In an earlier post I began a discussion on the recent upsurge in corporate stock buybacks, looking at this financial strategy from a basic probabilistic perspective of “good move/bad move.” In this follow-up, I want to explore the impact of stock buybacks as an exacerbation of the continuing problem of income equality in the United States.

In that earlier post I referenced a recent New York Times opinion piece entitled “End Stock Buybacks, Save the Economy.” The authors suggest here that a stock buyback, given an additional impetus in 2018 from the lowering of corporate tax rates in late 2017, is primarily a stock price manipulation that maximizes shareholder wealth, but at the expense of the other stakeholders, such as employees and the communities in which the companies do business. [1]

I want to propose here one way in which these buybacks have impacted income inequality via some economic data on income growth by sector of the populace that I examined in detail in a series of posts last January, soon after the new tax rates took effect. In that series I smoothed the actual after-inflation income growth data over 30 years to see how well it fit the “Rule of 72,” the mathematical “time value of money” computation that calculates how long it takes for your income to double at various growth rates. The simplified results are here, with the more ragged actual data history shown in the notes below. [2]

Since the mid-1980s, thirty years ago, annualized income growth for 90% of workers has averaged less than 3% after inflation (below the orange line), and for the bottom half, just 1.5%. For the next 9.9% of workers, primarily the “managerial class,” income growth has averaged 6%, and the top 0.1% of people have seen incomes grow on an annual average of 8% over that period of time. In short, you can see the rise of income inequality unfolding just by looking at what may appear to be relatively modest differences in growth rates, played out over time.

So how do stock buybacks exacerbate this trend? My first take is to look at the “cash hoard phenomenon.”

Explaining the cash hoards

From my earliest days in graduate school studying corporate finance, back in the 1970s, and through most of my teaching career, the conventional wisdom about a company holding large cash reserves was very negative. Cash is typically held by companies in very liquid and short-term investments which pay very little in earnings, especially over the low-inflation times of the past two decades.

However, the right side accounts of the balance sheet, from which come the debt and equity holdings required to underwrite this cash hoard, have a “cost of capital” that always far exceeds the earnings on this excess cash. In conventional corporate finance theory, you lose money on your cash holdings.

At the end of 2017, American corporations were sitting on over $1 trillion in cash and near-cash assets, 80% of it held overseas. [3] Clearly much of this is due to the fear of taking a tax hit on repatriated earnings, but the unspoken reality is that many high-growth companies have found it difficult to find equally-high-growth opportunities in which to invest. Purchasing a low-growth company with some of that cash would clearly signal this lower-growth future to the market, so the cash rich companies continue to insist that the “next big thing” is in the wings and waiting for that cash.

And the companies without cash hoards?

What about the larger number of companies that do not have these huge cash hoards? Again, we are in a situation counter to classical finance theory. Since 2008, the Federal Reserve has driven interest rates to record-low levels in an attempt to stimulate the economy. Virtually limitless amounts of debt at a very low “cost of capital” have been sitting in the market, waiting for “customers.” This low cost of capital for debt (with its generous tax advantages) has also kept the cost of equity capital very low for a long time, attractive bait for companies wanting to “invest in themselves.” But the reality has been tepid growth.

Two options for labor

If a company were to invest using all that available cash, there are two basic paths to go. One is to invest in new products or processes that force per-worker labor costs lower, primarily through outsourcing to lower-cost markets. The alternative is to invest in technological efficiency in the existing products and processes, which tend to make existing workers more efficient and productive. It is from the latter that income gains to workers have typically come over past decades.

However, in the last 30 years, as indicated by this data and supported by other analyses, companies have refused to share the financial benefits of these income gains with the workers, instead passing them on to managers, in the form of higher raises and stock incentives, and to the stockholders themselves, most recently through this trend of stock buybacks. [4]

In my view, the best explanation for why companies can get away with keeping salary growth low for the non-managerial part of their labor force is monopsony. That is, the consolidation of major sectors of the economy, such as retail and manufacturing, means that there are fewer differentiated “buyers” for labor. The increased use of non-compete and no-poaching contracts, plus the weakening of labor unions, have pushed much of the power balance back to the employer after several post-War decades where employees had marginally more power to negotiate the terms of their employment.

Even as we see some recent income growth in these low-unemployment times, that after-inflation number for the bottom half of the workforce is still averaging below 3% annual growth, and still tracking that 24-year doubling orange line in the graph above.

Notes:

1. Lazonick, William, and Ken Jacobson. “End Stock Buybacks, Save the Economy.” The New York Times, 23 Aug. 2018.
2. Income inequality and the Rule of 72 – part 2 (the unsmoothed data)
3. Pelisson, Anaele. “The 17 US Companies with the Biggest Piles of Cash.” Business Insider, 4 Dec. 2017.
4. Georgescu, Peter. “Employees Pay The Price For Three Decades Of Income Inequality.” Forbes, 20 Apr. 2018/.