How Corporations Inflate CEO Pay With Stock Buybacks — And Why It’s Bad for the Rest of Us

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In this Feb. 17, 2009 file photo, shoppers leave a Wal-Mart in Danvers, Mass. Wal-Mart Stores Inc., the world's largest retailer, on Thursday, Jan. 28, 2010 said it is realigning its U.S. operations in an effort to give more autonomy to executives in regional markets and reinvigorate U.S. growth. (AP Photo/Lisa Poole, File)

Wal-Mart in Danvers, Massachusetts. A new report shows that the retailer exploits a "performance pay" loophole saving it $104 million in corporate taxes. (AP Photo/Lisa Poole)

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Back in 1979, notes a new Economic Policy Institute report released last week, households in America’s statistical middle — the 20 percent of households making more than the nation’s poorest 40 percent and less than the nation’s most affluent 40 percent — averaged $16.72, after inflation, per hour worked. In 2012, households in this same statistical middle averaged $16.26 per hour.

Over roughly that same period, EPI analysts add, America’s top one percent of income-earners doubled their share of the nation’s income from paychecks, dividends, rent and business earnings, from 7.2 to 14.2 percent.

Wage stagnation for average Americans; record-level “success” for the one percent. The two have marched hand-in-hand for over three decades now, as EPI’s new Raising America’s Pay paper and two other new studies released last week detail with no small statistical panache.

The new EPI study emphasizes how the failure of wages to grow over recent decades has been driving growing inequality, undermining the living standards of America’s “broad middle class” and stalling all progress against poverty.

Apologists for our current economic order blame wage stagnation on technological change — or workers themselves. Workers don’t have the right skills and credentials to get ahead, their argument goes.

EPI’s Raising America’s Pay picks apart these bogus rationales and shifts the focus to business practices and policies that systematically shift income upwards.

Corporate leaders routinely stiff workers on overtime and misclassify many others as “independent contractors” to avoid paying benefits.

Corporate leaders, for instance, routinely stiff workers on overtime and misclassify many others as “independent contractors” to avoid paying benefits. Corporate muscle, meanwhile, keeps minimum wages low and unions weak.

All these moves add billions to corporate bottom lines and inflate the “metrics” — like share price — that corporate boards use to rate how well top corporate executives are “performing.”

But share prices can be capricious. They often rise and fall without much rhyme or reason. CEOs don’t particularly care for this share price uncertainty, and that brings us to the second of last week’s perceptive new studies, a Roosevelt Institute paper that explores just how far top execs will go to artificially rig higher share prices — and how much economic damage this rigging can wreak.

Corporations have been shelling out fabulous sums, Roosevelt Institute author William Lazonick relates, to “buy back” their own shares of stock off the open market, an exercise designed solely to jack up demand for their stock and, in the process, raise their share price.

In the decade from 2003 through 2012, IBM alone shelled out $107 billion on stock buybacks, an outlay that equaled 91 percent of the company’s total earnings over that span. The corporations that make up the S&P 500 have together spent an estimated $3.1 trillion on buybacks since 2001.

These buybacks have worked wonderfully — for top executives, who just happen to get most of their pay in stock-based rewards. In 2012, the 500 highest-paid executives of America’s S&P 500 corporations averaged $30.3 million each in total pay, with stock-based rewards making up 83 percent of their jackpots.

After inflation, the Roosevelt Institute notes, these 500 top execs are now grabbing nearly three times more than their executive counterparts in the early 1990s — and that early 1990s pay represented a significant increase over corporate executive pay levels of the 1970s, an increase so significant that excessive executive pay had become an issue in the 1992 presidential election.

Right after that election, the new Clinton White House moved to “reform” CEO pay, easing into law legislation that limited the amount of executive pay corporations could deduct off their taxes. But this “reform” had a loophole: Corporations could deduct as much as they chose for “performance-based pay.”

Few corporations have exploited this loophole, the third of last week’s new inequality studies points out, as fully as Wal-mart, America’s low-wage pacesetter.

The “performance pay” subsidy for just eight high-ranking Wal-mart execs has saved the company $104 million off its corporate tax bill, enough money to cover six years of free school lunches for 33,000 poor kids.

Over the past six years, report the Institute for Policy Studies and Americans for Tax Fairness, the “performance pay” subsidy for just eight high-ranking Wal-mart execs has saved the company $104 million off its corporate tax bill, enough money to cover six years of free school lunches for 33,000 poor kids.

