In 2009, a global coalition was pressing governments to lift the veil on corporate secrecy. Its members – U.S. President Barack Obama’s administration, influential senators, international law enforcement agencies, anti-corruption activists and major American allies — presented a formidable front in their campaign against money laundering and tax evasion.
The United States, championing the cause abroad, was also pursuing legislation for stronger disclosure rules at home.
Then along came Jeffrey Bullock, the newly appointed secretary of state for Delaware.His tiny East Coast state was in crisis, heading toward an $800 million budget deficit. Delaware’s second-biggest biggest source of revenue was fees from few-questions-asked company registrations and other corporate services. That cash cow was in danger.
A proposed U.S. law would have required states to track the true owners of the companies they register. The global pushback against shell companies was threatening to dim Delaware’s longstanding appeal as a secretive corporate domicile.Seven years later, the proposed law continues to languish, thanks in part to Bullock.
Just like the rest of us, corporate executives and board members have some tough choices to make about how to spend the company’s money. Or, I should say, our money.
A public company sells stock to outside investors, meaning those of us with pensions and 401(k) plans and mutual funds. Its primary obligation by law and presumably by market forces is to find the best use for that money to create long-term value for shareholders. Of course, they cannot create that value over the long term without attending to the needs of customers and employees and being careful about obeying the law. With that in mind, the executives and directors design the strategy. They have to decide whether the money will be spent more effectively on research and development of new products or on marketing the old ones.
Recently too many companies have opted for a third option — buying back their own stock. A report issued this week from the Investor Responsibility Research Center Institute and Tapestry Networks found:
S&P 500 companies acquired $166.3 billion of their own shares in the first quarter of 2016, more than in any other quarter since the financial crisis….In each of the last nine quarters, at least 370 S&P 500 companies repurchased shares, and over the last three years, S&P 500 companies spent over $1.5 trillion on buybacks. Between 2003 and 2013, S&P 500 companies doubled their spending on share repurchases and dividends while cutting their spending on investments in new plants and equipment. According to data from McKinsey, buybacks have accounted for 47% of US companies’ income since 2011, up from 23% in the early 1990s and less than 10% in the early 1980s.
There are valid reasons for companies to buy their stock, especially when they have excess cash and the stock price is substantially below their internal valuation. If the executives do not have a better use for the money, they should return it to shareholders and let them invest somewhere else. But stock prices are high right now. In buying back their own stock, CEOs are telling us that they can think of no better place to spend the company’s profits than buying their own shares while prices are at record highs. Gretchen Morgenson of the New York Times calls the positive impact on the stock price a “growth mirage.”
The increase in buybacks is a warning sign for three reasons. First, it should be a concern that executives do not have any better operational or strategic ideas for creating sustainable, organic growth. We’d rather have them return capital to investors than to overspend on acquisitions. But we invest in these companies because we believe in their business plans and if they cannot find a use for the capital, they owe us an explanation that has to go beyond financial engineering tied to quarterly numbers.
The second concern is that buybacks suggest that boards of directors have approved incentive compensation plans that promote buybacks even when they are not in the interest of shareholders. If they set performance goals in terms of earnings per share, there are two ways to hit the number: higher earnings or reduced number of shares. Boards should make it clear that they reward only higher earnings. The IRRCi/Tapestry report found “Although a number of directors mentioned that their companies project how buyback activity will affect EPS and adjust targets accordingly, only 20 S&P 500 companies disclosed that they did so.”
While compensation consultant Ira Kay acknowledges that executives with more stock options implement more buybacks, he insists that it did not diminish the returns to shareholders over the four-year period he studied. Over the longer term, however, the effects may not be as benign, as the money used for buybacks is not being used for improving operations.
Between 2003 and 2013, S&P 500 companies doubled their spending on share repurchases and dividends. But, at the same time, companies cut spending on investments in new plants and equipment.
A third warning sign is the shift in where the money for these buybacks is coming from. Increasingly, it is not excess cash but debt. David Ader writes in Barron’s:
The bond market should be concerned about stock buybacks, but not because of their bullish effect on share prices. Instead, bondholders should be anxious about where the cash to pay for them comes from. It isn’t widely appreciated that the money has been borrowed in the credit markets, and that the borrowers have taken on a large amount of debt to support the buybacks.
It is one thing to return excess cash to shareholders if executives have no strategic ideas, though it raises questions about management’s judgment and the company’s future prospects. But it is harder to understand a decision to take on debt to purchase the company’s own shares, a maneuver with short-term gains but significant long-term risks.
Directors interviewed for the IRRCi/Tapestry report justified using debt to buy back stock because US tax policies and low interest rates have made cheap and easy to borrow money.
