All this neoliberal talk about "maximizing shareholder value" is designed to hide a redistribution
mechanism of wealth up. Which is the essence of neoliberalism. It's all about executive
pay. “Shareholder value” is nothing then a ruse for getting outsize bonuses but top execs. Stock buybacks
is a form of asset-stripping, similar to one practiced by buyout sharks, but practiced by internal management
team. Who cares if the company will be destroyed if you have a golden parachute ?
By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist,
and author, with extensive international work experience. Originally published at
Magic trick turns into toxic mix.
Stocks have been on a tear to nowhere this year. Now investors are praying for a Santa rally to
pull them out of the mire. They're counting on desperate amounts of share buybacks that companies
fund by loading up on debt. But the magic trick that had performed miracles over the past few years
And there's a reason.
IBM has blown $125 billion on buybacks since 2005, more than the $111 billion it invested
in capital expenditures and R&D. It's staggering under its debt, while revenues have been declining
for 14 quarters in a row. It cut its workforce by 55,000 people since 2012. And its stock is
down 38% since March 2013.
Big-pharma icon Pfizer plowed $139 billion into buybacks and dividends in the past decade,
compared to $82 billion in R&D and $18 billion in capital spending. 3M spent $48 billion on buybacks
and dividends, and $30 billion on R&D and capital expenditures. They're all doing it.
"Activist investors" – hedge funds – have been clamoring for it. An investigative report by Reuters,
The Cannibalized Company, lined some of them up:
In March, General Motors Co acceded to a $5 billion share buyback to satisfy investor Harry
Wilson. He had threatened a proxy fight if the auto maker didn't distribute some of the $25 billion
cash hoard it had built up after emerging from bankruptcy just a few years earlier.
DuPont early this year announced a $4 billion buyback program – on top of a $5 billion program
announced a year earlier – to beat back activist investor Nelson Peltz's Trian Fund Management,
which was seeking four board seats to get its way.
In March, Qualcomm Inc., under pressure from hedge fund Jana Partners, agreed to boost its
program to purchase $10 billion of its shares over the next 12 months; the company already had
an existing $7.8 billion buyback program and a commitment to return three quarters of its free
cash flow to shareholders.
And in July, Qualcomm announced 5,000 layoffs. It's hard to innovate when you're trying to please
a hedge fund.
CEOs with a long-term outlook and a focus on innovation and investment, rather than financial
engineering, come under intense pressure.
"None of it is optional; if you ignore them, you go away," Russ Daniels, a tech executive with
15 years at Apple and 13 years at HP, told Reuters. "It's all just resource allocation," he said.
"The situation right now is there are a lot of investors who believe that they can make a better
decision about how to apply that resource than the management of the business can."
Nearly 60% of the 3,297 publicly traded non-financial US companies Reuters analyzed have engaged
in share buybacks since 2010. Last year, the money spent on buybacks and dividends exceeded net income
for the first time in a non-recession period.
This year, for the 613 companies that have reported earnings for fiscal 2015, share buybacks hit
a record $520 billion. They also paid $365 billion in dividends, for a total of $885 billion, against
their combined net income of $847 billion.
Buybacks and dividends amount to 113% of capital spending among companies that have repurchased
shares since 2010, up from 60% in 2000 and from 38% in 1990. Corporate investment is normally a big
driver in a recovery. Not this time! Hence the lousy recovery.
Financial engineering takes precedence over actual engineering in the minds of CEOs and CFOs.
A company buying its own shares creates additional demand for those shares. It's supposed to drive
up the share price. The hoopla surrounding buyback announcements drives up prices too. Buybacks also
reduce the number of outstanding shares, thus increase the earnings per share, even when net income
"Serving customers, creating innovative new products, employing workers, taking care of the
environment … are NOT the objectives of firms," sais Itzhak Ben-David, a finance professor of
Ohio State University, a buyback proponent, according to Reuters. "These are components in the
process that have the goal of maximizing shareholders' value."
But when companies load up on debt to fund buybacks while slashing investment in productive
activities and innovation, it has consequences for revenues down the road. And now that magic trick
to increase shareholder value has become a toxic mix. Shares of buyback queens are getting hammered.
Citigroup credit analysts looked into the extent to which this is happening – and why. Christine
Hughes, Chief Investment Strategist at
OtterWood Capital, summarized the Citi report this way: "This dynamic of borrowing from
bondholders to pay shareholders may be coming to an end…."
Their chart (via OtterWood Capital) shows that about half of the cumulative outperformance of
these buyback queens from 2012 through 2014 has been frittered away this year, as their shares, IBM-like,
Mbuna, November 21, 2015 at 7:31 am
Me thinks Wolf is slightly barking up the wrong tree here. What needs to be looked at is how
buy backs affect executive pay. "Shareholder value" is more often than not a ruse?
ng, November 21, 2015 at 8:58 am
probably, in some or most cases, but the effect on the stock is the same.
Alejandro, November 21, 2015 at 9:19 am
Interesting that you mention ruse, relating to "buy-backs"…from my POV, it seems like they've
legalized insider trading or engineered (a) loophole(s).
