Reminder: Shareholders Should Get The Profits
The Washington Post’s Harold Meyerson seizes on a study in the Harvard Business Review to argue that public companies are skimping on important spending to inordinately benefit their shareholders:
Like Thomas Piketty, [study author William] 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. [Emph. added.]
So to Meyerson, investors are enriching themselves at the expense of workers. I admit I haven’t a clue as to what he’s talking about. First, the “research and development, expansions, . . . or, God forbid, raises” he deems to be preferred uses of corporate resources are for the most part expenses. Which is to say, they get deducted from revenues in calculating the earnings that will ultimately be available to shareholders. So a given company might have already spent to the rafters on things like R&D, wages and salaries, and other Meyerson-approved items, but to him (and people like him) that still apparently wouldn’t be enough. Capital spending doesn’t get expensed, of course, but depreciation of prior years’ capex does and, as a practical matter, the two numbers are very often similar in size. But, again, to the Harold Meyersons of the world, no matter how big a company’s depreciation charge, it still wouldn’t seem to be enough.
Anyway, what’s left after all these expenses are deducted and taxes are paid are called earnings. And the group with the first claim on them are the owners of the business: the shareholders. What’s the matter with a company distributing its earnings to the owners?
But to people of a certain political ilk, shareholders don’t count as owners with important rights, but rather as a nuisance standing in the way of a more “equitable” distribution of a company’s profits. This is nonsense. Without shareholders—or, more, broadly, without private investors willing to put their own capital at risk—there would be no company in the first place. Nor would there be any long-suffering, underpaid workers to fairly distribute profits to. There wouldn’t be any profits to distribute.
Yet shareholder-bashing seems to be becoming fashionable lately. A key part of Thomas Piketty’s program, recall, is a global tax on wealth. A Cornell law professor, Lynn Stout, has written a whole book denouncing what she calls the “shareholder value myth.” Nor is this the first time Harold Meyerson himself has railed against the idea of shareholders getting their due. This kind of thinking is pernicious, and ought to be opposed. Economic policymakers (and their commentariat pals on the sidelines) should focus on ways to attract and reward more private risk capital, not screw it out of what it fairly deserves. By all means, companies should pay their workers a decent wage and undertake sensible and prudent capital and R&D projects. But come the end of the year, any profits that are generated ought to go to the only group that has a claim on them: the businesses owners.
What do you think? Let me know!
13 Responses to “Reminder: Shareholders Should Get The Profits”
You still have to balance taking care of your people with taking care of your providers of capital. Ultimately if you wind up with a brain drain on your hands your providers of capital will suffer with low growth and low roic. If your providers of capital aren’t compensated adequately for bearing financial risk they won’t invest. I realize you know this, so I’m just sayin’.
You speak to a different issue though, which is the nuts and bolts of managing a specific business. Of course, good management will want to attract and retain valuable employees. The companies that do this well will thrive, and the ones that don’t will die on the vine. But that is what the marketplace, both in terms of goods and services and capital, is good at discerning. We don’t need the Meyersons of the world imposing some top-down mandate as to how capital and labor should be treated.
As a bond investor I tend to think that debt holders have a first call on earnings, or rather cash flows. So I’m not real happy with companies that shove money at their shareholders at the expense of their bondholders, all in the short sighted effort to puff up their stock price.
The chase for yield has virtually eliminated all bond covenants (restrictive provisions to protect bondholders) and most bonds are sold at the holding company level without any claim on the assets of the operating companies! At the operating level bank lines are generally senior and often secured by claims on assets – inventory, receivables, equipment, etc.
So bond holders are just fixed rate senior equity holders with no upside! The best you can do is get your principal back with interest!
a 40 yr, FI manger with primarily equities!
I don’t know who thinks this is groundbreaking news. We only need to look at the gradual increase in leverage (debt/tangible net worth) over the last 4 decades.
Still, any bank must maintain a level of spending to maintain its income. Wells Fargo proved in the 1990s that simply cutting costs to please shareholders at the expense of income, i.e. customer attrition, was a losing proposition.
Sorry, oy, bond holders have no right to a call on earnings. Bonds are formal debt instruments with a set repayment schedule. So long as the borrower meets the covenants of the bond instrument, you are repaid with interest. It would be as silly to tell a bank borrower that he has to pay back his loan early, even if he is not in default.
I do not think we need economists or pundits telling companies how to allocate capital, but I do believe that many management teams and boards of directors do a poor job of allocating capital. Many share buybacks are enacted by management teams with the acquiescence of boards for the sole purpose of offsetting options granted to management or to help management hit EPS growth targets not otherwise achievable by organic growth. In addition, many buybacks are made irrespective of the price / valuation of a company’s stock — in other words, managements tend to buy high and sell (issue) low. These buybacks tend to destroy shareholder value and are dilutive to tangible book value per share, especially for banks.
What Harold Myerson sees as a deterioration in the US capitalist system is actually an improvement. Granting he and Prof. Lazonick their thesis that companies used to retain more earnings than they do today, I would argue that this change is an improvement. Instead of relying on existing companies — and their oft-mediocre managers — to determine how excess capital should be used, we now return that capital to the marketplace where, on average, it is invested in newer companies with better products that create new jobs and enhance the standard of living. I call that an improvement.
Amen
right on Randall
Hmmm Lets say a company found the cure to cancer, a miracle right. I am sure they would invest everything they have to produce it at any cost to be profitable. Please Hal Myerson is a clown. Who is John Galt?
Just try to take his tenure away!! It is a huge cost of the ever higher cost of education and we could get it done cheaper!!
Put his income at risk if he no longer produces!
The HBR article also identifies taxpayers as having claim on the earnings rather than shareholders…
what’s your point? you certainly don’t provide any substantiation.
you don’t address the key issue, that salaries are trending down as a percentage of production and this isn’t a sustainable trend. what was fair in 1980 is more than fair today. what determines fair? in a free market, the people with the most money win. temporarily.
what the ‘pundits’ and the ‘economists’ are saying, you are missing because you seem to have the purview of a field mouse and the IQ of a squirrel, despite a nice portfolio.
in 1980 salaries were about 55% of GDP. today they are about 45%. in 2030 if they are 35% who’s going to frequent your business?
sure, line your own pockets now–i do, but don’t forget where this is going. if you let it runs it’s natural Adam Smith free hand of economics course, you’ll find yourself, or your children–if your lucky, decapitated, pitchforked or hung by your thumbs.
Happy go lucky ‘merican capitalism doesn’t get you anywhere good.
Pay the middle class, so they don’t become poor, and stop participating in the economy.
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