Plenty of America’s poor kids come from Wal-mart worker families. Those workers simply don’t make enough to get by without the social safety net support that America’s tax dollars supply.

In effect, points out the new Wal-mart study, America’s “taxpayers pay twice” for the company’s pay practices, first when “they subsidize the company’s excessive executive pay” and then when they subsidize Wal-mart’s low wages.

Average Americans, adds William Lazonick’s Roosevelt Institute study, are also paying dearly for Corporate America’s trillions in stock buybacks.

One example: In the decade after 2001, high-tech giant Cisco spent 107 percent of its net income on stock repurchases. How do firms spend over 100 percent of what they make? They cut costs elsewhere. In Cisco’s case, Lazonick notes, that meant “rounds of large-scale layoffs to sustain its buyback habit.”

Cisco’s chief rivals — China’s Huawei Technologies and Sweden’s Ericsson — don’t do buybacks. They’ve been investing in innovation instead and improving their competitive posture.

America’s only big winners in all this? Top executives like Cisco CEO John Chambers. Over the 2003-2012 span, he stuffed $297 million into his pockets.

But execs like Chambers, the new reports on corporate greed and grasping all stress, don’t have to be the economy’s only winners. The three studies offer all sorts of suggestions for rule changes that could help unrig the economic game that average Americans always seem to lose.

We could yank the generous subsidy for corporate executive “performance pay” and reverse the federal regulations that opened the door to stock buybacks. We could set a $15 minimum wage and guarantee all workers the right to organize into unions and bargain collectively.

We need to be moving on all these fronts — and many more. After all, as the new EPI study observes, reversing rising inequality and America’s “disappointing growth of living standards” is never going to happen “in one fell swoop.”

But we had better start swooping.

Labor journalist Sam Pizzigati, an Institute for Policy Studies associate fellow, writes widely about inequality. His latest book: The Rich Don’t Always Win: The Forgotten Triumph over Plutocracy that Created the American Middle Class, 1900-1970.
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  • Anonymous

    “America’s only big winners in all this? Top executives like Cisco CEO John Chambers. Over the 2003-2012 span, he stuffed $297 million into his pockets.”

    What a disingenuous statement. Cisco has tens of millions of ordinary American stockholders (either directly, or indirectly through a mutual fund or pension plan), and every single one of them benefits when Cisco’s stock price rises, together with Cisco’s executives.

    Same for IBM, Walmart, etc.

    There are US$4,000,000,000,000 – that is $4 trillion dollars – invested by individual Americans in 401K accounts alone. Trillions more in IRAs. Trillions more in public and private pension plans. All of those are for the sole benefit of ordinary individual Americans and their families. And every single one of those individuals benefits greatly when the stock of those companies, specifically those in the S&P 500, does well.

    Even the very author of this article, with virtual certainty, benefited from the rise in the stock in Cisco and Walmart.

    The big winners and individual American investors, that are being rewarded with record stock market returns, including the S&P500 setting nearly daily all time highs. Americans want those CEOs stock options to win *huge*, because they make money when those options make money for the CEO.

  • tony tony

    you miss the point and try to compare two unequal market instruments. ceo compensation is increasingly heavy on stock options with generous strike prices versus cash incentive. if share prices rise, the value of in-the-money options rise in lock-step. if share prices fall, the ceo assumes no financial risk since the ceo need not exercise the options. because the average investor rides along not in options but in actual stock and due to the amount of options in executive compensation packages, the potential magnitude in which his income rises becomes enormous compared to the potential magnitude the average investor’s portfolio rises.

    the underlying theme of income inequality remains palpable. by nature of stock options, ceo’s stand to reap enormous gains when stock prices rise while taking zero risk for price falls. meanwhile, back on main street, participants of 401ks and pensions experience far less leveraged gains during the same price rises but, unlike the ceo, price declines impact their portfolios with actual wealth declines.

  • Dude

    Paying a higher dividend or keeping the money in the company as retained earnings or buying back shares should all result, in theory, with the stock price more or less in the same place. The big advantage of buying back shares is that the stockholders postpone paying capital gains until they sell the shares. So I don’t think the author has made his point. So some investors with a long term perspective may prefer the share buy back scenario.

  • Anonymous

    Sorry, that is not how executive compensation works. Executives in most companies have a target annual compensation. Say $5M.

    That $5M is composed of base pay, target incentive cash bonus, target stock (option or grants) awards. If corporate goals are not met cash and stock incentive pay is reduced or eliminated.