On a somewhat related perspective on subterfuge. The language of "affordability" has proven
to be insidiously clever. Not only does it reinforce and perpetuate the myth of "deserts", but
camouflages the means of embezzling the means of distribution. Isn't distribution, really, the
only rational purpose of finance, i.e., as a means of distribution as opposed to a means of embezzlement?
Jim, November 21, 2015 at 10:42 am
More nuance and less dogma please. The dogmatic tone really hurts what could otherwise be a
fine but more-qualified position.
"Results of all this financial engineering? Revenues of the S&P 500 companies are falling
for the fourth quarter in a row – the worst such spell since the Financial Crisis."
Eh, no. No question that buybacks *can* be asset-stripping and often are, but unless you
tie capital allocation decisions closer to investment in the business such that they're mutually
exclusive, this is specious and a reach. No one invests if they can't see the return. It would
be just as easy to say that they're buying back stock because revenue is slipping and they have
no other investment opportunities.
Revenues are falling in large part because these largest companies derive an ABSOLUTELY HUGE
portion of their business overseas and the dollar has been ridiculously strong in the last 12-15
months. Rates are poised to rise, and the easy Fed-inspired rate arbitrage vis a vis stocks and
"risk on" trade are closing. How about a little more context instead of just dogma?
John Malone made a career out of financial engineering, something like 30% annual returns for
the 25 years of his CEO tenure at TCI. Buybacks were a huge part of that.
Perhaps an analysis of the monopolistic positions of so many American businesses that allow
them the wherewithal to underinvest and still buy back huge amounts of stock? If we had a more
competitive economy, companies would have less ability to underinvest. Ultimately, I think buybacks
are more a result than a cause of dysfunction, but certainly not always bad.
NeqNeq, November 21, 2015 at 11:44 am
One aspect that Reuters piece mentions, but glosses over with a single paragraph buried
in the middle, is the fact that for many companies there are no ( or few) reasons to spend money
in other ways. If capex/r&d doesn't give you much return, why not buy out the shareholders who
are least interested in holding your stock?
Dumping cash into plants only makes sense in the places where the market is growing. For many
years that has meant Asia (China). For example, Apple gets 66% (iirc) of revenue from Asia, and
that is where they have continued investing in growth. If demand is slowing and costs are rising,
and it looks like both are true, why would you put even more money in?
Dumping money into R&D is always risky, although different industries have different levels,
and the "do it in-house" risk must be weighed against the costs of buying up companies with "proven"
technologies. Thus, R&D cash is hidden inside M&A. M&A is up 2-3 years in a row.
Normally when I come across an important piece, I put it in Links and instruct readers accordingly.
Lambert and Mike B pinged me about a new Bob Cringley piece,
The U.S. computer industry is dying and I'll tell you exactly who is killing it and why, which
makes such a powerful and compact statement of how American management has become virtually incapable
of building successful, durable enterprises that I wanted to make sure I did what I could to help
make sure it gets the attention it warrants.
Larry Headlund, June 25, 2015 at 10:19 am
And what is the cause of the boom-bust cycle?
Back when I studied control theory you would expect to see oscillations in a complex system with
feedback, usually unstable oscillations which would eventually lead to self destruction. This
was especially true when there was a delay in the feedback, as in most real world situations.
It is not booms and busts (oscillations) which cry out for an explanation. The absence of booms
and busts is what would be remarkable.
John Smith, June 25, 2015 at 10:34 am
"The absence of booms and busts is what would be remarkable."
Good point. The question is then: Why does the US (more dangerously, the entire world) have nation(world)wide,
synchronized boom-bust cycles?
Art Eclectic, June 25, 2015 at 11:37 am
Because gambling is an addiction. Boom and bust cycles are just gambling. As soon as the players
zero in on a table that looks hot or a machine that's paying out, they all flock in. It's a clear
pattern and the smart ones know how to ride the wave up and get out once the little old ladies
are seated and ready to play.
Fool, June 25, 2015 at 11:39 am
So then is it still gambling if you know you're gonna win?
NoFreeWill, June 25, 2015 at 5:01 pm
Because Capitalism is inherently an unstable system. Can lead to overproduction (or financial
bubbles) and many other causes of crisis. Read Marx.
Larry Headlund, June 25, 2015 at 5:31 pm
Because the US (and increasingly the entire world) are getting more connected. Sometimes making
a sytem bigger or connecting disparate parts damps down oscillations. Sometimes the connected
systems will increase (pump) each others oscillations.
Note we had frequent worldwide (more or less) panics pre-WWI, the previous high point of globalization.
Demeter, June 25, 2015 at 8:23 pm
That's the symptom of positive feedback in a closely coupled system (like having the microphone
too close to the speaker).
Good way to break the machine and ones eardrums….
Synoia, June 25, 2015 at 4:18 pm
The control theory you (and I studied) did not involve non-linear feedback, the feedback inherent
in chaotic systems.
"non-linearity" in system changes everything.
Christer Kamb, June 26, 2015 at 8:38 am
Expanding money supply(Mx) by banks is not really elastic money in it´s ordinary meaning.
Newly created central bank money is. I guess you talk about new debt?
I could think the closest definition of elastic money in the corporate world is when companies
buy another company by paying with their own highly valued stock. But it´s still not true.
