Why taxing share buybacks is the wrong solution for executive compensation


The DealBook newsletter delves into a single topic or theme each weekend, providing reports and analysis that provide a deeper understanding of an important issue in the news. This week the financial reporter Roger lowenstein weighs on a plan by Senate Democrats to tax share buybacks. If you do not already receive the daily newsletter, register here.

Corporate share buybacks have been a bogeyman to the left since Senator Bernie Sanders attacked them during his presidential race in 2016.

Now, the cause has been taken up by the Democrats in the Senate, who want to tax companies on their share buybacks. The reason given is that companies should use their cash to raise wages rather than jack up their stock prices and reward their executives.

But the truth is that taxing or restricting share buybacks won’t end corporate greed or excessive compensation.

Despite statements by business leaders about their efforts to help society, most of the social good they do arises incidentally, Therefore of their success. Private companies may be fundamental to the American experience, but most are not aimed at improving the overall standard of living or, specifically, at creating jobs.

Take Bill Gates. When he started Microsoft with Paul Allen in 1975, he had no idea of ​​making it one of the largest employers in the country. He was a smart, ambitious kid who loved computers. Today, the company has nearly 200,000 employees. Incidentally, Microsoft has just announced a $ 60 billion share buyback program.

Mr. Gates and Microsoft illustrate the paradox notoriously conceptualized by Adam Smith: Each individual “does not intend to promote the public interest, nor knows how much he is promoting it.” Instead, “he is aiming only for his own gain, and in this case, as in many other cases, he is guided by an invisible hand to promote an end that was not part of his intention.”

Decisions of modern businesses, including those that determine capital levels, are also made for selfish or self-serving reasons. Subject to well-enforced laws and strong regulation, more success usually translates into more jobs and more investment. Conversely, during the financial crisis, when businesses struggled, Main Street suffered even more.

The public capital system depends on the sale of shares in companies, but we do not require that companies sell stocks. There is no public obligation (except in regulated sectors like banking) to maintain a specific level of capital.

Here’s one way to think about it: If it’s not wrong for a company to sell $ 3 billion in stock, is it wrong for it to sell $ 4 billion and later buy back $ 1 billion? In the end, it’s the same thing.

Buyouts are just one way, through investors, to reallocate capital from surplus firms to firms in need of capital. And too much capital can be just as harmful as too little, leading to misallocation and waste of social resources.

“The best use of cash, if there’s no other good use in business, if the stock is undervalued, that’s a buyout,” Warren Buffett said in 2004.

Even so, companies frequently make capital allocation errors. Determining the right level of capital depends on predicting future returns, a highly flawed science.

It’s also true that buybacks are often made out of an unfortunate obsession with short-term stock prices. But it would be difficult to legislate a distinction between “bad” redemptions and “good” redemptions.

Proponents of taxing share buybacks say the corporate tax cut in 2017 sparked a wave of share buybacks. They argue that business leaders used the money for selfish reasons rather than investing in workers.

But the supposed link between redemptions and inequalities has not been proven. (In some periods, the correlation actually works the other way around.) Share buybacks by S&P 500 companies hit a record high of $ 806 billion in 2018. They have since fallen but remain at historically high levels . Meanwhile, over a roughly coincident period, from 2016 to 2019, inequality, measured by both income and wealth, declined slightly, reversing the trend of sharply rising inequalities since the collapse. financial, according to the Federal Reserve’s triennial consumer finance survey.

Inequality, of course, remains high (and has been reinforced by the pandemic). Its causes are complex. But in general, companies do not increase wages because they have excess capital; they are increasing wages to attract more and more talented workers. If there is a link between buyouts and wages, it is rather obscure; what we do know for sure is that before the pandemic, when executives actively bought back stocks, the relative wages of the lowest were finally starting to regain lost ground.

The worst aspect of penalizing share buybacks to restrict executive compensation is that it is a painfully indirect approach. The argument that buybacks sometimes improve executive compensation holds true for anything that raises stock prices. This can include investing in a new product, leveraging the balance sheet by borrowing (which has the same effect as taking out equity), cutting expenses, or doing whatever else shareholders decide to reward.

Those who oppose the corporate tax cut might better achieve their goals by reversing it than by taxing the buyouts that were a supposed and relatively minor result of the reduced tax rates.

For those who believe that executives are unreasonably and often obscenely playing their control over company assets, it would be more effective to tackle the problem head-on. Increase the marginal income tax on very high incomes.

More directly, the Securities and Exchange Commission could require that executive compensation plans above a minimum threshold be subject to a binding vote by shareholders, who foot the bill.

Finally, there is an argument that options given to insiders create an untenable conflict of interest and an abuse of fiduciary responsibility. Perhaps they should be banned or the profits of the options should be taxed at high punitive rates.

But does the takeover deserve to be a whipped child for real or imagined corporate ills? Common sense suggests that it is best to leave it alone.

Roger Lowenstein is the author of six books, the most recent being “America’s Bank: The Epic Struggle to Create the Federal Reserve”. He is also a director of the Sequoia Fund. He writes regularly here.

What do you think? Should the government tax share buybacks? Are there better ways to control executive compensation? Let us know: [email protected]

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