"Maximizing shareholder value" has indeed gotten out of hand. There are several reasons for this.
One is tax policy. A corporation can pay for its capital in three ways: 1) dividends on stock, 2) interest on loans, and 3) stock buybacks to increase the stock price. The first is taxed more highly than the second two. This has a huge influence on corporate behavior. Because payments on loans are not taxed, converting equity to debt increases profits. This funds the entire "private equity" industry, which is really about leveraged buyouts. This bias in favor of loans also increases the involvement of the banking industry in corporate finance.
Loans and investments aren't really that different. They once were; lenders expected to be paid back. Then came junk bonds, where the interest rate is cranked up to compensate for the risk, and the securitiziation of debt, which allowed off-loading the risk onto other investors. (See 2008 financial crisis.)
There's an occasional call to "end the double taxation of dividends". Taxing interest paid and stock buybacks at the same rate would be equally effective. This would be a good time to do that economically, because interest rates are so low.
Stock buybacks are mostly a tax dodge. But that's not the full reason for their popularity. For stockholders, they're no better than dividends. But for stock option holders, which usually include the CEO, they're a windfall. Option holders get nothing when the company pays a dividend and the stock price remains the same. But in a buyback, the stock goes up and they win big. This is one of the major factors driving CEO pay upward. (If you assume CEOs are rational actors as regards their own compensation, much corporate behavior becomes clearer.) Japan doesn't allow stock buybacks for most types of corporations. The US does. It doesn't really benefit anybody but management.
So that's the tax policy argument. It's dull, but important.
As for why companies prioritize shareholders so much, more than they used to, the reason is simple - less fear by companies. Companies used to be afraid that overdoing it would lead to government action. Their business might be nationalized, taken over by the Government. Britain did that to the rail, coal, steel, airline, power and telephone industries. The US never went quite that far, but electric power and telephone companies used to be regulated utilities with rate-of-return regulation, and the airline and trucking industries were regulated by the Civil Aeronautics Board and the Interstate Commerce Commission. In the US, this was a political compromise between big business and small business. Small businesses didn't want big monopolies to have control over their essential services, like power and transportation.
All this changed starting in the late 1970s. Nationalized and regulated businesses were stable, but seemed inefficient. They had no incentive to take risks to improve. The history of the Reagan era is well known, so that doesn't have to be repeated here, but reviewing the history of deregulation is useful. What seems to happen in deregulation of regulated monopolies is that a large number of new companies enter the field, and prices go down. Then most of the new companies go bust, and the winners consolidate. The result tends to be deregulated monopolies. Look at the last 30 years of the telephone industry, from AT&T to lots of little companies and back to AT&T.
There's another source for the decrease in corporate fear - the end of communism. It's hard to realize this now, but from the 1930s through the 1970s, there was real worry in the US that communism might beat capitalism economically. By the 1950s and 1960s, the USSR had a successful space program and was industrializing rapidly. Capitalism had serious ideological competition. In the 1980s, though, it became clear that the USSR couldn't make their system work. It worked for some of the big, centralized stuff - coal, steel, power, and such. But the rest of the economy didn't work very well. With that threat removed, companies could stop worrying about socialism and communism gaining popularity.
Related to this was the decline in labor unions. This has a lot of causes, but the biggest one is simply that unions peaked in the era when industry centered around huge plants with huge numbers of semi-skilled employees. Those were the situations in which unions had the most leverage. There were once steel mills which employed 5,000 people with shovels. If you visit a steel mill today, there will be some shovels around, but they're just for cleanup. You'll see a lot of machinery and not many people. Manufacturing employs 7% of the US workforce. It was around 40% in 1950.
Labor unions once had a big influence on working conditions. When a sizable portion of the workforce was unionized, non-union businesses tended to have working conditions not much worse than union shops. Companies didn't want a labor-organizing campaign. So the 8 hour day and the 40 hour week were standard, and pay tended to follow union levels in non-union businesses. That's disappeared.
