism. Alternatively, entirely new regulations might need to be crafted. A compromise including increased disclosure and stronger limits on the volume of buybacks would certainly be a viable option to address the problems buybacks create.
In the end, any attempt to regulate buybacks will of course require significant political capital. Businesses and corporate executives are unlikely to see the moves as friendly to them. Yet, the damages buybacks are doing to the U.S. economy are growing, as is economic inequality in this country. American legislators must act quickly for the sake of Americans everywhere.