The large build-up of capital in non-US affiliates means that companies have an emergency fund to draw upon should it become necessary. As a result, creditors offer very attractive loans to companies, meaning some corporations are able to engage in almost costless borrowing to fund buyback programs.
The directors IRRCi/Tapestry interviewed insisted that “their companies can afford both buybacks and adequate investment. They listed the usual justifications for buybacks,
• To return capital to shareholders
• To invest in the company’s shares
• To offset dilution from using equity as currency
• To alter the company’s capital structure
Many directors said that they would be unlikely to find enough good opportunities to invest all their companies’ available capital in today’s low-growth, low-interest-rate environment, and that it was often better to return capital to shareholders than to hoard capital or invest in projects with less-than-desired projected returns. Directors also said they tend to prefer buybacks to dividends because they believe a buyback program offers greater flexibility over time.
IRRCi executive director Jon Lukomnik says, “A trillion and a half dollars in buybacks over three years certainly returns capital to shareowners and reduces the number of shares outstanding. That’s why buybacks are popular. But, some view buybacks as financial engineering to juice short-term corporate performance at the expense of investments that would better grow companies and the economy over the long-term.”
The report’s most significant recommendation is for improved disclosures about share repurchase programs, noting, “Few companies publicly disclose details about buyback decision-making and very few state the reasons for a specific buyback program.” Concerns about misaligned incentives and the increased use of debt shift the burden of proof to require much more specific disclosure about the process and calculus used to quantify the benefits of buybacks. Shareholders need to know whether they are getting their money’s worth from buybacks and from the executives and directors who approve them.
By stripping people of any meaningful way to hold companies accountable for fraud or abuse, forced arbitration grants Wall Street an effective license to steal from consumers to pad its bottom line.
But the era of the “rip-off clause” may soon come to an end — at least in consumer finance. When Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, legislators specifically addressed the growing harm of forced arbitration. In addition to creating a new consumer watchdog in the Consumer Financial Protection Bureau (CFPB), Dodd-Frank tasked the agency with studying the impact of forced arbitration in the financial marketplace. If it found evidence of harm to consumers, the agency was specifically instructed to restrict or ban the practice.
Last year, the CFPB completed the most comprehensive study of arbitration ever done, and the data showed very clearly that forced arbitration favors companies and wipes out consumer claims. The agency then moved to fulfill its mandate by proposing a new federal rule to rein in this increasingly widespread practice. Americans for Financial Reform (AFR) and Public Citizen recently partnered to step up a joint campaign to take on forced arbitration, working with a broad coalition of organizations to build support for the CFPB’s rule-making by raising public awareness of rip-off clauses and the way they work across a range of industries, products and services. In just the last few months, public attention on forced arbitration has expanded rapidly.
A New York Times investigation last fall brought significant attention to veterans, students and consumers harmed by rip-off clauses. More recently, Roger Ailes’s move to push Gretchen Carlson’s allegations of sexual harassment into arbitration has reignited national interest in the inherent secrecy and injustice of forced arbitration.This week marked another milestone in this fight: an unprecedented level of public engagement on forced arbitration as the comment period for the CFPB rule came to a close on Monday.In a joint comment letter, 281 consumer, civil rights, labor and small business organizations registered strong support for the CFPB to move forward with its proposal. Led by AFR and Public Citizen, the letter was signed by national powerhouses advocating for consumer protections, civil rights, labor, women’s rights and small business, along with state and local groups from 42 states and the District of Columbia. Many of these organizations also submitted separate comment letters highlighting specific issues and perspectives.
This is an outrage. Who wants to stop a rule that would save money, paper, trees, and transportation costs by permitting the required mutual fund disclosures to be delivered digitally?
The paper industry, of course.
[L]ast year, regulators proposed what to them was an obvious adaptation to the age of Venmo, bitcoin and mobile banking: make it easier for funds to provide certain records electronically.
But what was logical progress to some loomed as a menace to others—notably the American Forest & Paper Association and the Envelope Manufacturers Association. The two industries’ jointly funded group Consumers for Paper Options rallied retiree and consumer groups to join their campaign, decrying what they call the government’s “rush to digitize.” They persuaded a bipartisan coalition of politicians—especially from the paper-heavy state of Maine—to threaten legislation blocking the rule.
There have been a lot of headlines about the shocking 400% price increase for the vital EpiPen, which is essential for people with life-threatening allergies. An article by a doctor in the NY Times says:
EpiPens are a perfect example of a health care nightmare. They’re also just a typical example of the dysfunction of the American health care system.
With the increase, EpiPens now amount to as much as 40% of the company’s revenues.