    Pre Clinton (“lets do something about CEO compensation”), The base pay was way higher, and the incentive or performance pay was lower. Clinton and the Dems put in place the incentives for performance based pay. So, surprise, surprise, the market responded.

    Anyway, oversimplifying a bit for brevity, of that $5M, the executive will have say $4M be at risk pay. If the company (or the area of the company the executive is responsible for or a combination) does poorly, the executive “lost” a portion or all of his $4M at risk. If the company/executive meets its goals, he gets the $4M. If the company/executive exceeds the goals she gets say $4M (in stock or cash additional compensation).

    And the stock prices roughly reacts to that performance, and Investors see that rise and fall. Sure, external events can cause broad market up/down cycles, just like business conditions occasionally bankrupt (or severely depress) a company, rendering all stock options and grants worthless.

    So, net/net, is that executives take all their risk upfront, when they agree to, not be paid 1/52 of that $5M every week, and instead get paid 20% of that, with the other 80% being up to performance.

    Investors, similarly can do the same – using options – or take the ups and downs as they come, rather than upfront. Most choose the latter. Investors also have additional tools that executives don’t have. Lets list two of them.

    1 – Investors can short the stock of a company they think is poorly managed and likely to underperform. Executives are generally forbidden from shorting their own stock, and never do.

    2 – Investors can sell and buy shares anytime. Executives are locked out of selling or buying share except during a restrictive number of days that doesn’t conflict with earnings release cycles, material information not available to public, etc.

    This notion that long term CEOs – Cisco’s CEO has been running the company for two decades – can continuously prosper while harming the stockholders is bizarre. CEOs that are bad for stockholders are generally quite quickly fired.

    This whole article is another disingenuous and misguided attempt to claim that CEOs and top corporate executives can do well long term without rewarding stockholders. Total nonsense.

    Are there exceptions on occasion? Sure. Just like there are Doctors who get paid for surgery while killing the patient, lawyers who get paid while the client gets convicted, public school teachers in New York who are on the payroll for years whiteout teaching after abusive behavior to kids, journalists being paid for biased reporting, etc, etc, etc. There are people occasionally being rewarded for bad performance all over the economy.

  • JonThomas

    Excellent article! Thank you for posting!

  • ElC

    Talk about disingenuous, I shouldnt even have to point out that rising stock prices disproportionately benefit the 1%, along with the CEO’s.

    And buy backs may pump up the stock price short term, but it’s a totally unproductive use of profit, as the author said long term it hurts the company because it’s not going to the things that grow the company such as investing in employees and R and D.

  • Anonymous

    Absurd notion.

    The profits of a corporation, above and beyond what is needed for investment that increase future profits and financial reserves, belong to the owners of the corporation – i.e. stockholders/investors/private owners.

    Those profits can be returned to stockholders in two basic forms. 1 – paying dividends, 2 – stock buybacks that help increase stock value. That is it.

    There are certain advantages to do share buybacks. For example, with a share buyback, the stockholder decides when to realize the gain (and pay taxes on it); with dividend payment, there is no choice.

    So stock buybacks are a very effective and productive way to return corporate profits to the owners of that profit – the stockholders.

    A corporations mission is simply to return profits to investors – nothing else. Not to employ people. Not to pay high wages. Not to reinvest in the business. But to maximize profit returns to investors. Simple as that. Don’t like it, don’t invest in them.

    The author, you and most people here, for some reason seem to think that corporations exist to pay taxes, on employ the maximum number of workers, or to barely break even or to raise wages. They don’t. They exist to generate returns to investors. Come to grips with it.

  • Dude

    Stock buy backs don’t pump up the stock price. That is a factually incorrect premise.Profits and careful financial and business management pump up stock prices. The author of this article does not understand how shares are valued. Stock buy backs are just one way of returning value to the shareholders which is managements fiduciary responsibility. WMT and IBM shares are held by countless 401k and other pension funds which benefit many many middle class people. Baron 95 is correct about that.

  • ElC

    Google is your friend, buybacks raise stock price in a number of ways:
    1. Less outstanding stock means each stock is worth a bigger portion of the company.
    2. It sends a (potentially false) message that the company has confidence in itself.
    3. It makes return on assets look better.

    If it didn’t raise stock prices how would it be a way to ‘return value to shareholders’?

