Time to curb the counterproductive mis-incentives of share buybacks (again)

In 1982 the U.S. Securities and Exchange Commission (financial firm controlled) used Rule 10b-18 to legalize large-scale buybacks so long as they did not exceed 25% of a company’s average daily trading volume over the previous four weeks. Previously the limit had been 15%. See: Share buybacks let income inequality grow, for an excellent summary of how the counterproductive short-term obsession with share buybacks has enriched executive pay scales beyond reason while stagnating meaningful investment and innovation. Talk about a dumb incentive system.

“A new research paper written by William Lazonick of the University of Massachusetts Lowell, which will be presented at the conference of the Institute of New Economic Thinking in Toronto on April 10 to 12, noted that in 2012, the 500 highest-paid executives in the United States received an average pay of $24.4-million (U.S.) – 52 per cent from stock options and 26 per cent from stock awards.

“The more one delves into the reasons for the huge increase in open-market [share] repurchase since the mid-1980s, the clearer it becomes that the only plausible reason for this mode of resource allocation is that the very executives who make the buyback decisions have much to gain personally through their stock-based pay,” Mr. Lazonick said.

As executive pay soared, workers’ wages stagnated when measured against productivity gains. Between 1948 and 1983, when regulations severely limited the size of buybacks, real compensation per hour and gains in productivity per hour closely tracked one other. That’s no longer the case. In the early 1980s, a significant gap between productivity and wages emerged and kept getting wider…

The rule was a godsend to stock-based pay, and buybacks climbed. Between 2001 and 2012, the S&P 500 companies spent an astounding $3.5-trillion on buybacks, an average of $600-million per company per year (perversely, the buybacks peaked in 2007, the pre-crash year, destroying the boardroom argument that buybacks were launched because executives believed their companies’ shares were fundamentally undervalued).

Some companies practised the art with abandon. Exxon Mobil spent $207-billion buying back shares between 2003 and 2012, equivalent to 60 per cent of its profit over those years. Cisco Systems and Hewlett-Packard spend more than 100 per cent of their profit on buybacks. Canada’s BlackBerry and Finland’s Nokia launched huge buybacks even as their market shares were collapsing. Imagine if they had devoted those fortunes to innovation instead?”

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