I think the boom-bust cycle is a free market(or badly regulated) business-cycle which not always
is dependent on overindebtness. It´s more about man´s optimism transforming to overoptimism.
But when the banking sector becomes an unregulated "shareholder maximizer" then things easily
get out of hand re-inforcing the boom-bust cycle.
ArkansasAngie, June 25, 2015 at 7:10 am
I would argue that the problem is that people running companies are not owners. They are employees
and their interests are not the same as owners. This causes a short term attitude.
The company … the asset … isn't maximized over the long term.
An owner takes care of their asset. They don't put their asset in jeopardy. They don't steal from
the asset because they don't steal from themselves. And when someone else misbehaves there is
no one there to say "no" not with my asset you don't.
For me this is caused by financialization of company ownership. Individuals don't own enough of
a company to have power or a sense of ownership.
diptherio, June 25, 2015 at 9:18 am
Hence, the worker cooperative ownership structure. Equal Exchange, one of our biggest, just
got done with a $4.1 million class B stock sale. Here's the details on how they did that ethically:
How Equal Exchange Aligns Capital with Mission.
Adam Eran, June 25, 2015 at 12:18 pm
There's a movement for that: Coops. See 1worker1vote.org/
Drew, June 25, 2015 at 7:26 am
Even if the duty of the board and the officers is to the corporation itself, they are still
elected solely by the shareholders. Expecting the officers and directors to serve anyone else's
interests is foolish.
Yves Smith, June 25, 2015 at 7:45 am
Under the law, board members have a duty of loyalty and care to the corporation, not the shareholders.
Officers are not hired by the shareholders except in small, closely held corporations. And your
view is contradicted by the fact that until the Jensen/Mickelberg thesis became popular, the view
in executive suites all over America was that they had to consider their duties to all of their
stakeholders, including employees, communities, and customers.
Limited liability share corporations are normal in the rest of the world, and you will find
in almost all societies, save the UK, where the US model has taken hold. that they also view corporate
board and offices as having to consider the interests of multiple constituencies. In Japan, employment
is considered to be the most important duty of a company.
In China, I have heard of owner-controlled companies taking insufficiently profitable orders
from WalMart because they had a social duty to maintain employment. The US view is extreme and
eccentric by global standards, as well as a historical anomaly.
Mbuna, June 25, 2015 at 9:16 am
Fool, June 25, 2015 at 11:05 am
This question arises in my mind- How much of this "enhancing shareholder value" is now
just a smokescreen for the executive class to enhance their salaries? Even if this started off
as an academic exercise that caught on, do all these executives really still believe this? Or
are they just saying so in front of the cameras while they knowingly are lining their pockets
on the way to the bank? I tend to think the latter is the case because I can't believe they are
all that shallow and naive.
Mbuna - It is entirely a smokescreen.
swendr, June 25, 2015 at 4:20 pm
I think you're over-simplifying the matter. Sure, for a few psychopaths, it's a smokescreen. For
many others, it's just the accepted norm. They probably never thought much about it except that
it's one of the tough realities facing executives today.
Brooklin Bridge, June 25, 2015 at 6:03 pm
I recently listened to an interview with Stephen Kotkin about his book Stalin. One of the interesting
observations he made was that the communists of Stalin's era, behind closed doors, talked exactly
like they did in their propaganda. In other words, contrary to what many in the West thought,
they actually believed their rhetoric. It is entirely possible to believe in something and act
on it with integrity only to have things go horribly wrong.
Fool, June 25, 2015 at 11:02 am
I know at least one who is quite bright and yet who fully buys into that nonsense. We are talking
about very large egos here. Also, there is no doubt that some of them have reasonable skills and
this helps to support at least the launch pad of the illusion. The only thing that can keep up
(for the most part) unquestioning faith with the truly orbital extent of the fantasy is ego combined
By in large, I think one would be amazed at how many CEO's swallow the skills-match-the-staggering-pay+bonuses
meme hook line and stinker.
…the view in executive suites all over America was that they had to consider their duties
to all of their stakeholders, including employees, communities, and customers.
Oh please. Evidence? That sounds more like what they may have told their shareholders when
Carl Icahn wanted board seats. (Also who are you referring to? I though "executive suites" refers
to Management though the rest of your point seems to be about directors…)...
Yves Smith, June 26, 2015 at 5:33 am
Fool, June 26, 2015 at 11:47 am
The onus is on YOU to provide evidence. Cringley himself is a source. I've cited scholarly
papers like Corporate Malfeasance and the Myth of Shareholder Value (
) as well as Private Equity at Work, which separately has citations of its own. This is a theory
made up by economists that is happily parroted by the media.
"Shareholder Value" isn't merely "a theory made up by economists," if for the very fact of its
actual, real-world embrace by the corporate establishment.
Christer Kamb, June 26, 2015 at 8:49 am
Today, unless you're Mark Zuckerberg
and can go public while retaining virtually all governing authority, when you sell your company
to the public, you'd better be satisfying your shareholders, or else. That's the world we live
in - for better or for worse - but it's hardly a "myth".