  • Dude

    You are conflating financial concepts and not understanding the how and why profits are distributed to shareholders. Re read my previous posts and get out a finance book. The bottom line is profits. If you have good profitability the dividend can be increased or the money can be reinvested or the money can be retained or shares can be bought back. In the end all these methods of using profits can increase the value of the stock, But the real driver is profits. There is nothing particularly special about buying back shares. The authors needs an editor that understands finance. This is like many articles on this site that start with a false premise and then twist “facts” and concepts to fit a preordained belief and ideology.

  • Anonymous

    Buybacks allow executives to reward themselves (and stockholders in general as fall out) when a company is losing sales and market share. Cisco would be totally out of business right now if China’s Huawei Technologies was allowed to sell here in the US. It is the old story of be careful what you ask for. Remunerate executives with stock options and they very well may sacrifice the future of the company and its employees to keep that price as high as possible until they can cash out.

    It should also be pointed out that the opposite is also true. Executives have been known to punish a stock’s price (and its stockholders) with bad news shortly before they set their option price. Even though it is illegal, it is seldom prosecuted.

  • Dude

    You don’t understand the math underlying stock buy backs.

  • Anonymous

    Thank god, at least one other person here gets it. It is amazing how people here work themselves into a “we are powerless and being abused” frenzy, when they can simply participate in the success of corporations and CEOs buy – drum roll – regularly buying into an S&P500 or other low cost index fund.

    The one that my 401K is on – Vanguard Institutional Index I – has a net annual management fee of 0.02%.

  • lostinbago

    True, but that is also why investments are weighed against the middle income folks looking for retirement security. There are so many tricks that can benefit the CEOs and investors wealthy enough to hire analysts while the majority of us are financing their maneuvers.

  • Dude

    If one is concerned that they don’t understand the details of investing, or are concerned that a specific investment is subject to improper manipulation, the best solution is to buy an index fund as baron95 suggests elsewhere here. The vast majority of “experts” have not, do not and will not out perform the S&P 500 benchmark. That includes hedge funds. Just make sure you get into a low cost broad index fund like baron95 has suggested. Also make sure that you are not investing money you might need in the next couple of years. That way you will not be forced to sell at the wrong time. Buy and hold an index like this for the long term and you will do just fine. The key is not to panic if the market pulls back. Markets move up and down. That is the nature of markets. They always eventually come back. Also look up the concept of dollar cost averaging. Warren Buffett advises this overall course of action be followed by most people. His logic is very very sound.

  • GregoryC

    The stock buybacks are largely, from my understanding, done so with borrowed money while the same corporations hold billions in offshore tax havens, never taxed in any country, awaiting repatriation at a low-taxed rate. I don’t think the investors are being rewarded. I do think the executive class is reaping most of the benefits of this scam.

  • GregoryC

    How many years did it take for investors in the 1920s to recapture losses after the great crash? The 1950s?

    The Federal Reserve has removed risk from the market with their quantitative easing. How much longer can the market only rise? The last real correction was in 2011.

  • GregoryC

    The bottom 80% of Americans owns 11% of the wealth, so most of us aren’t benefiting from stock buybacks.

  • Dude

    Some are done with borrowed money. Some are done out of current earnings. Some are done with a combination of the foregoing. The whole point of a stock buy back is to purchase shares that the market is undervaluing. If you have an opportunity to buy a brand new Ford F150 at a 25 pct discount for your construction business you would probably do it, right?
    It would make sense to borrow money to do that right? Would it make sense to borrow money to buy the same truck if it was selling for 125 pct of its value? The answer is no , right? There is nothing wrong with borrowing money if you do it for the right reasons and don’t over leverage the business. Borrowing money to buy undervalued shares rewards the remaining shareholders. It’s just that simple. Why is this so hard to understand. It’s basic finance.

  • Anonymous

    That is right. And a big part of the reason are liberals like Bill Moyers and many comments here scaring people away from investing in the stock market.

    Look how many stories were published here on “401K investments wiped out”, how “the stock market is risky and no one should put their money there”.

    Did you see any stories here saying that the stock market has gone up 250% in the past 5 years and that 401K balances are at all time highs?

    That is a tremendously destructive agenda that the left has.

    I don’t care how much money a person makes. If every one put 5% of each pay check into an low cost index stock fund, it would do more to combat wealth inequality than anything else being debated.

    Yet, liberals, including this very site do everything they can to scare ordinary people away from the stock market. And then they want to comment envy and hate towards those who invest and see their wealth grow.

  • Dude

    Thanks Baron95. I have been reading your posts. You add an interesting perspective.