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Why taxing stock repurchases is the wrong solution for executive compensation

The DealBook Newsletter delves into one topic or theme each weekend and provides reports and analysis to better understand the key issues in the news.Financial journalist this week Roger Lowenstein Consider the Senate Democratic Party’s plans to tax stock repurchases. If you haven’t received your daily newsletter yet Sign up here..

Since then, the company’s share buyback has been Boogeyman on the left. Senator Bernie Sanders attacked them During the 2016 presidential election.

Now the cause has been taken up by Democrats in the Senate. Tax corporation for stock repurchase.. The reason stated is that companies should use their cash to raise wages, rather than geese their stock prices to reward their CEOs.

But the truth is that taxing or limiting stock repurchases cannot end a company’s desires or excessive compensation.

Despite business leaders’ announcements about their efforts to help society, most of the social benefits they make come by chance, as a result Of their success. Private sector may be the basis of American experiments, but most are not aimed at improving the overall standard of living, especially creating employment.

Take Bill Gates. When he started Microsoft with Paul Allen in 1975, he had no idea of ​​turning it into one of the country’s largest employers. He loved computers and was a bright and ambitious kid. Currently, the company’s salary is close to 200,000. By the way, Microsoft has just announced a $ 60 billion stock repurchase program.

Gates and Microsoft are famous examples of the paradox Conceptualized by Adam Smith: All individuals “do not intend to promote the public interest and do not know how much he promotes it.” Instead, “he intends only for his own benefit and, as in many other cases, is guided by the invisible hand to promote a purpose that was not part of his intention.”

The decisions of modern enterprises, including those that determine the level of capital, are also made for selfish or self-interest reasons. Following well-enforced laws and strong regulations, increased success usually results in more work and investment. Conversely, the main street was even worse damaged when businesses were upset during the financial crisis.

The system of public capital depends on the shares sold by the company, but we are not Mandatory The company sells stock. There is no public obligation to maintain a certain level of capital (except in regulated industries such as banks).

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

Repurchase is just a way to redistribute capital from a surplus company to a company that needs it through an investor. Also, too much capital is as harmful as too little, and can lead to misassignment and waste of social resources.

“The best way to use cash is to buy it back if there is no other effective use in your business, or if the stock price is low,” Warren Buffett said in 2004.

Still, companies often make mistakes in capital allocation. Determining the right level of capital depends on predicting future returns. This is a very incomplete science.

It is also true that repurchases often result from a false attachment to short-term stock prices. However, it will be difficult to legislate the distinction between “bad” buybacks and “good” buybacks.

Proponents of share buybacks say the 2017 corporate tax cut has affected the wave of share buybacks. They claim that the CEO used cash for selfish reasons rather than investing in workers.

However, the assumed link between repurchase and inequality has not been proven. (For some periods, the correlation is actually the opposite.) Share buybacks from S & P 500 companies reached a record $ 806 billion in 2018. It has declined since then, but has historically remained at a high level. Meanwhile, inequality measured in both income and wealth declined moderately around the same time from 2016 to 2019. According to the Federal Reserve’s triennial consumer finance survey, it has reversed the trend of inequality that has grown rapidly since the financial collapse.

Of course, inequality remains high (and pushed further by the pandemic). The cause is complicated. However, in general, companies do not raise their salaries because they have excess capital. They raise wages to attract more and more talented workers. If there is a link between repurchase and wages, it’s pretty vague. What we do know for sure is that before the pandemic, when executives were busy repurchasing stock, the relative wages of the bottom people were finally beginning to reclaim the lost land.

The worst aspect of penalizing share repurchases to curb executive compensation is that it is a painfully indirect approach. The argument that repurchases can have the effect of increasing executive compensation applies to everything that raises stock prices. This includes investing in new products, leveraging the balance sheet by borrowing (which has the same effect as retirement of equity), reducing costs, or doing other things that shareholders have decided to reward. ..

Those who oppose the corporate tax cut can better achieve their goals by reversing it rather than taxing the repurchase, which was the expected relatively minor consequence of the tax cut.

For those who think that executives are playing games unfairly and often obscenely in managing corporate assets, it may be more effective to tackle the problem head-on. Raise the marginal income tax on ultra-high-income earners.

More directly, the Securities and Exchange Commission may require executive compensation plans that exceed the minimum threshold to be subject to binding voting by shareholders who support the bill.

Finally, it is argued that the options granted to insiders create unacceptable conflicts of interest and abuse of fiduciary duty. Perhaps they should be banned or the profits of the option should be taxed at a punishably high tax rate.

But is the buyback worth becoming a sick whiplash kid in a real or imaginary business? Evidence suggests that it is better to leave it alone.

Roger Lowenstein is the author of six books, most recently “American Banks: A Grand 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 the repurchase of shares? Is there a better way to reduce executive compensation? Please let me know: Dealbook@..

Why taxing stock repurchases is the wrong solution for executive compensation

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