Personally, I believe it's sinful how much CEO's get paid, but at the end of the day, true
corporate democracy - and with that a democratization of wealth - isn't impossible so I'm all
for empowering the shareholders. Indeed, shareholders can vote on executive compensation; is the
fact that they enable outrageous pay packages not more a reflection of our society's values than
it is, say, the undeserved influence of Michael Jensen?
Dobbin's paper is good - though I feel he underestimates the extent to which the lawyers, bankers,
lobbyists, etc. were behind all this. I mean, WLRK was legally structuring incentives for executives
to put their companies in play (viz. golden parachutes, stock-based comp, etc.) while at the same
time decrying acquirers as Bad for America, or whatever. (In other words, what was supposedly
"Bad for America" was, to such discontents, good for business). At the end of the day, acquirers
and targets and friends all got rich. Labor, needless to say, did not.
My point is that blaming a Michael Jensen for the degeneration of American capitalist values
falls short of the bigger picture, which transcends any singular person or occupation. As the
"Bad Man of Private Equity" shows, the incentives of the system (taxes, regulations, etc.) practically
encourage greed, a demoralization of law, and a degeneration of the American laborer. With that
in mind, a more democratized market - of democratically governed companies that are subject to
democratically conceived regulation - can underlie an empowerment of public-market shareholders
(of the people).
PS: Cringley? Really? The self-proclaimed "sex symbol, airplane enthusiast and adventurer [who]
continues to write about personal computers and has an active consulting business in Silicon Valley,
selling his cybersoul to the highest bidder"…
Yves wrote "Officers are not hired by the shareholders"
MartyH, June 25, 2015 at 7:33 am
I guess CEO´s are. The board decides
to fire one and recruit another.
The CEO is managing the shareholder´s(majority) strategy. A strategy that CEO´s develop to
get acceptance from the board.
Unfortunately shareholder-majority today involves public stockfunds demanding fast profits
and soaring stockprices.
Cringely is an observer/analyst with a good eye. Where he errs, it is because he isn't actually
in the conversations, meetings, email-flow so he has to interpret from subsequent history. His
recent book on IBM, was painful to me as one who lived it from the inside for a couple of decades.
I'm still in the industry and working with the people he's analyzing. On balance, he's right.
There is a thread of work emerging that says "Financialization is Bad for your economy's health."
Cringely points out that "Financialization" (the running of a business by the accountants and
bankers) is bad for actually operating a business that isn't a financial institution. By extension,
start-ups that mortgage their futures by eliciting and getting big initial Venture Capital cash
infusions gives the VCs the chance to start maximizing financial benefits from a very early stage.
I guess it's a Feature, not a defect.
TheCatSaid, June 25, 2015 at 2:25 pm
Yes, and I've been told that some governments and their enterprise-supporting departments
or semi-state bodies have this as an unspoken agenda–while supposedly promoting "innovation",
they are really promoting financialization, including young companies.
Organic growth is not sufficiently "interesting" or "viable"; companies are encouraged to "think
big" and "go for export" regardless of whether the timing is appropriate or not. This "thinking
big" of course requires lots of outside capital, which coincidentally comes with multiple strings
attached that allow the financial middlemen to do very well indeed. The target company, not so
Eric Patton, June 25, 2015 at 8:25 am
Cringley points out that there were plenty of other remedies for the problem that Jensen and
Meckling were pretending to solve, that the interests of managers and shareholders weren't aligned
Nor are the interests of workers and managers aligned. There are three classes, not two. There
are owners, workers, and coordinators - managers - not just owners and workers.
marco, June 25, 2015 at 8:26 am
As a software developer with 15 years in industry, Cringley's comments regarding off-shoring
and the signal it sends to remaining technical staff are spot on. At my last contract (healthcare
software company) they off-shored about 40% of the IT staff to South Asia over the course of 2
years. They also laid off 4 of 8 program managers with team leads basically taking up the slack
(without a promotion, pay increase or even a pitiful change in title).
A former colleague still working there told me the atmosphere is toxic, fear-based and adversarial
even among lower level staff…utterly depressing.
alex morfesis, June 25, 2015 at 9:22 am
passing on v-capital…
as cringley rightly points out…one of the main problems today is the designed for failure aahhrssezz
running most (tech) businesses today…but anyone who looks for fast and furious v – cap bux is
probably not too bright to begin with…the next wave of tech or other start ups will avoid venture
money…just by working around the issues.
wanted: stealth startup looking for partners who can put in 5 to 10 hours per week for 18 months…also
looking for sales staff…retirees over 67 preferred…multiple languages helpful…
there are plenty of very hungry securities attys for start ups who will work for gas money and
a piece of the deal…cpa's with pcaob designations not so much…
jonf, June 25, 2015 at 9:43 am
I was first introduced to the " maximize profit" meme back in the 90s. It became a big thing
in our company as our CEO fully embraced it. That was followed by programs to "improve the process",
aka reduce costs by eliminating jobs.
Executives, of course, were a different class and stock options became more plentiful. At the
annual review cycle we were forced to rank the staff, and those at the bottom joined the unemployed
at the next almost regularly scheduled layoff. And we did make more money, just not so much more
as to make any of it worthwhile. One thing some of us noticed was that we were not developing
new products or customers. (marketing development was not my favorite side of the business, but
it is necessary.) For a time we even went through a "new business development " cycle buying other
companies. But that failed, as the fools who ran the program were more interested in stock options
than a successful business.
