1982: E.T., My Little Pony, & Stock Buybacks

What were you doing in 1982? E.T. was the #1 movie at the box office, Olivia Newton-John had the #1 billboard song, “Physical,” and My Little Pony was the #1 Christmas gift.

Looking back, we were all clueless.

For in 1982 something far more diabolical was going on.  1982 ushered in full-scale the “trickle-down theory” of economics, brought to us by President Reagan. Under this now debunked theory, tax cuts and deregulation favoring the rich and corporate interests, would also be a windfall for those at the bottom of the economic spectrum under the notion the largesse would “trickle down.”

A key part of implementing “trickle-down” was changing the rules.  In 1982, the SEC instituted Rule 10b-18 of the Securities Exchange Act. Harvard Business Review author, and Professor of Economics, William Lazonick, explained what the rule did:

“Under the rule, a corporation’s board of directors can authorize senior executives to repurchase up to a certain amount of stock over a specified or open-ended period of time, and the company must publicly announce the buyback program. After that, management can buy a large number of a company’s shares on any given business day without fear that the SEC will charge it with stock manipulation.”

Essentially the rule gave companies the ability to make money without selling anything or investing in anything, in essence, defying a fundamental principle of capitalism: the need to create value in order to make money.

Today, instead of producing goods and services consumers want to buy, or investing in research and development to create new products, companies buy back their own stock to inflate their share price and lavishly reward executives whose compensation is tied to share price.

In December, Reuters ran a three-part series on “The Cannibalized Company,” chronicling the rise of share buybacks. Reuters looked at 3,297 publicly-traded non-financial U.S. companies and found that 60% engaged in buying their own shares back. In fact, Reuters reported:

“In fiscal 2014, spending on buybacks and dividends surpassed the companies’ combined net income for the first time outside of a recessionary period, and continued to climb for the 613 companies that have already reported for fiscal 2015.”

Why does it matter?

Aside from stifling innovation and slowing growth, share buybacks contribute substantially to income inequality.

The primary beneficiaries of stock buybacks, apart from shareholders, are executives whose compensation is often tied to Earnings Per Share (EPS). Stock buybacks are a handy way for these executives to artificially lift EPS for the short-term. Quite often quarterly bonuses for executives will be tied to hitting a pre-determined EPS. So even when quarterly income falls below expectations, executives have share buybacks in their toolbox for manipulating EPS and rewarding themselves with bonuses.

Who pays?

Middle-class workers pay dearly for this practice. Often a stock buyback plan that enriches an executive will be followed by an announcement of lay-offs. When companies do not make capital spending decisions for long-term growth, there are fewer good-paying jobs for middle-class workers.

What can be done?

Efforts by Democrat senators Elizabeth Warren and Tammy Baldwin are underway to investigate if the SEC can treat buybacks as a potential form of market manipulation. A number of presidential candidates have made reforming executive compensation packages key parts of their platforms too.

When executives use stock repurchases to reward themselves, without any thought for the long-term health of their company or their employees, something has gone terribly wrong.

President Obama agrees: “Reality has rendered its judgement, trickle-down economics does not work and middle-class economics does.”