Why does a company go public? Money. I mean, in theory there are a myriad of reasons why a specific company would decide to take on an initial public offering but the most likely scenario boils down to a company that needs additional cash to expand. The idea is to raise funds to in turn invest in infrastructure, or commercialize a product, or expand the business. It can even be used to attract new top managers by way of creating stock options. In each of these scenarios a company looks to create cash to improve their business.
Hopefully, as things progress, that company begins to succeed. They sell more products; they improve operational processes; and in turn generate even more cash. With that cash they can generate new products, create more jobs, and essentially drive the economy forward in the eyes of the everyday consumer. But what happens when that company decides it is going to hoard that cash. Instead of looking to invest in new technology or expand its market share, a firm simply returns the cash to its investors in the form of a dividend, or decides to buy back some of their own shares on the open market? How does that help the economy? In short it really doesn’t.
As we have apparently reached the official end of the Great Recession, corporate profits are high, and the stock market is booming but the majority of Americans are not seeing results. Now why is that? Because all of the gains are being kept at the top and stock buybacks are part of the reason why. Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market. Dividends then also absorbed an additional 37% of their company earnings. Examining these statistics, it is clear that firms have given incredible gains back to their top investors, usually those in the upper classes, while leaving very little for investments in productive capabilities or higher incomes for their employees. Furthermore, the scarcity of shares on the open market due to stock buybacks drives up the share price, often rewarding corporate executives who hold stock options and are trusted to make these strategic decisions. Sounds pretty corrupt right? Well the trend has become so dangerous that even top investors have become worried. Quoting Laurence Fink, the chairman and CEO of BlackRock, the world’s largest asset manager, “Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks.” So, this type of behavior not only increases inequality in the United States, but it is also just bad business.
So why should you care and what do we do about it?
Every day there is a new story or a new program focusing on science, technology, engineering, and mathematics (STEM) education in the United States in order to “prepare our children” and grow our economy, but guess what, without investment it’s nearly useless. If business leaders continue to reward themselves through dishonest strategic decisions like drastically increasing dividends and share repurchase agreements, the economy will suffer and we will all fall behind. The bottom line is that share buy-backs were meant to be used to correct when a company is being undervalued by the market, not to squeeze every available dollar out of an organization. Looking to the future, companies should be required to justify the price and returns on repurchases as they would on acquisitions or any other investments by the United States Government. This type of regulation will incentivize responsible investment in the private sector and prevent those in power from lining their own pockets with the fruits of our labor and productivity.