Anyway, that gave way to the corporate raiders who figured out the company could make more
money for the owners if it were split up. We went through several of them. What now remains is
a shell and has been purchased by another smart guy. That shell is a mere shadow of its former
self. I pass the place every day and the cars in the parking lot are less than half they once
were and old friends have sad tales of old customers lost. Progress, I suppose.
Stephen Rhodes, June 25, 2015 at 10:26 am
Again, what do NC sophisticates think?
Cohan's Modest Proposal (Oct. 2010 NYT)
…We can't turn back the clock: Wall Street's big firms will never again be private partnerships.
Instead, I propose that each large Wall Street firm create a new security that represents - and
is secured by - the entire net worth of its 100 top executives. This security would be subordinated
to all other creditors as well as to all preferred and common shareholders; in other words, if
a firm goes bankrupt, this security is the first to be wiped out.
Had such a security existed at the time of the collapse of Lehman Brothers, the net worth of the
top 100 Lehman executives - no doubt totaling several billion dollars - would have been collected
after liquidating everything they owned and paid to Lehman creditors, who under the current system
will be lucky if they get back 10 cents on the dollar.
Wall Street's first reaction to this idea - aside from profanities - will be that it cannot possibly
be done. Or that it would somehow threaten the sanctity of our capital markets.
But, in fact, it can and should be done. Indeed, Wall Street has all the intellectual capital
it needs in its own archives to construct such a security: in the old partnership days every partner
signed an agreement requiring him (and rarely her) to put his net worth on the line every day.
Surely, clever Wall Street lawyers can draft a 21st-century version of the old partnership agreement…
Ivy, June 25, 2015 at 10:31 am
Anecdote: I worked for a company some years ago that practiced 'the customer comes first' and
had that in our DNA. The employees were focused on anticipating and meeting customer needs, and
were successful at executing that.
We got acquired and the new owners had a different philosophy. They subscribed to a decision-making
hierarchy that focused on owners, then vendors, then customers and lastly employees. What wasn't
shared with employees during the transition, but soon became apparent, was that the CEO leading
the new owners was getting incentive payments to slash and burn. The hierarchy had that little
exception for him. He ended up alienating vendors, customers and employees, and the business shrank.
Then he cashed out. The End. Except for the survivors, who continue to seek more fulfilling options.
Brooklin Bridge, June 25, 2015 at 10:47 am
In the early 90's, I worked for a computer company that had been taken over by a so called
"white knight" outfit but where the result was the same as if it had been taken over by the worst
corporate raider. For five years straight, they had lay-off after lay-off; always to maximize
profit (illegally on more than one occasion) and that made less and less sense internally. Toward
the end, they seemed to go berserk; for instance, one day they laid off the entire admin group
in one fell swoop leaving multiple buildings, each with multiple climate conditioned rooms full
of very expensive servers (for the time) simply running by the grace of what ever deity takes
care of those things.
All this caught up with them of course, though they couldn't have cared less. Word got out. Eventually,
no one in the industry worth anything would even accept to interview with the company, never mind
work for them. But the ceo and senior executives had long since fled with their piles of dough
to greener pastures where they could repeat the whole sequence. Incredibly ugly and scarring.
And yes, it was simply amazing how many times the ceo would use that phrase, maximizing profit
for the sacred "shareholders", to explain each and every insane dismantling of the company. It
got to be a joke about all the little old ladies with white sneakers who would be destitute if
upper management didn't continue the madness (which was more often than not for their own personal
Fool, June 25, 2015 at 11:12 am
I believe the semantical nuances distinguishing "white knights" from "corporate raiders" depended
on whether the bankers/lawyers with whom they had relationships worked with the target or the
acquirer (respectively). Your anecdote is instructive in that regard.
Brooklin Bridge, June 25, 2015 at 11:51 pm
Right, they fit the legal description of the white knight and the horror story behavior of
the dreaded corporate raider.
Fool, June 26, 2015 at 11:56 am
We live in an age in which people are called what they want to be called, e.g. Carl Icahn the
Activist, Michael Milken the Philanthropist; ["white knight" firm/corp] is a "strategic acquirer",
Bruce Jenner is Caitlyn Jenner….
Jazzbuff, June 25, 2015 at 11:55 am
I have been in the tech business for over 50 years and have watched the deterioration of quality
of service. I have seen fraud, blackmail, and kick-backs used to secure and retain business. There
is rampant manipulation of sales figures to show steady earnings growth to keep Wall Street happy.
The needs of the customer and quality of service delivery is an afterthought.
Min, June 25, 2015 at 1:04 pm
How did the idea of maximizing shareholder value get divorced from the idea of maximizing return
on investment? Maximizing return on investment and avoiding bankruptcy are not only compatible,
they are intrinsically linked. (See the Kelly criterion, for example.) If I am considering buying
shares in a company, I am definitely looking to maximize return on investment.
John Smith, June 25, 2015 at 6:48 pm
Not to play Devil's Advocate but isn't a leveraged buyback of a company's common stock an effective
"poison pill" strategy because it:
1) Decreases the number of outstanding shares at risk of being acquired in a hostile takeover
2) Decrease the attractiveness of the company by encumbering its assets with debt?
