By Lynn Parramore, Senior Research Analyst at the Institute for New Economic Thinking. Originally published at the Institute for New Economic Thinking website
President Biden’s $2 trillion infrastructure and climate proposal has a lot of people excited, and no wonder. Americans are sick of being stuck with frazzled electric grids, foul drinking water, falling bridges, far too many left out of prosperity, and feeling that the country’s global status is suffering.
On March 31st, President Biden described his vision to carpenters at a training facility in Pittsburgh: “It’s going to boost America’s innovative edge in markets where global leadership is up for grabs—markets like battery technology, biotechnology, computer chips, clean energy, the competition with China in particular.”
Sounds great! But according to economist William Lazonick, a leading expert on business innovation, we can’t get there without first dealing with how Wall Street billionaires are allowed to call the shots for American businesses. Right now, large, capable companies like GE and Intel – companies that could be mobilized to help achieve the laudable goals of Biden’s plan — are getting their marching orders from hedge fund predators looking to make a quick buck. The interests of these financiers don’t align with what firms need to be doing to achieve large-scale, long-term goals, like competing with China on clean energy.
In Lazonick’s view, any company that gets taxpayer-funded subsidies to partner with the Biden administration on an infrastructure and climate plan should be focused on ramping up its capabilities and delivering the products America needs, not playing Wall Street casino games for the benefit of wealthy hedge fund managers and executives.
Shaking Off Shareholder Value Ideology
First, a little history. Back in the 1980s, a very bad idea took over America, so bad that Jack Welch, the famous CEO of GE from 1981 to 2001, called it “the dumbest idea in the world.”
“Shareholder value theory” held that the sole purpose of a company is to make money for its shareholders. Never mind its products, customers, or employees. Forget about the firm’s long-term health, or heaven forbid, contributing something useful to society. Nope—a company existed only to shovel money to shareholders as fast as possible. Full stop, end of story.
This myopic mentality resulted in big firms losing interest in doing things like investing in R&D, building manufacturing plants, or using profits to attract and retain the best talent. Nowadays, whenever they try these things, a set of Wall Street predators stands poised and ready to attack them.
These predators are known as “shareholder activists” and they’re the descendants of the corporate raiders of yesterday. Usually they are hedge fund managers seeking high yields for clients. Their modus operandi is to buy up shares of a company’s stock, pressure the management to jack up the stock price by any means necessary, then dump the stock, make a cool profit on the turnaround, and move on to the next target. It’s quick and dirty.
Certainly these hedge fund activists aren’t interested in a CEO’s dreams to build technology for the future. They are fixated on the short-term, and their favorite way to inflate a company’s stock price quickly is to force it to buy outstanding shares of its own stock – a trick known as a “stock buyback.” When a company does this, the number of shares is reduced and the price of each individual share goes up – not because the company has announced a great new product or a good business plan, but simply because there are fewer shares. It’s an illusion, but it can make certain people rich in the short-term. Hint: you and I are not those people.
The use of stock buybacks for stock price manipulation used to be unlawful. But in 1982, enter Ronald Reagan and his Wall Street-friendly cohorts. They handed companies what Lazonick calls “a license to loot.” The ‘80s was the time when people started accepting the “Greed is Good” mentality reflected in Oliver Stone’s iconic movie, “Wall Street” – an attitude that has helped stoke many societal and economic problems, including the worst rates of inequality the country has ever seen.
Stock buybacks are as dated and ugly as neon Spandex, and should have been left behind in the go-go 80s. But instead, they are still happening everywhere and taking an increasingly alarming toll on American firms’ ability to do anything useful.
The reason this matters to Biden’s proposal is that the government can’t make things like batteries for electric cars or semiconductors out of thin air. It has to collaborate with companies that have the deep know-how and the substantial resources to develop these complicated and cutting-edge technologies.
Take, for example, GE. Now, here’s a company that knows all about producing electric power systems. A venerable American firm like this should be ready to team up with the Biden administration, to make batteries for the electric vehicle market, for example, one of the President’s stated priorities. But that’s unlikely because of a billionaire hedge fund manager named Nelson Peltz, who started to buy shares of GE back in 2015. GE was already doing stock buybacks at that time – the practice had become so expected that companies were doing them preemptively just to keep hedge fund activists from targeting them — and the senior executives didn’t mind the boosts to their stock-based pay. But GE’s longstanding CEO Jeffrey Immelt still wanted to invest in technology and renewables that would pay off in the future.
Peltz wasn’t having it and told Immelt to do even bigger stock buybacks so Peltz could double his money. GE was prevented from focusing on its current businesses, much less investing in the technologies of the future. Today, the company is limping along, selling off pieces of itself instead of investing in climate change-fighting batteries or other renewable-energy technologies.
Then there’s Intel, the designer and manufacturer of semiconductor chips – those amazing chips that sit inside almost every electronic product these days, from cell phones to cars. They are particularly critical for clean technology, critical to computers used for clean energy grids and to electric vehicles.
