STOCK BUYBACKS | More Risk, Inequality

Source: IZA

Business school professors have struggled with aligning the interests of executives with the interests of company owners. It is called the principal-agent problem, or just agency problem.

One idea is stock options to reward executives when stock prices rise.

It was understood from the inception of this idea that some long-run measure of stock price should be used to avoid gaming the system. Michael Porter recommended that stock options not be exercisable for five years, and then only a portion of them. Those who have studied abuses of stock options recommend that averages of stock prices over several years be used, again to avoid executives goosing the stock price at a benchmark date.

Sadly, those who have studied the impact of executive pay on stock prices find a negative correlation. CEOs with pay that is in the top ten percent of their industry and size have stock prices that are 13 percent lower for periods up to five years after the high payouts.

OMG, how could this happen? Researchers try to explain the result as overconfidence among executives or investor mistrust of companies with high-paid executives, or both.

Now a better explanation of what has been going on has been presented by none other than Goldman Sachs. A big problems seems to lie in the timing of stock buybacks. What is going on is worrisome both from a social welfare standpoint and from the perspective of managing risks in financial markets. I am grateful to Wall Street on Parade for noting the implications.

In a research note, Goldman has compared the buybacks at high market multiples to the bad investment decisions that corporations made in this arena just before the market crash of 2008:

[B]uybacks peaked in 2007 (34 percent of cash spent) and troughed in 2009 (13 percent). Firms should focus on M&A [mergers and acquisitions] rather than pursue buybacks at a time when P/E [price to earnings] multiples are so high.

Goldman's alert picks up on an article in the September Harvard Business Review, “Profits Without Prosperity”, which notes that corporate profits have been high, but are not being passed through to workers or shareholders. The culprit? Stock buybacks.

[I]n the short term buybacks drive up stock prices. In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42 percent of their compensation came from stock options and 41 percent from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets.

In calendar years 2006-2013, says Birinyi Associates, public corporations authorized $4.14 trillion in buybacks of their U.S.-traded stock; in 2013 alone, corporations borrowed $782 billion, almost all paid out for stock buybacks.

In the past two quarters, investment-grade non-financial companies have issued $366 billion in bonds; the $195 billion of bonds they sold in the first quarter alone was a record.  Companies in the S&P 500 are expected to spend more than $1 trillion - two-thirds of their cash - buying back stocks and repaying dividends in 2015.

The debt these companies are taking on to prop up their stock prices is diverting corporate profits to executive pay, and is making the U.S. stock market a riskier place to put money. It helps explain why the prosperity at the top of the companies is not trickling down to the 99 percent very fast.

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OBIT | Michael Katz, Poverty Historian

Prof. Michael B. Katz

Today's New York Times has a four-column obituary of Michael B. Katz, Harvard '61, Ph.D. '66, Walter H. Annenberg Professor of History at the University of Pennsylvania, who died on August 23 in Philadelphia.

His obit is worth reading.  It recognizes a long life spent on the topic of poverty, which recently has regained mainstream interest because of U.S. and global trends toward greater inequality.

The obit by Paul Vitello identifies succinctly the core question about poverty that Katz addressed in his histories of how America has treated its poor people, which is: Do we have our policies toward the poor wrong, or do our policies reflect our national attitudes?

Katz was a Penn history professor for 36 years and founded its urban studies program. Less than one year ago, he wrote in The New York Times about NYC Mayor Michael Bloomberg's antipoverty record, suggesting that it was significant and insufficiently recognized.

The two best-known books by Prof. Katz were "In the Shadow of the Poorhouse" and "The Undeserving Poor". His history of poverty programs extends from the poorhouses modeled on England's, to the Progressive Era reforms, to a Freudian analysis of poverty in the 1920s and FDR's New Deal.

Katz contrasted two economic ideas:

• The microeconomic idea that as economic agents we are masters of the marketplace – and therefore the poor must be defective or "undeserving" in some way.
• The macroeconomic idea that the poor remain poor because rich people who control the rules of the economic game make sure the game is rigged in their favor, and the goal is to change the policies.

Katz took to irony in his search for the criteria that Americans use to identify the "deserving poor". They seem to be, he said, based on his dispassionate review of the literature:

• disabled war veterans
• widows with children
• anyone else with Anglo-Saxon forebears

He chronicled the ways in which prejudice in the workplace, in lending practices, in housing, in business location and in the political process have kept the poor in their place. The thrust of his published work was to question the idea that there is an "underclass" and a "culture of poverty" that is beyond the help of public policy.

He asked, ultimately, whether macroeconomic public policies are not the major source of the problem of poverty, but rather microeconomic public attitudes toward the poor. So long as we have the microeconomic idea hard-wired to public thinking, there will be no progress at the macroeconomic level.

Ec Inequality - Piketty - Milanovic Take Is Glorious and Short

The basic story is that World War II
redistributed wealth, because assets were
wiped out. Inequality is again rising. 

Achilles's mother (the sea-nymph Thetis), prophesied two futures for him. (1) If he took part in the Trojan War, his life would be glorious but short. (2) If he did not, his life would be long but inglorious. Achilles chose glorious but short.

I posted something short about Thomas Piketty's Capital in the Twentieth Century on April 12. Piketty has raised the issue of economic inequality in an interesting way.

Yesterday I received  the latest (June 2014) issue of the Journal of Economic Literature with a glorious review by Branko Milanovic of Piketty's book. Milanovic's review is the fourth and last featured article in the journal issue.

If you don't subscribe to this journal, a version of it was issued as a working paper by CUNY and is available here.

The review shows the ways in which Piketty's interpretation and message differ from those of many leading economists of the 20th century. The basic data for the United States (see chart upper left) show that World War II redistributed wealth, because assets were wiped out, and the egalitarian effects lasted until the 1970s. The trend toward greater income inequality returned starting with the Thatcher-Reagan years. Piketty has a theory, based largely on historical tax data, that links the level of inequality to  the relationship between return to capital (r) and economic growth (g). Milanovic warns in the last paragraph of his review:

[The] best compliment that the author of an almost 700-page-long economics book can ever expect to get [is - ] Don't take this book on vacation: it will spoil it. 

In other words, Piketty's book is glorious and long. If you take his advice, I suggest that in the meantime, if you haven't read the book, read Milanovic's glorious-and-short (15-page) review. If you accept the premise of Milanovic's last paragraph, the decision facing the vacation reader is unlike that facing Achilles. In this case there is no tradeoff between glorious and short.

Can a President Affect the Business Cycle? Yes.

The excellent graphic in the New York Times yesterday asked: "Can a President Tame the Business Cycle?" Provocative. Draws attention to the graphic. But it's like asking "Can a President End Poverty?" Unfair. Invites a shrug of the shoulders.

The text accompanying the chart - which depicts the consequences of the economic policies of rec ent presidents - asks a more reasonable question:

Today, Americans save less and earn a lower minimum wage — in real, or inflation-adjusted, terms — than at nearly any other time since 1950. Can voters reasonably expect these and other indicators to change significantly after a new president takes office in January?

But the appropriate question is not whether one can always “tame” a tiger. It is whether we have to feed people to it.

Voters reasonably can expect better policies than the disastrous laisser-faire policies of the last eight years.

By ignoring the unsustainable runup in asset values (especially housing values) that occurred under George W. Bush, recent policies have invited the collapse of these values in recent weeks. In Keynesian terms, Dubya had the furnace running during the month of August. Allowing and encouraging the extreme increase creates the probability of an extreme correction. Dubya is responsible for the economic hardships and inefficiencies that accompany the correction.

Starting in January under President Obama one can expect a move toward less inequality of income and a less extreme business cycle.