Thus preempting leveraged buyout attempts?
Note that the banking cartel, as is typical, thrives on the conflict or the threat thereof.
Doug, June 26, 2015 at 7:55 am
"Maximizing shareholder value" is one of several pernicious examples of single-answer fundamentalism.
Like it's twin - free market fundamentalism – it claims to answer any and all questions, challenge,
issues, problems and so forth. In this respect, it is no different from any other form of terrorism
- whether religious or racial or otherwise. True believers cannot see the world except through
this lens - and, as a consequence, have lost all power of critical thought and action.
washunate, June 26, 2015 at 8:03 am
I would bring a much more critical eye to that piece. First, the author confuses the basic
idea of running publicly traded organizations for the benefit of shareholders with the specific
tactic of giving management lots of stock options. The latter can be a bad operational move without
saying anything about the former.
Secondly, the author is making a huge unfounded claim that the U.S. computer industry is in trouble.
IT is one of the few places where the U.S. actually still has some influence in the world. IT
is one of the few places where significant numbers of workers actually make pretty decent wages.
Apple, Microsoft, Google, and others are major global players. Then there are the consulting firms
and smaller companies and so forth.
And what's gone wrong in IT is public policy, from intellectual property to spying on the planet.
January 8, 2015 |
Nothing will be better received by the economic elites than a theory that rationalizes and promotes
their self interest, and few theories have done so as well as the myth of "Shareholder Value."
Harold Meyerson summed the theory up succinctly:
"The idea that corporations exist to reward their shareholders arose not in a body of law but
from the work of ideologically driven economists. In 1970,Milton
Friedman wrote that business properly had but one goal: to maximize profits. The same year,
Friedman's University of Chicago colleague
argued that a corporation's share price was always the accurate reflection of the enterprise's
worth, an idea that trickled down into the belief that the proper goal of a corporation was to
boost its share value - particularly
most CEO salaries and bonuses became linked to that value." [WaPo]
The musings (or rationalizations if you will) of Friedman and Fama were expanded by Michael Jensen
and William Meckling in a 1976 Journal of Financial Economics article "Theory of the Firm:
Managerial Behavior, Agency Cost, and Ownership Structure," a long title for a short idea: Shareholder
post took a few swings at the Shareholder Value mythology, but the subject deserves a closer
First, there is no requirement in law which requires the management of an enterprise
to direct its focus toward Shareholder Value. None, zip, zero. [HarvardLawF]
So, why is the theory now treated as dogmatically as received wisdom?
Let's try one notion on for size – the theory is arithmetically convenient.
As a nation, we do love to count things. We'll even count the number of times we've counted things.
A posted price for a share of common stock is easy to recognize and count. It is what
the stock market for the day says it is. Arena Pharmaceuticals is selling for $5.12 today [YahooF]
There are some sticky questions we might ask, such as will the study of its autoimmune drug yield
an effective and profitable product? If the price of ARNA today is $5.12 per share does that
describe the value of the company? The Friedman/Fama profit motif combined with the
Shareholder Value Theory assumes that the price of the share x number of shares = the value of the
company. And, here's where things break down.
According to the vaunted "efficient market" theory the answer is Yes! The share price is a measure
of value - except when it isn't. On July 23, 2008 the closing price for Lehman Brothers was
$16.05 for 33,685 in share volume. Did that describe the value of the corporation? Or, should
we look at the stock price in September 22, 2008 when Lehman Brothers was closing at $0.23?
one of the flaws in the arithmetically convenient adoption of stock price as a measure of corporate
value is that if the corporation can't properly value its holdings then the price and the value aren't
coterminous. In English that would be: If the company can't value its assets properly then
why on God's Green Earth should we believe the stock price is anything other than guesswork
on the part of some investors?
Since the Shareholder Value Theory, although flawed, might be convenient it also appeals
to another notion worth exploring – the theory holds appeal for those who have short term
interest in market trading. Under all the fancy mathematics and all but impenetrable
jargon, the proponents of the Shareholder Value myth were alleging that since the price equated to
the value of the firm, then using the stock price as a measuring tool meant one could evaluate the
short term success of a company. Lovely, but that misses a few marks.
Secondly, under the older "retain and reinvest" or the "stakeholders" models
of corporate performance there were niches for thinking about long term corporate viability.
Was the company doing enough in terms of research and development? Was it investing in new plants
and equipment? Was it retaining and retraining its labor force? If "Engulf & Devour"
acquired some firms using leveraged buyouts and hostile takeovers in the heat of the 20th century
M&A boom, then what was to prevent the management from treating the newly acquired companies as little
more than paper in the portfolio? Share price moved the M&A, and share price would be the convenient
measure of the "value" of the company. What shareholder value was produced by, say, the Quaker
Oats takeover of Snapple? Or America Online with Time Warner? Or Sprint and Nextel? [Investopedia]
Instead of "stakeholders," management, labor, customers, etc. involved in the interests of the
corporation, the financial engineers became the model for corporate management. Thence, the
financial engineers became beholden to the financial Auspex. Roger Martin's book,
Fixing the Game, proposes two categories – the "real market," and the "expectations market."