California-based Intel is a hugely important company, a pioneer in chip fabrication and still one of the few firms in the world that not only designs chips, but makes them, too.
Manufacturing chips is extremely expensive, so Intel has been making huge capital investments to stay in the chip fabrication game. Unfortunately, it has gotten caught up in the stock buyback game, too, doing $39 billion in buybacks in 2018-2020, in large part to keep hedge fund activists off its back. But they came anyway, seeing Intel’s use of cash to upgrade its fabrication capabilities as a waste of money. Billionaire Daniel Loeb, head of Third Point, a New York-based hedge fund, bought about $50 billion in Intel stock on the market—0.02% of the company’s outstanding shares—and pushed Intel’s board to split off the chip manufacturing operation from its design business. This would basically be the end of Intel’s proud claim of being America’s leading integrated semiconductor maker.
Loeb is continuing to pressure Intel to do more buybacks, so, just like GE, Intel may lose its status as a world industry leader. Lazonick predicts that its fabrication business may very well end up getting bought by a Taiwanese company. And there’s no American company that can replace it.
Guess which country is not hampered by stock buybacks? That would be China. Companies like Huawei don’t do buybacks and are able to spend billions in profits on cutting-edge technology instead of making sure some guy on Wall Street can buy a superyacht.
As Lazonick sees it, Biden’s goal of competing with China for leadership in industries like computer chips or clean energy is a non-starter as long as stock buybacks continue.
“Biden is open to the buyback issue,” Lazonick notes, “but with the exception of a few people, like Senator Tammy Baldwin of Wisconsin, who has called for a ban on stock buybacks, few advisers around him truly understand the problem.” Lazonick adds that the Biden administration ought to put down some rules for companies it partners with on any infrastructure and climate plan. As he sees it, if they are going to get taxpayer money, then they shouldn’t be doing buybacks while they have a government contract, period. Furthermore, there should be a ban on company insiders selling their stock as long as they are getting subsidized, because it creates conflicts of interest. “You don’t get to cash out during the duration of the contract,” Lazonick explains.
Large government projects face plenty of hurdles moving from conception to construction and operations. Making sure that the taxpayers get their money’s worth out of the large companies the government must partner with to design, produce, and implement various parts of the plan is one of them. In Lazonick’s view, it’s time to blow the whistle on stock buybacks that waste resources and do not reflect sound business practices.
You can’t achieve a great leap into the future with billions in buybacks dragging you down.
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This kind of misses a point. Buybacks, as executed, do two things:
i) reduce the number of shares as described
ii) by being done on an ongoing basis, effectively manipulate the share price.
There’s issues about i) which are debatable, but IMHO ii) is clearly wrong.
I think there is a middle ground that makes sense. An outright ban seems wrong to me as there are circumstances where a buyback justified, most notably around single transactions. For example, say GE sold a large business then perhaps a buyback might be justified rather than buying a new business. My suggestion would be a rule where buybacks are only permitted once a quarter. That would remove the manipulation, and reduce management incentives to do buybacks. It might not totally solve the reinvestment problem, which is bigger than just buybacks, but I think is an easily justified step in the right direction.
Might be but wrong abt this…. allowing buybacks in certain cases WAS allowed before buybacks were effectively broadly legalized. It was so rare because companies had no need or didn’t want to do the work to justify buybacks, so now we refer to the good days as a “ban”. More broadly, buybacks allow elites to hit their fake bonus target (so often earnings per share which buybacks can very efficiently manipulate) and encourage ZIRP fueled borrowing for the sake of financial games, at the expense of honest to goodness investment.
Yeah, I’m interested in what law allowed this liberalization. It’s got to be about more than a Michael Douglas movie.
@cocomaan
April 9, 2021 at 8:50 am
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It was a change in regulations by Reagan’s SEC that eliminated the definition of stock buybacks as stock manipulation.
I would be for a more punitive form of taxing on the stock buybacks. Separate line item after all accounted business activity. Stock buybacks have nothing to do with running the business. A Separate tax rate on it that sits outside of normal corporate tax calculations. With an additional clause if their overall effective corporate tax rate prior to this line item is less than something like 10% then you tax the buy backs at 100%.
Don’t cry for the CEO’s and other C level executives. Stock compensation is just an income tax avoidance scheme. This would kill a several birds with one stone.
1) companies avoiding paying taxes
2) Disincentive on share buy backs
3) Reduce inequity in CEO to employee pay
Since corporations are government created entities, the government can do anything. A minimum would be to make buybacks illegal, then ban linking stock price to employer pay, then capping all pay, including bonuses, to ten times the minimum pay in the company.
Then taxing all stock sales as regular income, adding a transaction tax to effectively ban HFT. Both I think Yves has stated are obviously needed changes. If the MMT people are correct, then taxing is a way to remedy the inherent flaws in capitalism.
