The 1980s were a tipping point for economic inequality. Up to that point, there had been a fair distribution of the wealth that the workers of a nation created. On a single salary, an average family could afford a modest home and a car.
But since the 1980s, although worker productivity increased and corporate profits increased, worker pay stagnated. Yet the value of capital, which includes houses, increased. Headlines continuously blare how a smaller and smaller group control a larger and larger share of the wealth in the country. Workers can’t afford houses, and many can’t pay rent.
One of the prime methods for the upward transfer of wealth has been the share buyback.
Why Are They So Popular?
In the 1990s a significant number of voters were outraged over the increasing gap between executive pay and worker pay. Traditionally, it had been 20 to 1, but it was reaching 100 to 1 (now 300:1). Bill Clinton as part of his ‘Putting People First’ campaign promised to reign it in.
Clinton’s policy is a good lesson in how this, as well as other, attempts to end inequality are based on a complete misunderstanding of how the relevant systems work — and a naivety about human nature.
Clinton’s solution: only allow a corporation to deduct $1 million in executive pay from its income tax. But then Treasury Secretary, Robert Rubin (an ex CEO of Goldman Sachs) said there should be an exemption — read loophole — for performance pay. A corporation could pay its executives in stock and that could be deducted from its income tax. The skin-in-the-game reasoning being that the executives would want to earn the highest profit to get the better value for their stock.
So, let’s see what happened. The graph below shows that CEO pay was slowly increasing until the Clinton reform in 1993; then in the following year it skyrocketed.
Now, this compensation was mostly in shares, mountains of them. How were the executives going to turn them into cash?
Insider Trading Permitted
We all know the danger of insider trading. Insiders can manipulate their companies’ financial statements. An easy example is to defer some expenses so the results in that quarter will artificially be higher.Thus, corporations were once completely prohibited from buying executive shares. Executives could sell on the open market only.
However, in 1982, during the Reagan government-is-the-problem era, the SEC passed a ‘safe harbour’ regulation allowing a corporation to buy executive shares if they met four conditions. The conditions are nearly impossible to understand and actually impossible to police. Then SEC Chair, Mary Jo White, admitted that the SEC could not monitor corporate buybacks of executive shares.
And there is strong evidence that the stock prices are being manipulated so the corporations buy executive shares above the true market price.
In an article for the 2014 Harvard Business Review entitled Profits Without Prosperity, economist William Lazonick explained that, contrary to the interests of the corporation, stock buybacks were done when the stock price was high. The reason in Lazonick’s words: “Because stock-based instruments make up the majority of executives’ pay, and buybacks drive up short-term stock prices.” He confirms his investigations found these firms are engaged in “what is effectively stock-price manipulation.”
Less you think that this is an opinion only held on the left, Trump appointee, SEC Commissioner Robert J. Jackson, also studied corporate purchases of executive shares and concluded that there was price manipulation for the benefit of the executives: “Thus, executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement . . .”
How Buybacks Enable Economic Inequality
Economist Thomas Piketty stunned the reading world with a best-selling book on the dull subject, economics. His Capitalism in the 21st-Century identified executive pay as a prime mechanism for the upper transfer of wealth since the 1980s. As shown above, the buyback has been an important tool in that mechanism to convert shares to cash.
It is relevant to remember that the richest 10% of Americans now own 84% of all stocks; and almost half of all Americans own zero stocks. The poorest Americans and the youngest Americans are almost entirely frozen out of the stock market entirely.
Economist Corrado Gini developed a formula for measuring economic inequality that is called the Gini coefficient. Look at the development of inequality in the graph below from 1980 and see how it tracks with the increasing CEO pay in the graph above.
Ineffective Reforms (Again)
An additional carrot for the executives and other shareholders: buybacks are taxed less than if the profit was distributed by dividend. For an excellent geek level explanation see Joe Hughes writing for the Institute on Taxation and Economic Policy.
The current proposals to reign in buybacks focusses on a transaction tax on buybacks, so that the tax on buybacks would come closer to the tax on dividends. But as Hughes points out there has been a 1% tax transaction tax since January 2023 under the Inflation Reduction Act, and it’s not slowing the buybacks down at all. “Despite the excise tax taking effect on January 1st, it does not appear that buybacks are slowing. In fact, the early evidence looks like 2023 could be another marquee year for buybacks”.
Hughes believes the excise tax on buybacks would need to be approximately 10 to 12 percent so that buybacks were taxed the same as dividends (tax parity).
This will raise tax revenue of an estimated $237 billion, very welcome, but do nothing to stop the buybacks. This reform is focusing on a secondary aspect. Executives are not going to stop having the corporation buy their shares even if the tax were the same as if the money was paid out by dividends. There are other benefits to the buyback: executives will still get the cash for their shares and at a peak value; the fewer shares in the market, the higher the value of the remaining shares.
Note, that in 2017 Congress removed that exception for performance pay so that all pay above $1 million would not be tax deductible. According to a study by Lisa De Simone, Charles McClure, and Bridget Stomberg in Contemporary Accounting Research, that removal did nothing to stop the skyrocketing executive pay. Another naïve assumption: that the executives care about how much tax a company will pay on their dazzling compensation. And that major shareholders care. Money managers for equity/hedge funds and pension funds don’t care about outrageous executive pay as long as those executive strip out all possible profit in buybacks and dividends to pad the money managers own lucrative commissions.
The first reform should be to eliminate insider trading and prohibit the corporation from purchasing executive shares. But the other equally or more important concern is that, more of this profit be shared with the workers whose labor has produced it — just as it was in the past.
Sarah Anderson, Sam Pizzigati and Brian Wakamo, writing for The Institute for Policy Studies, noted that with the Lowe’s buyback of $13 billion last year, the company could have given each of its 325,000 employees $40,000. Instead, worker median pay fell 7.6 percent to $22,697.
And note that paying the buyback amount to the workers would not decrease the share dividends. In the year of that buyback, according to analyst Mark Roussin, Lowes increased its dividend.
But, at present, there is no consciousness in the voting public that a greater share of corporate profits could easily be given to workers without raising prices or affecting lucrative dividends—and so make America fair again.
Acknowledgements: Header image by Gerd Altman from pixabay
CEO pay and Gini Coefficient graphs: Economic Policy Institute
Jan D. Weir is a retired trial lawyer who has advised international corporations, banks, accounting firms and Lloyds of London that insured auditors. He has taught business law at the University of Toronto, and is the co-author of a text on business law (available on KOBO). He discusses how the superrich have been using unrecognized methods for the upward transfer of wealth since the 1980s in the tax, corporate and banking areas on https://janweirlaw.medium.com/, and Twitter@JanWeirLaw.