The 'real' market includes the world in which factories are built and staffed, goods and services
are bought and sold, and revenue is earned and the bills are paid. The Expectations Market is another
world. In it the stock market via the analysts and rating services assess the real market activities
of the firm and based on that analysis makes prognostications about how the company will perform
in the future. Why would an executive go to all the trouble to improve real market performance in
the long run when simply raising short term expectations will do nicely? Who loves this short term
If you guessed Hedge Funds, take your seat at the head of the class. And, do the hedge fund
and private equity firms deliver on Shareholder Value? Not quite:
"…the most generous conclusion one may reach from these empirical studies has to be that "activist"
hedge funds create some short-term wealth for some shareholders as a result of investors who believe
hedge fund propaganda (and some academic studies), jumping in the stock of targeted companies.
In a minority of cases, activist hedge funds may bring some lasting value for shareholders but
largely at the expense of workers and bond holders; thus, the impact of activist hedge funds seems
to take the form of wealth transfer rather than wealth creation." [IOGPP
Note the last part? "Take the form of wealth transfer rather than wealth creation." What
have some of the more critical articles of the current economic situation been saying all along?
That in the matrix of Shareholder Value and Financialism, intensified by corporate compensation schemes,
and further abetted by hedge fund activism – we have transfers of wealth without the actual creation
of a better economy for everyone.
Finally, about all that can be said of the Shareholder Value Scam is that it
serves the purposes of those who have vested interests in stock market short-termism and volatility,
who have an interest in transferring rather than creating wealth, and who have a predilection for
espousing those theories which will make them feel better about the whole thing.
References and Recommended Reading: R. Straub, "Shareholder Value – A Theory that
changed the course of history – for the better or the worse,"
Drucker Society Europe, June,
2012. Jensen and Meckling, "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership
of Financial Economics, October 1976. (pdf) Lynn Stout, "The Shareholder Value Myth,"
Harvard Law School Forum, June 2012. Yves Smith, "Maximize Shareholder Value" Myth,
Naked Capitalism, May 2014. Diane E. Davis, "Political Power and Social Theory,"
MIT Cambridge, 2005. (pdf) Steve Denning, "The Origin of the World's Dumbest Idea: Milton
Forbes, June 2013. Steve Denning, The Dumbest Idea in the World,
Forbes, Novmber 2011. Yvan Allaire, "Activist Hedge Funds: Creators of lasting wealth,
What do the empirical studies really say?
Institute for Governance of Private and Public Organizations, July 2014.
When a talking head, on CNBC, proclaims that Company X has announced a stock buyback,
it is unfailingly hailed as good news for shareholders. After all, in the world of high finance,
cash is trash, leverage is good, and stock buybacks can boost earnings per share and the price of
the stock itself. When stock buybacks are executed judiciously, shares are purchased when management
recognizes that the stock is undervalued - as it is preferable to buy while the price is low (at
least that's the theory). All of this is done, of course, under the guise of enhancing shareholder
value. Hence, what is good for the shareholder (i.e., a stock buyback) must be good for the company
itself. This is exactly what the charlatans, of Wall Street, want you to believe; and it is a lie.
The financial distress, besieging America's largest financial institutions, exposes the pernicious
nature of stock buybacks. Call me old fashioned and financially conservative as I have never agreed
with the idea that weakening a company's balance sheet is beneficial for the company and its shareholders
- yet, it does benefit a very select group of shareholders and this will be covered below. Repurchasing
shares weakens a company's balance sheet in three key ways in that cash, working capital, and equity
are diminished by the dollar amount of the shares repurchased. When a company's stock-buyback program,
over time, adds up to billions of dollars, the negative financial impact can be staggering.
The stock prices, of America's largest banks and brokerages, have been getting hammered. Yet the
declining stock prices fly in the face of the "wisdom" of buying back shares in that a scarcer number
of shares should lead to higher stock prices. The following table, comprised of seven high-profile
American financial institutions, neatly exposes the falsehood that stock buybacks increase shareholder
From 2001 Through 2007
From fiscal-year 2001 through fiscal year-end 2007, these seven companies have repurchased $127.3
billion of their common stock. I would argue that each company's stock-buyback program actually intensified
the downward pressure on the price of their respective common shares.
It is well known that there is a global credit crisis and that investors are nervous about which
financial institutions will or will not survive through these uncertain times. Top-notch financial
strength, consequently, is viewed as a virtue. Thus, it stands to reason that had each of the above-mentioned
companies not engaged in such reckless stock buybacks, each company would possess a dramatically
stronger balance sheet. In turn, better financial strength provides a company with a greater chance
of surviving difficult economic circumstances and, accordingly, would be reflected favorably in the
price of its common shares. Return, to any one of these companies, the money it squandered on stock
buybacks and you'd see a company with a higher stock price than currently bestowed by the marketplace.
Let's test, a little more, Wall Street's "logic" with respect to share repurchases. If a stock
buyback is good for a company, shouldn't buybacks take place when times are tough? After all, during
tough times, shouldn't management do good things for a company? Moreover, if stock prices have dropped
precipitously, shouldn't management be repurchasing shares hand-over-fist? The actions, of the seven
aforementioned companies, speak volumes about such questions; and exposes stock buybacks as nothing
more than a Wall Street scam.
