WEBVTT

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Five years after
the great recession,

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the major indicators
suggest that the economy

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is booming again and corporate
profits are abundant.

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But for 99% of people,
it doesn't feel that way.

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According to economist
William Lazonick,

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a major reason is
stock buybacks --

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a technique companies use
to finesse their stock price

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and increase the value
of stock options.

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This is the story
of how they came

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to dominate what companies
do with their cash,

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and why they foster inequality
and stifle innovation

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and growth.

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For three decades after World
War II, most U.S. workers

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shared in post-War
growth and prosperity.

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Companies retained
their workers,

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paid them well, and
reinvested their earnings

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in strengthening
their capabilities.

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Real wages and
productivity gains

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marched upward in lockstep,
expanding the middle class.

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But in the 1970s,
things got out of sync.

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Wages started to lag even
though workers continued

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to help generate sturdy
productivity gains,

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and during the
next three decades

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workers shared less and less in
the resulting financial rewards

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of corporate growth.

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So companies continued
to generate more profits

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but were sharing less
of it with workers.

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What did they do with
all of that cash?

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When companies
have cash on hand,

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they can do three
things with it.

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First, they can re-invest it:
expand their employees' skills,

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increase their pay and
benefits, hire more people,

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create new products
and services,

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and make capital investments
that make their companies more

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competitive.

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Second, they can pay
out cash dividends

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to shareholders, who
can put that money back

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into the economy, re-invest
in other companies

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and new ventures, and help
keep the economy humming,

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to a point.

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Third, a company can
repurchase its own shares --

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that's a stock buyback.

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This reduces the number of
company shares on the market,

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automatically increasing the
company's earnings per share,

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or EPS -- a key metric that Wall
Street expects CEOs to hit each

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quarter.

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In general, experts will tell
you that the first activity --

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re-investing in your
people and your company --

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is the most important way to
spend company cash in order

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to remain competitive and
find growth opportunities.

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But for the past three decades
major corporations have

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increasingly focused on the
second and third activities --

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dividends and buybacks.

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In the early '80s, stock
buybacks were negligible.

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But the cash spent on dividends
hit 50% of net income,

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prompting concerns
that such a high payout

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ratio was impeding investment
in productive capabilities.

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By the late '80s, buybacks
had also taken hold.

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Buybacks and dividends combined
accounted for, on average,

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a whopping 80% of net income.

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That left precious little cash
to put back into the business

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or into employees' pockets
in the form of higher wages.

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Beginning in the late '90s,
the amount spent on buybacks

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has surpassed the amount spent
on dividends in many years.

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During the 2000s, the 449
companies listed on the S&P 500

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between 2003 and 2012 spent
54% of their earnings --

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2.4 trillion dollars
-- on buybacks.

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Another 37% went to dividends.

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That left 9% of
earnings available

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for productive re-investment.

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In some cases, at the
height of buyback mania,

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companies spent more than
100% of earnings on buybacks.

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Meaning they were dipping
into reserves or borrowing

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to do stock buybacks.

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Meanwhile, as companies
use less and less

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of their money for productive
re-investment or wages,

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they're asking the public to
use more and more of its money

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for the same.

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William Lazonick, author
of the HBR article

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"Profits Without
Prosperity," explains

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that in nanotechnology,
for example,

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industry leaders have pleaded
for publicly funded research,

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arguing that the United States
can't remain competitive

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without it.

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Lobbying yielded the
taxpayer-funded National

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Nanotechnology Initiative,
which spends about $1.5

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billion dollars per year.

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WILLIAM LAZONICK:
Intel alone has

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spent four times that amount
just buying back its own stock.

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So the question I ask is, why
isn't a company like Intel --

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if it says, this
is what we need,

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and this needs to
be collaboration --

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stepping forward with
even a fraction of that,

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and taking a leadership
position, and saying,

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we're putting this money in.

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Everybody else
should put this money

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into this National
Research project

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before or as they go ask
the government to do it.

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This is why most Americans
aren't feeling the recovery.