As a result of these changes, there's no major political opposition left to "maximizing shareholder value". That's why we're where we are now.
> There's an occasional call to "end the double taxation of dividends". Taxing interest paid and stock buybacks at the same rate would be equally effective. This would be a good time to do that economically, because interest rates are so low.
I'm in Australia where there's a system of dividend imputation. That means that together with dividends one will receive franking credits representing tax that a company has already paid. This has another advantage of really benefitting shareholders on a low income, few as there may be. The corporate tax rate is 30%. The highest marginal tax rate for the median income earner is 32.5%, meaning dividends, as paid out, will typically attract an effective 2.5% tax. Wonderful.
For someone receiving 70c in dividends and earning under $18k a year, they will get another 30c back through their tax return.
It's a pretty nice system and it's astonishing to me that the vast majority of other countries don't do this. It also means that domestic shareholders are advantaged over foreign ones.
Then there's also the government restriction on mergers/acquisitions among the four big banks, which provides stability, consumer benefits, a nice dividend for the shareholders - it provides an actual desire by the banks to create value.
http://en.wikipedia.org/wiki/Dividend_imputation
http://en.wikipedia.org/wiki/Four_pillars_policy
When it comes to taxes on lower incomes and dividends, an earner in the US under $36,900/year has a qualified dividend tax rate of 0%. (From what I understand, at least)
http://en.wikipedia.org/wiki/Qualified_dividend#cite_ref-4 http://en.wikipedia.org/wiki/Rate_schedule_(federal_income_t...
Few people with incomes under $36K a year own significant amounts of stock, except maybe some retirees.
>among the four big banks, which provides stability
I suppose "stability" is one upside of a government supported quasi-monopoly. Australian banks are an absolute disgrace. I say that as an Australian who returns home from time to time. Charging $2.50 to withdraw money from an ATM?? They get away with gouging customers in ways that simply couldn't happen in the UK or US.
1. Pervasive cashless transactions, years ahead of the US or even the UK means that the need for ATMs is minute. I have withdrawn a total of $290 in 2014 (so far, but we're in December now). $1750 in 2012, $510 in 2013 and now $290. Everything else is contactless/chip/electronic transfers.
2. Only if you use an ATM not run by your bank or not in your bank's network. There's near enough always going to be a cluster of four ATMs corresponding to the four big banks in any area, at least one of which will be free to withdraw from.
3. Get an account with ING Direct and they will refund you any ATM fees, even those charged by other companies.
Disgrace? Please.
>Pervasive cashless transactions, years ahead of ... even the UK
I've shuttled back and forth between the two countries for seven years now, and I can tell you, unequivocally, that you're speaking out of your bumhole.
With a few minutes of Googling, not even per capita or anything:
Visa PayWave transactions in Australia, in July 2014: 58 million
All contactless transactions in the UK, in September 2014: 32 million
And with ING Direct offering 2% cashback (and some banks doing a promotional 5%) on all contactless transactions under $100 things are good. And in the UK contactless is limited to less than A$40, while in Australia it's A$100.
Everything you said sounds logical. But, it's a wide swath of information. What books/articles are you sourcing to piece this all together?
I will say that it is a complete mess. A lot of businesses today treat their customers and employees like garbage. On the other hand a lot of of the existing unions are parasitic so I understand criticisms on both sides. I can only suggest that it is because we have a very bad form of corporatism run amok in the US. Where regulation does exist it tends to support large companies (which I suppose is not much different from the picture in the 1970s).
The left is afraid of big heartless business. The right is afraid of big inefficient government. We have a wonderful mix of both. Both sides are too busy screaming about the splinter in the other's eye that they miss the log in their own.
> Nationalized and regulated businesses were stable, but seemed inefficient. They had no incentive to take risks to improve. The history of the Reagan era is well known, so that doesn't have to be repeated here, but reviewing the history of deregulation is useful. What seems to happen in deregulation of regulated monopolies is that a large number of new companies enter the field, and prices go down. Then most of the new companies go bust, and the winners consolidate. The result tends to be deregulated monopolies.