It is also a case study in corporate governance dysfunction. There have also been a lot of headlines about the shocking compensation increase for the CEO of Mylan, the company that makes EpiPens. Forbes writes:
But that 400% increase in wholesale price for EpiPen looks meager compared to the whopping 671% salary increase company CEO Heather Bresch is reported to have enjoyed in that same time period.
For the record, Mylan’s compensation committee members:
Mark W. Parrish
And, it’s a study in US tax policy dysfunction and an example of the global “race to the bottom.” Mylan is also a corporate tax dodger, taking advantage of “inversion” so that it is a corporate “citizen” of The Netherlands, though its board is in the UK and its operations are in the US. In addition to escaping taxes, this means it also reduces its accountability through the US corporate governance system.
Bresch is the daughter of a United States Senator and former governor, Joe Manchin of West Virginia. Perhaps he and his colleagues could take a look at what happens when we allow American companies to cherry-pick their tax domiciles without any consequences for their ability to do business with the US government, including government-funded healthcare, and the cost of reduced oversight when “inverted” companies continue to sell stock on US exchanges
Mylan has been “actively lobbying” in favor of a bill in the Senate that would mandate that all airlines, domestic and foreign, carry at least two packs of epinephrine auto-injectors. EpiPens are, by a large degree, the most commonly used devices of that nature in the United States.
Mylan has spent a reported $875,000 on lobbying so far this year, after having spent $1.55 million in 2015, according to OpenSecrets.org,
On Tuesday, CNBC noted how Bresch’s company, in addition to hiking the price of EpiPen by double-digit percentage amounts ever since Mylan acquired the device in 2007, has also been sharply raising the prices of other products this year.
The plan to reward Johnson Controls Inc. executives with “golden parachute” compensation if they are terminated following the merger with Tyco International PLC is not sitting well with shareholders.
About 64 percent of Johnson Controls shareholders who voted on an advisory basis today opposed the compensation plan for the company’s named executive officers. The compensation vote was taken today when shareholders approved the merger of Johnson Controls and Tyco. The deal is set to go through on Sept. 2.
Gretchen Morgenson writes in the New York Times about Hain Celestial, where excessive pay based on a skewed “peer group” should have been a warning sign of investment risk.
The Hain Celestial Group, a maker of natural and organic foods and beverages, has been riding high in the market. But on Monday it came crashing to earth when it disclosed an accounting problem, delayed its full-year financial report and said it probably wouldn’t meet its earnings guidance for 2016….Clearly, investors were stunned by Hain’s statement. Maybe they shouldn’t have been.According to corporate governance experts, clues to oversight problems at Hain have been evident for a while in its excessive executive pay practices and disdain for shareholders’ anger about them.
Corporate Japan now has more than 7,000 outside directors on its boards. That is one of every four and up by about 1,000 from around the same time last year.
According to Tokyo Stock Exchange data, the number of outside directors totaled 7,270 as of Friday, representing 25% of the combined total of directors at all listed companies.The ratio of outside directors still lags that of the U.S. and Britain, where such directors represent the majority. But analysts said Japanese companies are increasingly listening to shareholders when it comes to corporate governance issues.
The data shows that 96% of all listed companies now have at least one outside director. The figure drops to 70% for companies with two or more such directors.
The idea of an international market for CEOs has since been used ad nauseam to justify high CEO pay. But there is little evidence to support it.One recent study found that 80% of CEO appointments in the Fortune Global 500 were internal promotions and only four CEOs had been poached while they were CEOs of another company in a foreign country. There is some evidence to suggest that this makes economic sense. CEOs promoted from within seem to perform better than external recruits.
Whether UK senior management has improved relative to their international counterparts since the 1980s is a moot, and untestable, point. The Chairmen’s Club does, however, appear to have been successful in ensuring that the lion’s share of improvements in company value and productivity have gone to those at the top. The irony is that this seems partly a consequence of elite collective action – which when practised by conventional trade unions is claimed to price their members out of work.
Wage inequality not only undermines the consumption of core goods and services, which keeps the economy on an even keel, it also de-legitimises the very system that rewards the rich. The logical conclusion is that the government should use everything at its disposal to control excessive pay: regulation, the tax system and further lobbying reform. Perhaps it might start by ignoring the pleas of various business groups currently lobbying against the planned increase to the UK’s minimum wage.
The Chamber of Commerce has endorsed proposed legislation that would establish an advisory group within the Securities and Exchange Commission to produce a study on gender diversity among corporate directors and make recommendations on how to promote gender equality on boards.
It would also require public companies to report the gender of board directors and nominees. The Chamber says:
“The bill’s goal of promoting gender diversity in the boardroom of American businesses reflects the reality that women, who historically have been statistically underrepresented among corporate boards of directors, possess invaluable insights, experiences, and management skills that can and should be deployed to support the corporate goals of our nation’s producers, innovators, and employers.”