Through the first five months of 2007, these seven financial institutions bought back $14.4 billion
of their common stock. Through the first five months of 2008, the same exact companies repurchased
only $786 million of their shares - a reduction of nearly 95%. It is painfully clear that each company's
management team has determined now is not the time to further weaken their respective balance sheets.
Corporate survival may be at stake. After all, share repurchases would further erode the balance
sheet and the share price may suffer even further. So, when is it ever a good time to weaken a company's
In Berkshire Hathaway's 2005 annual report, Warren Buffett criticized executive compensation schemes
in his letter to shareholders.
In the following example, Mr. Buffett makes it quite clear that a company's top executives and managers
can be compensated handsomely even if the company's performance is mediocre or poor. At the epicenter,
of such a compensation scheme, is management's control over whether or not to engage in stock repurchases.
Read it and weep:
Too often, executive compensation in the U.S. is ridiculously out of line with performance. That
won't change, moreover, because the deck is stacked against investors when it comes to the CEO's
pay. The upshot is that a mediocre-or-worse CEO - aided by his handpicked VP of human relations and
a consultant from the ever-accommodating firm of Ratchet, Ratchet and Bingo - all too often receives
gobs of money from an ill-designed compensation arrangement.
Take, for instance, ten year, fixed-price options (and who wouldn't?). If Fred Futile, CEO of
Stagnant, Inc., receives a bundle of these - let's say enough to give him an option on 1% of the
company - his self-interest is clear: He should skip dividends entirely and instead use all of the
company's earnings to repurchase stock.
Let's assume that under Fred's leadership Stagnant lives up to its name. In each of the ten years
after the option grant, it earns $1 billion on $10 billion of net worth, which initially comes to
$10 per share on the 100 million shares then outstanding. Fred eschews dividends and regularly uses
all earnings to repurchase shares. If the stock constantly sells at ten times earnings per share,
it will have appreciated 158% by the end of the option period. That's because repurchases would reduce
the number of shares to 38.7 million by that time, and earnings per share would thereby increase
to $25.80. Simply by withholding earnings from owners, Fred gets very rich, making a cool $158 million,
despite the business itself improving not at all. Astonishingly, Fred could have made more than $100
million if Stagnant's earnings had declined by 20% during the ten-year period.
Indeed, stock repurchases benefit a narrow group of corporate insiders. Not only can such insiders
benefit while the company remains stagnant, they can financially benefit while simultaneously demolishing
the company's balance sheet. A perfect example can be found at Citigroup.
As you saw above, Citigroup was the most aggressive company when it came to repurchasing shares.
Over the past three quarters, Citigroup has suffered a cumulative net loss of
$17.4 billion. To be sure,
these losses were "baked in the cake" ten to fourteen quarters ago when Citigroup was speculating
in mortgage-backed securities, extending shaky loans, entering into risky transactions with the
monoline insurers, and participating
in speculative leveraged buyouts. Credit standards were set irresponsibly low so that revenues and
net earnings would go sky high. And, in order to goose Citigroup's stock price and executive compensation,
Citigroup engaged in nothing short of an orgiastic stock buyback program. It worked for a while with
the stock peaking at nearly $56 per share in December of 2007. Now, the chickens have come home to
roost as Citigroup's share price has collapsed by approximately 65%.
Since Vikram Pandit became Citigroup's CEO eight months ago, he has been instrumental in raising
$40 billion in new capital for Citigroup. As stated in this July 15, 2008 International Herald Tribune
article, Mr. Pandit "…is
trying to turn around Citigroup as the banking industry struggles through one of its most challenging
periods since the Depression. His task is particularly difficult because many Citigroup bankers,
paid with stock and options for years, have seen their fortunes vanish. Morale is low." I have no
sympathy for these demoralized Citigroup executives and managers as their "fortunes" were built upon
a financially destructive stock-buyback program pyramided upon intellectually bankrupt business and
next time you hear a CNBC talking head gush over a company's stock-buyback announcement, think of
Fred Futile and his self-dealing management style. To praise the weakening of a company's financial
condition reveals the vapid nature of financial reporting. More importantly, the incredible amount
of stock repurchased by the seven above-mentioned financial institutions exposes the intellectual
and moral rot of countless business managers and their Wall Street enablers. Not a single analyst
has cried "foul" and questioned the grotesque balance sheet mismanagement of any of these financial
powerhouses (or, more accurately, former powerhouses). To me, this further reinforces my core belief
that Wall Street exists to redistribute wealth from the poor and the middle-class to the wealthy.
To deny this is to remain comfortable dealing with liars and thieves.
Eric Englund [send him mail], who has an MBA
from Boise State University, lives in the state of Oregon. He is the publisher of
Survival Guide by Dr. Gerald Swanson. You are invited to visit his
The Best of Eric Englund
Eric Englund [send him mail], who has
an MBA from Boise State University, lives in the state of Oregon. He is the publisher of
Survival Guide by Dr. Gerald Swanson. He is also a member of The National Society, Sons of the
American Revolution. You are invited to visit his website.