What mistakes? Is it a mistake to not keep a rainy day fund that will allow a company to weather a once-in-a-hundred-years shutdown of the entire economy? If this turns out to last a year, will you think it's a mistake that companies didn't keep a year's worth of reserves?
Especially since we're talking about SMBs here. Your local electrician, who has a staff of 3, should keep enough money saved up to pay all staff for the next year just in case?
You're saying a bunch of buzzwordy slogans kind of like "limited liability is bad" or "obligation to shareholders was invented by Friedman", but not dealing with the actual facts on the ground or the current catastrophe.
In the last 20 years we have had at least 3 “once in 100 years events”, so yes, maybe corporations should be required to be more prepared for down turns as a condition of being granted the right to operate with limited liability.
These are not buzz words, I practiced law in New York and worked on the bankruptcy of American Airlines, Lehman, GM and others. I saw the conditions on the ground, the incentives management responded to; I saw $200M bonuses for traders that lost $1B, I saw how decoupled management was from the risks they engineered. There is a prevalent attitude that as long as the short term reward hits before they quit then they should do it.
Since 2008, airlines have experienced one of the most profitable periods in their history with drastically lower competition and low oil prices. What did they do with that? They wasted significant amounts of cash on buy backs. American Airlines reduces outstanding stock by 37%, thats massive. Why? Because executives are taught in business school that there is an obligation to maximize shareholder value. No such obligation exists in law and I am arguing that is really bad social policy.
Employees are going to be decimated as this unfolds, are they more responsible or in a better position to plan for these once in 100 year events?
Fair enough - I was mostly talking in the context of the article (SMBs).
And to be frank, it sounds like you're much more knowledgeable about this issue than I am, certainly in terms of actual practice.
That said, I still disagree with you and not sure why you arrived at your conclusion.
Let's put aside for a second the question of whether shareholder primacy is good social policy or not in the general case - and I agree with you here - it's not mandated by law, and even if it were, we could change that if we decide it's bad policy.
Your specific contention here is that companies are using buybacks to prop up their share price, and thus are reducing their reserves. And that they should keep more reserves around.
So firstly - tax structure aside, I've never understood why anyone treats buybacks differently than dividend payments. It's just a way of giving money back to shareholders. Do you agree with that or not?
Secondly, how much reserves should a company actually keep? If this situation/recession drags on for a year, will you be saying that it's bad that companies didn't keep a year's worth of reserves? Two years?
I think that's both an unrealistic demand, and a supremely inefficient one. No company could've, nor should've, had to predict this kind of disaster happening, and been prepared for it. I'm generally a libertarian, but this is exactly the reason we have governments - this kind of crisis should be prevent by the government - both in terms of preventing a pandemic in the first place, and in terms of fixing the economy once we're in this situation.
In other words, I don't see any good way to change the market to incentivize companies to keep tons of cash lying around as a rainy day fund - and I don't think it would make sense for so many companies to hoard so much money. Much better to have them return the money to shareholders, to go invest in new companies.
Where do we disagree?
Who is this guy? Also where can I learn more about this and related topics. I’ve taken an interest to learning about our economic system in my free time and would love it if someone could point me to some good resources/podcasts/whatever.
https://www.forbes.com/sites/stevedenning/2013/06/26/the-ori...
The amazing thing is when you compare this with the history of corporate structures. For much of history after the joint stock ventures were created in the 1600s they were extraordinary one time grants from the king and only for very very risky ventures. Basically they were used to induce businesses that wouldn’t exist but were vital for society. In exchange there was an express charter that laid out the obligations of the firm. There were expectations on how the company would act in society. There were obligations to employees, bond holders, the community etc.
It is an insidious and morally bankrupt myth that this is the only purpose of a company.
If that return is at the cost of the stability and welfare of society at large then sorry, but no. No-one "deserves" a return and nothing happens in a vacuum. Larger society comes first, full stop. Seems this is a lesson we humans forget, and need to collectively and painfully relearn, every few decades.
Ah, the rallying cry of 20th-century tyrants. You can justify just about anything with that statement.
Clearly the past year has proven why it should have stayed banned.
Or maybe you’re suggesting we should have liquidity requirements for all businesses like we do for banks? That’s actually not the worst idea in a world where we’re going to be bailing companies out. If you want a bailout, you have to have a rainy day fund to make it less likely you’ll need one.
Yes, liquidity requirements and add personal liability for executives if their firm goes through bankruptcy, or restructuring. Goldman Sachs was a partnership until the 90s with each banker personally liable for the firms debts. They took risk much more seriously then.
So are buybacks
If you wouldn’t have chosen to reinvest your dividends, you can sell a fraction of your shares to achieve the same effect.
You may think there are social or cultural reasons why one return of capital is preferable to another (I can’t tell, you haven’t made any of those arguments as far as I can see), but mathematically, a return of capital is cash in existing shareholder hands, and there’s no difference between the two approaches.
Share buybacks have an impact on taxes paid, but we have a system where people are encouraged to minimize taxes, so you’d need to make an argument about tax rates for that to make sense.
It’s true that changing the number of shares for the same size pot of money has an impact on share based compensation schemes, but that’s an argument about not liking share based compensation.
If an executive is paid in stock, and has compensation tied to stock price then there is an incentive to conduct stock buy backs and not issue dividends. Further, declaring a dividend sets future expectations of performance that management is hesitant to be tied to as missing dividend payments lowers stock prices.
My point is that these incentives causes management to spend more company resources on buy backs than they would on dividends because there is a personal benefit. This harms stockholders because they lose the option to use the dividend. Not every investor wants to reinvest, some want to use the dividend. So no, they are not equivalent as you say. There are meaningful practical considerations that make dividends better for shareholders and buy backs better for managers.
> Stock buy backs make stock prices go up. Dividends do not.
Not true. https://en.wikipedia.org/wiki/Dividend_discount_model
> If an executive is paid in stock, and has compensation tied to stock price then there is an incentive to conduct stock buy backs and not issue dividends.
You're touching on agency costs (https://en.wikipedia.org/wiki/Agency_cost), which is a broader issue than stock buybacks. Management can always game their actions to favor their self-interest (compensation) over shareholder interests. They can also choose to invest in projects that will make the company look good in the short-term at the expense of long-term profits to shareholders, because management can always just stick around for a few year before shit hits the fan. See, e.g. what Jack Welch did to GE https://www.foxbusiness.com/markets/ge-ceo-feud-welch-vs-imm...
My point is the fact that share buybacks are yet another avenue for management to mismanage a company for their own benefit doesn't make them bad per se, or worse than stock dividends. Investors should evaluate share buybacks on a case-by-case basis to assess whether they believe
The solution is improved corporate governance predicated on having an top-tier Board of Director structure with a significant share of independent directors vs. an entrenched BoD. That's why ESG is an increasingly relevant theme. https://en.wikipedia.org/wiki/Environmental%2C_social_and_co...
2) Businesses exist to make a profit for their shareholders. Yes, they should have some retained earnings as a rainy day fund, but some of these companies are losing 75-100% of their revenue (airlines, cruises) and it doesn’t make sense to try and self-insure for the most extreme tail risk ever. So they return profit to shareholders. And for various reasons, buybacks are often preferred to dividends.
Would you be this up in arms if they had never done a buyback but had been paying a regular dividend to return those profits?