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The obvious question it
raises is: How are companies

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getting away with this?

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Executives give three main
justifications for buybacks.

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One: their company's shares are
undervalued -- in other words,

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the share price is lower
than what its leaders think

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the price should be given
their firm's prospects.

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Buying back stock
increases EPS, and raises

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the share price to
match what leaders

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think the value should be.

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WILLIAM LAZONICK: In fact,
what we know overwhelmingly

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from the evidence is
that companies buy back

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their stock when prices are
high not when prices are low.

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Two: buybacks offset the
dilutions of earnings per share

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that happens when employees
are granted stock options.

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But Lazonick's research shows
that the volume of buybacks

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far outstrips the
options granted.

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Also, buybacks belie the
point of granting options

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in the first place,
which is to motivate

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people to work hard to increase
the value of the company.

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WILLIAM LAZONICK: Basically
what they're doing

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is saying that process
of paying workers

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was not successful in generating
the earnings that led to higher

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stock prices, so
we have to do it

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through the manipulation
of the stock price.

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And basically, that's
what's going on.

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So either they should get rid
of that so-called incentive

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payment through stock
options, or they

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should stop doing the buybacks.

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Three: Buybacks
return unneeded cash

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to shareholders at companies
with limited investment options

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because they are
mature companies.

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Lazonick believes
that this failure

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to find opportunities
worthy of investment

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is a failure of
corporate leadership.

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WILLIAM LAZONICK: If that's
the attitude of the executives

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of major companies that
have built up capabilities

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over decades and are the
only ones in the US economy

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that can invest for the
future in their field,

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then we have a problem,
and they have a problem.

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They're not really
doing their jobs

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in running these companies
by thinking about the future.

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So, if the reasons
executives give

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aren't the real justifications
for buybacks, what are?

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Lazonick cites two, rather
prosaic explanations.

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One, it's a way to
manipulate the stock

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price for the short
term, goosing the price

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to please investors.

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And two, it's a way to increase
pay for the top executives.

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It's true that a huge proportion
of executive compensation

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is in the form of
their company's stock.

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In 2012, the 500
highest-paid executives

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of U.S. public companies
received, on average,

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about $30 million.

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42% percent of that compensation
came from stock options and 41%

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from stock awards.

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The 10 companies that bought
back the most stock from 2003

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to 2012 spent 68% of
their combined net income,

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almost $900 billion.

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Their CEOs received, on
average $168 million each,

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58% of which was in the form
of stock options and awards.

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Despite these buybacks, only
three of these 10 companies --

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Exxon Mobil, IBM, and
Procter & Gamble --

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outperformed the S&P
500 index in that time.

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William Lazonick believes that
if companies won't voluntarily

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change course and
shift spending back

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to re-investment and
wages, they must be made

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to do so, with four solutions:

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One: Ban buybacks.

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This should include rescinding
rules passed by the U.S.

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Securities and Exchange
Commission during the Reagan

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years that give companies
substantial freedom

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to buy back their shares and
manipulate the stock market.

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Two: Change executive incentives
to encourage value creation,

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not value extraction.

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Specifically, change
regulations in order

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to rein in stock-based
executive pay.

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Three: Change corporate boards
from including only CEOs

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and other executives to
include more stakeholders --

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especially workers
and taxpayers.

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Four: Fix the tax regime,
which focuses on tax breaks

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as incentives.

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Instead of giving established
corporations lower tax rates,

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the government should make
them pay higher taxes in order

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to fund investments in the
infrastructure and knowledge

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base needed to generate more
innovation in the United

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States.

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For a fuller explanation
of these solutions,

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read Lazonick's article
"Profits Without Prosperity"

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in the September 2014 issue of
the Harvard Business Review.

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Given the importance
of corporations

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and the stock market
to the U.S. economy,

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the government must
step in to check

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the behavior of those who are
unable or unwilling to control

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themselves.

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It must help us recreate a
society where many, many more

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share in the growth and
prosperity of the U.S. economy.

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Where work and wages
march upward, in lockstep.

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