How do you combat this? Both seem less than satisfactory.
Everything you said sounds logical. But, it's a wide swath of information. What books/articles are you sourcing to piece this all together?
Hacker News barely supports links, and you want footnotes?
Volatility and CEO pay, Harvard Business Review: https://hbr.org/2011/06/volatility-the-nasty-truth-abo.html
AT&T breakup and reassembly: http://gadgets.boingboing.net/gimages/atthistory.jpg
Union decline: http://www.hup.harvard.edu/catalog.php?isbn=9780674725119
I thought it was fairly common etiquette on HN to actually provide footnotes[0].
[0] like this
I was under the assumption people who did that had a special plug-in that would automatically do that. I picked the habit and do it by hand though.
I would seriously love that plugin but I just use a text editor.
Here's a plugin for an editor: footnode-mode for emacs.[0]
[0] - http://www.emacswiki.org/emacs/FootnoteMode
> Stock buybacks are mostly a tax dodge. But that's not the full reason for their popularity. For stockholders, they're no better than dividends.
Aren't they better for stockholders as well?
Suppose I have 1 share of stock, and I will sell it two years from now.
If the company pays out dividends, won't those be taxed as income at my marginal rate? Whereas if the company does a stock buy back, then two years down the road the marginal value that would have been paid out in dividends is now captured in the stock price. So instead of paying the marginal rate, I pay capital gains on that amount.
I might be missing something, but it seems like a tax dodge that benefits all (except the government).
Dividends are taxed at the marginal rate? US corporate "Qualified Dividends" are taxed at the same rate as Capital Gains.
the real argument should be tax-free growth.
With dividends, you pay the tax immediately/that year.
With capital gains, you don't pay until you sell.
If one looks long-term enough, you could also sell when you are in a lower income tax bracket or the government has lowered capital gains for random political reasons.
You are correct that they are usually taxed like capital gains (up to 23.8% currently), but stock buybacks allow deferment of these taxes, which is usually better. If you hold the stock until you die and don't reach estate tax levels, then the stock gets passed on essentially tax free, making stock buyback even better.
Ah, that makes sense. TIL.
I'm Canadian, and we have something similar. But it only applies to corporations that are resident in Canada (where Canadian corporate taxes are paid on retained earnings?). I think the intent is to recognize the tax already paid on earnings, not necessarily to make it like taxable like capital gains... but it's all a wash.
It seems that qualified dividends in U.S. are limited in similar ways.
My confusion makes sense in retrospect: I have generally held stock from U.S. markets, so I don't often benefit from the credit. I believe dividends were always counted directly as taxable income.
So... supposing that you're in the U.S. and your stock isn't U.S.-based, wouldn't buybacks always be more tax favorable?
Yes, but tax policy changes. If taxes were even, there would be no difference between dividends & stock buy backs for stock holders, but there would still be a difference for option holders.
I think it's worth clarifying what's meant by the "double taxation of dividends". This refers to the fact that the company (at least in theory) already paid taxes on its profits, which are then taxed again as ordinary income when passed on to shareholders in the form of dividends. Arguably, this second tax occurs even when the profits are returned as capital gains (which is the case with buybacks), but in that case a) the tax rate is much lower, and b) the shareholder can choose to defer the tax payment by simply holding onto the stock until a future date. Long story short, the preference for buybacks over dividends is not about avoiding double taxation per se, but rather minimizing the tax rate of profit distributions. Per OP, one way to fix this would be to tax them the same regardless of the distribution mechanism.
Another example of how taxing capital gains at less than 'ordinary' income has all sorts of weird and often undesirable effects.
Of course, I guess the argument for it is that it has the favorable effect of encouraging capital investment, that's what it's supposed to do right? I am curious what evidence there is of how well it does that.
According to wikipedia, capital gains were taxed as ordinary income in the U.S. until 1921, and the history since then have gone up and down -- but are currently at their historical low. http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United....
