Why taxing share buybacks is the wrong solution for executive compensation

DealBook newsletter deals with a single topic or topic every weekend, and offers reports and analysis to help better understand an important topic in the news. This week the financial journalist has Roger Lowenstein comments on Senate Democrats’ plan to tax share buybacks. If you have not yet received the daily newsletter, Sign up here.

Company share buybacks have been a boogeyman on the left since Senator Bernie Sanders attacked them during his 2016 presidential election.

Now the Democrats in the Senate have taken on the matter that corporations want to tax on their share buybacks. The reason given is that companies should use their money to raise wages rather than raise their stock prices and reward their bosses.

But the truth is, taxing or restricting share buybacks is not going to end corporate greed or excessive compensation.

Despite what business leaders have said about their efforts to help society, most of the social good they do is incidental, as a result of their success. Private corporations may be fundamental to the American experiment, but most are not aimed at improving general living standards or, in particular, at creating jobs.

Take Bill Gates. When he founded Microsoft with Paul Allen in 1975, he had no idea of ​​making it one of the largest employers in the country. He was a bright, ambitious boy who liked computers. Today the company employs almost 200,000 people. Incidentally, Microsoft has just announced a $ 60 billion share buyback program.

Gates and Microsoft exemplify the paradox famously conceptualized by Adam Smith: each individual “neither intends to promote the public interest nor knows how much he is promoting it”. Instead, “he only intends for his own gain, and here, as in many other cases, it is guided by an invisible hand in order to further a goal which was not part of his intention”.

Modern business decisions, including those that determine capital levels, are similarly made for selfish or selfish reasons. Depending on well-enforced laws and strict regulations, more success usually leads to more jobs and more investment. Conversely, Main Street suffered worse during the financial crisis when the corporations thrived.

The public capital system depends on the sale of the company’s shares, but we do not require that companies sell stocks. There is no public obligation (except in regulated industries like banking) to hold a certain level of capital.

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

Buybacks are merely a means of reallocating capital from companies with a surplus to companies with capital needs through the intermediary of investors. And too much capital can be just as harmful as too little, leading to misallocation and wasting of social resources.

“The best use of cash, when there’s no other good use in business, when the stock is undervalued, is to buy it back,” Warren Buffett said in 2004.

Even so, companies often make mistakes when allocating capital. Determining the right level of capital depends on forecasting future returns, a highly imperfect science.

It is also true that buybacks are often made out of a false obsession with short-term stock prices. But it would be difficult to regulate a distinction between “bad” and “good” buybacks in law.

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

But the alleged link between buybacks and inequality is unproven. (In fact, in some time periods the correlation goes the other way.) S&P 500 company share buybacks hit a record $ 806 billion in 2018. They have fallen since then, but remain at a historically high level. Meanwhile, inequality in terms of income and wealth declined slightly in roughly the same period from 2016 to 2019 – reversing the trend of soaring inequality since the financial collapse, according to the Federal Reserve’s three-year Survey of Consumer Finances.

Inequality remains high, of course (and received another boost from the pandemic). Its causes are complex. But in general, companies don’t raise salaries because they have excess capital; they raise wages to attract more and more talented workers. If there is a relationship between buybacks and wages, it is rather unclear; What we know for sure is that prior to the pandemic, when executives were busily buying back stocks, relative wages for those on the lower end finally began to regain lost ground.

The worst part about penalizing stock buybacks to curb executive salaries is that it’s a painfully indirect approach. The argument that buybacks sometimes increase executive compensation applies to anything that increases stock prices. This can include investing in a new product, taking advantage of the balance sheet by borrowing (which has the same effect as collecting equity), cutting expenses, or doing anything else that will reward shareholders.

Opponents of the corporate tax cut could better accomplish their goals by reversing them than taxing the buybacks that were a supposed and relatively minor result of the reduced tax rates.

For those who feel that executives are inappropriately and often obscenely exploiting their control over corporate assets, it would be more effective to address the problem head on. Raise marginal income tax for ultra-high earners.

Specifically, the Securities and Exchange Commission could require that executive pay plans above a minimum threshold be subject to a mandatory vote of shareholders to take the account.

Finally, it is argued that options granted to insiders create an untenable conflict of interest and abuse of fiduciary responsibility. Perhaps they should be banned or the profits from options should be criminally taxed at high rates.

But does the buyback deserve to be a whipping child for real or imagined corporate evils? Common sense suggests that it is better 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 the director of the Sequoia Fund. He writes regularly here.

What do you think? Should the government tax share buybacks? What better ways to keep executive salaries in check? Let us know: [email protected]

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