Profits Without Prosperity - William Lazonick

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, over all 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……

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William Lazonick is a professor of economics at the University of Massachusetts Lowell, the codirector of its Center for Industrial Competitiveness, and the president of the Academic-Industry Research Network. His bookSustainable Prosperity in the New Economy? Business Organization and High-Tech Employment in the United States won the 2010 Schumpeter Prize.

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IN CORPORATIONS, IT’S OWNER-TAKE-ALL - BY HAROLD MEYERSON

Labor Day — that mocking reminder that this nation once honored workers — is upon us again, posing the nagging question of why the economy ceased to reward work. Was globalization the culprit? Technological change? Anyone seeking a more fundamental answer should pick up the September issue of the Harvard Business Review and check out William Lazonick’s seminal essay on U.S. corporations, “Profits Without Prosperity.” Like Thomas Piketty, Lazonick, a professor at the University of Massachusetts at Lowell, is that rare economist who actually performs empirical research. What he has uncovered is a shift in corporate conduct that transformed the U.S. economy — for the worse. From the end of World War II through the late 1970s, he writes, major U.S. corporations retained most of their earnings and reinvested them in business expansions, new or improved technologies, worker training and pay increases. Beginning in the early ’80s, however, they have devoted a steadily higher share of their profits to shareholders. How high? Lazonick looked at the 449 companies listed every year on the S&P 500 from 2003 to 2012. He found that they devoted 54 percent of their net earnings to buying back their stock on the open market — thereby reducing the number of outstanding shares, whose values rose accordingly. They devoted another 37 percent of those earnings to dividends. That’s a total of 91 percent of their profits that America’s leading corporations targeted to their shareholders, leaving a scant 9 percent for investments, research and development, expansions, cash reserves or, God forbid, raises.

As late as 1981, corporations directed a little less than half their profits to shareholders, but the shareholders’ share began rising in 1982, when Ronald Reagan’s Securities and Exchange Commission removed any limits on corporations’ ability to repurchase their own stock and when employers — emboldened by Reagan’s destruction of the federal air traffic controllers’ union — began large-scale union-busting. Buybacks really came into their own during the 1990s, when the pay of corporations’ chief executives became linked to the rise in the value of their company’s shares. From 2Cisco Systems devoted 121 percent of its net income to repurchases and dividends, and 92 percent of its CEO pay was stock-based. About that 121 percent: With companies lavishing virtually all their net income on shareholders and executives, the way many of them cover their actual business expenses — their R&D, their expansion — is by taking on debt through the sale of corporate bonds. A number of companies, however —most prominently, IBM — borrow specifically to increase their payout to shareholders. And IBM is not alone. Friday’s Wall Street Journal reportedthat U.S. companies are currently incurring record levels of debt, much of which, the Journal noted, “is being used to refinance existing debt, being sent back to shareholders as dividend payments and share buybacks, or banked in the corporate treasury as executives consider how to potentially deploy funds as the economy expands.” Many of the companies that have spent the most on buybacks, Lazonick demonstrates, have also received taxpayer money to fund research they could otherwise afford to perform themselves. 2003 through 2012, the chief executives of the 10 companies that repurchased the most stock (totaling $859 billion in aggregate) received 58 percent of their pay in stock options or stock awards. For a CEO, getting your company to use its earnings to buy back its shares might reduce its capacity to research or expand, but it’s a sure-fire way to boost your own pay. Exxon Mobil, for instance, devoted 83 percent of its net income to stock repurchases and dividends, and 73 percent of its CEO pay was stock-based.

What Lazonick has uncovered is the present-day American validation of Piketty’s central thesis that the rate of return on investment generally exceeds the rate of economic growth. Indeed, Lazonick has documented that wealth in the United States today comes chiefly from retarding businesses’ ability to invest in growth-engendering activity. The purpose of the modern U.S. corporation is to reward large investors and top executives with income that once was spent on expansion, research, training and employees. To restore a more socially beneficial purpose, Lazonick proposes scrapping the SEC rule that permitted rampant stock repurchases and requiring corporations to have employee and public representatives on their boards. Lazonick’s article does nothing less than decode the Rosetta Stone of America’s economic decline. The reason only luxury and dollar stores are thriving, the reason German companies outcompete ours, the redistribution of income from workers to investors – it’s all here, in Lazonick’s numbers. The lesson for Labor Day 2014 couldn’t be plainer: Unless we compel changes such as those Lazonick suggests to our model of capitalism, ours will remain a country for investors only, where work is a sucker’s game

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