In many countries, capital gains are not taxed at all: http://en.wikipedia.org/wiki/Capital_gains_tax
I haven't actually counted it up from the wikipedia article, just skimmed, but looks like maybe mostly "developing"/"third world" countries? Which are desperate to attract capital investment, and usually not entirely in control of their own fiscal policies.
Animats' post is one of the best in HN history.
Most people who follow financial news know that share buybacks increase EPS, but Animats goes a whole level deeper.
As we found out from Wall Street's behavior during the recent crash, executives are rational actors, and what they want is as much as they can take, economy be damned.
> "Maximizing shareholder value" has indeed gotten out of hand.
None of the examples you give show this. What they show is that, because of flaws in corporate governance, things that do not maximize shareholder value are being done in the name of "maximizing shareholder value".
I am not sure why you are being down voted as you are 100% right. It is not the stated aim that is the problem it is the implementation which is being corrupted.
Quite!
I don't follow the logic at all; other than altruism, why would anyone buy shares of a company that wasn't trying to make an excellent sustainable profit over time / increase its share value?
> why would anyone buy shares of a company that wasn't trying to make an excellent sustainable profit over time / increase its share value?
Because they're not trying to make money from the shares increasing in value sustainably; they're trying to make money in other ways. A couple of examples:
* Buying some shares, creating a bubble that causes those shares to increase in value non-sustainably, then selling the shares before the bubble pops;
* Getting compensated in stock options with a low exercise price, taking short-term actions that cause the share price to rise non-sustainably, exercising the options and selling the stock at a higher share price, then using a golden parachute to leave the company, letting others pay the price for the non-sustainable actions.
> In the 1980s, though, it became clear that the USSR couldn't make their system work.
It was clear long before then. There was a lot of fear of the USSR's military capability, but not their economy. One obvious example was Kansas was shipping wheat to the USSR starting in the early 70's to make up for Soviet agricultural shortfalls.
"Clear" as in "the overwhelming opinion of experts operating without the benefit of hindsight" or "clear" as in "a position held by the masses primarily out patriotic faith"?
The GDP charts I've seen seem to support the latter: the USSR's developing economy grew significantly faster than the US's developed economy for a sustained period of several decades. The "collapse" of the USSR didn't look so much like an adjustment (i.e. what you would expect if those numbers were completely fictitious) but rather a leveling off of growth. As for your "obvious example," 1. importing food is not necessarily indicative of a shortfall and 2. from what I understand, the central government of the USSR occasionally starved sizable chunks of its population for political reasons rather than due to actual shortfalls (e.g. while simultaneously exporting food).
Who was the source of the GDP charts?
From the personal experience (I was born in USSR in mid-70ies and have lived there since) 50% of the GDP should have been military expenses, including space program. Everyday life was more like to the poorest Latin America or African countries now, plus common shortage of anything but very basic food items. Even these were also often grown by people themselves. Common joke was following. Lecturer: "By 1980 Soviet Union will bypass USA economically". Student: "Better catch, but not to bypass". "Why not bypass?" Answer: "Then they would see that ass is naked".
> Japan doesn't allow stock buybacks for most types of corporations.
Where did you get this? Stock buybacks are commonplace in Japan. Try and search "ＴＯＢ 株" or "株式公開買い付け" on Google News (use Google Translate if you can't read Japanese).
Non-dividend-paying stocks are much less common than in the US, but that doesn't mean that buybacks aren't allowed.
Sorry, obsolete info. "Repurchases by firms in the open market, the main type of buy-backs today, used to be banned. America loosened its rules in 1982, Japan in 1994 and Germany in 1998." (http://www.economist.com/news/business/21616968-companies-ha...)
So if I'm understanding you correctly, a dividend is just as good as a buyback from the POV of a shareholder but a buyback is preferred because it makes options holders more money. If this is the case, can you explain why there are companies that issue dividends at all? Are these companies that are paying their execs with few options?
