And in Mazzuacato's book, she constantly refers to share buyback programs and how revenues that could be used for R&D and other activities to fuel innovation are being absorbed by these programs. This got me curious about what exactly a share buyback program is and why its significant to know about them -- especially in the context of understanding innovation ecosystems and the misleading rhetoric used to describe the role of large corporations. After reading Profits without Prosperity by William Lazonick in the Harvard Business Review, I found out that from 2003-2012, 54% of profits from fortune 500 companies —a total of $2.4 trillion—was used buy back their own stock and an additional 37% of their earnings was used to pay dividends to shareholders. That's 81% of profits not used for R&D and/or as Lazonick points out, productive activities like higher-incomes for employees.
Why do they do this? While Lazonick points out a few reasons -- like trying to signal confidence to a speculative market -- I think the most plausible and simple reason is that stock-based returns make up the majority of a senior executives pay and buybacks drive up stock prices (temporarily). Of the 500 highest paid executives, 42% of their compensation comes from stock options and 41% from stock awards, according to Lazonick.
How does it work? Imagine Company L has 1000 shares and the company earned $1000 this year. That means everyone shareholder will get $1. Now, if this company decided to buyback 500 shares, the earning per share (EPS) will be $2 (1000/500). That's a 200% increase in return by just purchasing half of the stock on the market. This is an extreme example, but it illustrates the point and as Lazonick points out, companies have been allowed to repurchase their shares on the open market with virtually no regulatory limits since 1982.
I hope this sheds a little light on the financial incentive for large corporations to use the "retain-and-reinvest approach" rather than investing in R&D and productive activities for workers. This is why increasingly, companies in industries like biotechnology and pharmaceuticals are leaning on government research labs to find the next 'big idea' to commercialize. And its important to acknowledge that in order to appreciate the role the public sector plays in our innovation ecosystems.
Yes, it seems like a 'trick' in some ways. Inflate shrare prices by reducing the amount available on the market. Companies do it frequently, sometimes if they feel the company is undervalued. Other times for tax reasons, or to increase shareholder value as you indicate. It's a balancing act I think...no profits, no shareholders, then no company eventually.
ReplyDeleteEven APPLE is into the practice
http://www.cbc.ca/news/business/apple-buys-back-14b-us-of-own-stock-1.2527425
This is an interesting concept. From the way you've described them "share buy backs" definitely appear like a way for companies to avoid regulations while increasing the value of their shares. In doing so companies are also increasing their ownership, even if their business see's zero growth.
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