How are buybacks a tax dodge? If they have the desired effect of boosting share price, then there will be increased taxes paid by shareholders when those positions are exited, no?
Dividends are taxed immediately. Stock buybacks are unrealized gains.
to expand, since Dividends are taxed immediately, you can only reinvest the nontaxed portion, whereas with buybacks, you effectively reinvest the entirely amount and can have better compound returns.
Also, some people will need dividends for cash flow needs.
I think that's mistaken. You can invest the not-yet-taxed amount, but eventually you're gonna pay the tax. The real advantage (apart from the lower rate) is that the taxes are deferred.
With buybacks your profit is taxed once. With dividends, you first pay tax on your dividends. When you reinvest your dividends, you then pay tax again on the return of those reinvested dividends, and so on.
Let's see what happens to two companies, one of which pays 10% dividend each year, and the other which increases in price 10% each year. Use a tax rate of 15%.
The first company: Every year we get 10% dividend, pay 15% tax on that, have 8.5% post tax dividend. Reinvest in company.
value = initial * (1.085)^nyears
The second company: Every year it increases in value by 10%. If we ever were to sell we would have to pay 15% tax on appreciation.
value = initial + initial * (1.1^nyears-1) * 0.85
This isn't really the issue. See my comment above, which in your example translates to the tax rate in company one's scenario being ~2x the rate in company two's.
While both are indeed taxed, dividends are taxed as ordinary income, whereas gains from sale of stock are considered and taxed as capital gains. In the US at least, the capital gains rate is somewhere around 1/4 to 1/2 of the ordinary income rate, so it's much more "tax efficient" to do a buyback than to pay dividends.
Uh, what about Qualified Dividends? http://en.wikipedia.org/wiki/Qualified_dividend
Very good point, I was unaware these were still in effect (haven't been a US tax payer in several years).
In the popular media the impression is that dividends are not taxed as ordinary income. The reason those evil rich trust fund guys pay lower taxes than the secretary etc.
I don't mean to take pot shots, but I picked up a few quibbles along the way. Touching just the more technical early paragraphs:
Dividends, interest, and repurchases aren't the whole picture. Especially when funders are also insiders, a variety of other (sometimes "soft") benefits reward investment. Much corporate behavior studied in the vein of management conflicts of interest relates to executive compensation and other benefits that may or may not contribute to personal tax base. There is also the matter of trade in securities based on valuation, on public markets and otherwise, by investors of all stripes. Many listed companies have never paid a dividend and probably won't ever pay a dividend. S-1s for well subscribed IPOs often warn pro forma this will be the case. Companies may also adjust the amount and kind of risk they bear to align with one constituency at the expense of another (e.g. management over outsiders, well organized institutional investors over the masses).
While leveraged buyouts are by no means dead, PE is far more than LBOs. The industry predates and has long outlived the 80s LBO boom. The term is a broad umbrella over many different kinds of operators leveraging (or suffering under) various features of our tax system.
Debt and equity still enjoy different rights in liquidation, and contractual covenants and controls accompanying credit are different than rights assigned to equity holders by statute, governing documents, financing agreements, securities laws, and exchange rules. Like the time-remote possibility of dividends from a growth company, different spots in line to the coffer of a healthy operation still affect valuation. Derivatives and public markets can facilitate decoupling of control rights from equity. Instruments can be designed to blend equity and debt characteristics. But debt and equity still confer different rights to affect operations.
It is difficult to speak of stock buybacks out of context; their use is varied, from purely financial to entirely structural. They are not entirely "unregulated", either. Background state corporate law, governing documents, exchange rules, and contracts (including debt documents) impose restrictions on when and how. The board is involved. Markets, public and private, may take note.
It is also difficult to make tax arguments out of context. Even statements about the macroeconomic effects of certain policies have to turn on the prevalence and kinds of tax situations meaningful populations of companies inhabit. Tying the tax effect to rising executive compensation requires at least time-correlating tax policy changes to compensation. I'm not sure that's borne out. There are many additional confounding variables.
Thanks for sharing your opinions. You've got some good back-and-forth started.
Edit: Changed "bankruptcy-remote", which is a term of art in bankruptcy, to "healthy", which makes the point with less risk of confusion.
I'm aware of many of those issues, but they're a bit much to explore in detail on Hacker Digest.
Not trying to be a dick, but he pretty concisely and clearly proved your proposal to be unviable and relatively unsubstantiated. So the "bit much" would literally be the actual reasoning or if it has any empirical backing what-so-ever.
We on "Hacker Digest" (actually curious, do some people call it that?) would kind of appreciate that.
I'm simplifying. If you want more detail, here it is.
Much corporate behavior studied in the vein of management conflicts of interest relates to executive compensation and other benefits that may or may not contribute to personal tax base.
Er, yes. Problems include "pay for volatility". If the CEO gets an option grant at market every year, and the stock price is flat, the option is worthless. If there's huge volatility, the option can be exercised at a peak, but is costless in a down year. McKinsey has a nice article on this: https://www.gsb.stanford.edu/sites/default/files/documents/m...
While leveraged buyouts are by no means dead, PE is far more than LBOs. The industry predates and has long outlived the 80s LBO boom. The term is a broad umbrella over many different kinds of operators leveraging (or suffering under) various features of our tax system.
Seldom does "private equity" mean an actual cash purchase by a private party. There's usually debt involved, often taken on by the business being bought. There's also usually some tax gimmick involved. It's interesting how often a business turns around after going private, even with the same management team. See this article on Dell, a year after going private: http://www.cnbc.com/id/102026551
Debt and equity still enjoy different rights in liquidation ... But debt and equity still confer different rights to affect operations.
Yes, debt and equity are not the same thing. But they're a lot closer than they used to be. Here's a piece on startup financing, comparing convertible debt vs. preferred equity. (http://mintonlawgroup.com/?p=173) The classic property of debt is that there is a bounded upside; the best that could happen was that the creditor got their money back with interest. With convertible debt, if the company does well, or even just gets another round of funding, the loan can be converted to stock and the creditor can win big. If the company fails, as creditors they're ahead of all equity holders and maybe even general creditors. It's also not unusual for creditors to demand a seat or seats on the board, even if they don't have equity.
It is difficult to speak of stock buybacks out of context; their use is varied, from purely financial to entirely structural.
Yes, their use is varied. But about 87% of US corporate borrowing since 2009 is for stock buybacks or dividends. (http://www.washingtonpost.com/business/corporations-cant-sto...). This reflects the low, low interest rates the Fed is offering. Equity to debt conversion is so tempting.
It is also difficult to make tax arguments out of context.
Most tax arguments for political campaign purposes are over tax rates over time. There's less public discussion over what is taxed at which rate. That, though, is what a sizable fraction of K Street lobbyists spend their time on. See "http://www.nytimes.com/2014/04/02/business/tax-lobby-works-t..., which notes, on tax breaks, "If you are not at the table, you are on the menu". Relative tax rates for alternatives drive many business decisions. Absolute rates, less so. Over the years, capital gains tax rates have gone up and down without affecting capital spending comparably. See "https://en.wikipedia.org/wiki/Capital_gains_tax_in_the_Unite..., the graph for note 17.
(I suspect I'm boring everyone to death at this point, so I'll stop.)
>I suspect I'm boring everyone to death at this point, so I'll stop.
On the contrary, I, for one, am quite engaged by both your commentary and citations. Thanks!
With everyone else on this - if you have the time and inclination turning the above into a series of posts would be very informative, and link worthy.
Thank you for your comment. The week is picking up, and I may not have a chance to repay you in kind once more.
I have put a few of the links on my reading list.
Doesn't share price typically go down after a dividend payment, by exactly the amount of the payment per share?
They do, but that's a very short term logical thing. If you reason about the long term, the stock that pays a steady and steadily increasing divident is obviously worth more than one that doesn't.