What the Sec did, the Sec can undo. Biden controls the majority on the Sec, so changing back to effective ban seems the way to go… plus, most suggestions here would require an act of congress, can’t imagine that such could be passed… imo a majority of dems would vote it down, just following their owners… er, donors, orders… er, advice.
I agree buybacks are crippling the country.
A small divergence before my main comment. So old Joe is promising America a $2 T dollar check which even Joe Manchin says should be at least $4 T. Myself, I reckon at least 10. So when it comes time to deliver, will it actually be a $1.4 T check with old Joe saying that the other 600 mil was delivered when Trump was in office?
So with buybacks, here is the thing. I think that we are now seeing Fintech America facing off with Industrial America – or what’s left of it. Anything that the US tries to do to upgrade the failing infrastructure will be crippled by people like Nelson Peltz & Daniel Loeb for their own personal financial gain. And the way that the financial scene is set, the later will win. I can see why the Chinese government has some of their billionaires disappear from time to time.
So here is something to note. Withing living memory, stock buybacks were actually illegal. As in a felony because a company was trying to manipulate their stock price by doing so. You could go to prison for doing so. So enters from stage right one Ronnie Reagan who in 1982 had the SEC instituted Rule 10b-18 of the Securities Exchange Act which now made this felony legal. And it has screwed up and undercut the country ever since-
https://www.forbes.com/sites/stevedenning/2018/03/25/why-its-raining-share-buybacks-on-wall-street/?sh=460cc28e3346
So if the Democrats were serious, they would bullet-proof any company from stock buybacks while undertaking a Federal program or better yet make stock buybacks illegal once more. And if those hedge fund predators complain too much, well, just because they drive home one night does not mean that they necessarily get there.
About your implied action at the end: when that feeling becomes dominant, then society has a chance. A friend who was abused in an Amazon warehouse for six months posted on FB the other day railing against “socialism”. To quote Wolfgang Pauli: he hasn’t eaten enough grass yet. Next time I see him I’ll ask how much grass will it take.
I suspect that a government contract with a restriction on stock buybacks would be a great idea, not just for infrastructure but more importantly for the MIC. Also include any corporation that receives government subsidies. Naturally, it’d be even better if stock buybacks reverted back to the old ways before Reagan.
“The reason this matters to Biden’s proposal is that the government can’t make things like batteries for electric cars or semiconductors out of thin air. It has to collaborate with companies that have the deep know-how and the substantial resources to develop these complicated and cutting-edge technologies.”
Not gonna happen anytime soon due to political constraints, obviously, but it’s perfectly possible for “deep know-how and substantial resources” to be publicly developed/marshaled. It’s important, I think, to continually resist the tunnel vision that assumes innovation can only be achieved by profit-seeking private companies and that governments are inherently incapable of successfully executing complex projects, even if saying so in a hypercapitalist culture is like whispering into a tornado.
I don’t see how banning stock buybacks would ever have motivated Welch or Immelt (and their ilk) NOT to dis-invest in their power systems business. They surely would have done the same in the absence of buybacks because it is cheaper to them to outsource or for customers to import. Nor do I see how or why GE would ever start a battery business, given that it was never a big battery manufacturer.
High voltage electrical equipment, an industry GE and Westinghouse dominated for most of the last century, was never a “strategic industry”. It was strictly at corporate discretion to invest or close such a business.
Welch shut down GE’s high voltage laboratories in Schenectady, NY — it was a world class facility, larger than anything else in the western world. It was completely gutted and shuttered. The manufacturing plants in Schenectady employed 30,000; less than 1/10 remain today. Pittsfield, MA had 13,000 employees and made the AC high voltage transformers used in electric transmission. There is virtually nothing left today. I do not believe there is a single US manufacturer of large AC power transformers remaining, much less equipment for HVDC that is essenjtial for widespread renewables generation.
One simply cannot decide in 2021 “hey, we’re gonna build high voltage electric transmission equipment in the USA to support Biden’s infrastructure program!” It doesn’t work that way; most of the experienced engineers, researchers and skilled trades are long gone (well past retirement age or dead). The tooling is gone and destroyed Few US universities have robust high voltage programs. The actual buildings don’t exist. Rebuilding this industry would take an entire generation. Who is going to pay?
Good comment, the people advocating on-shoring do not seem to realize that off shoring is a long process with many, many, pieces falling (and hard sticking) in place..
I work in the electronics industry and watched the off-shoring proceed apace since the 1990’s.
Lower level component manufacturers have moved overseas, and many of the auxiliary businesses to support overseas manufacturing have also built up overseas (die casting facilities, machine shops, PCB fabrication shops, assembly shops, plastic molding)
And, as you mention, the “institutional knowledge” of USA workers has declined as they are distanced from research, product design and the manufacturing process.
.It took more than a generation to move much USA manufacturing overseas, and that movement was abetted by the US government, the US politicians, the USA economics profession, business schools, the financial industry and senior level corporate managers….
Now that so much manufacturing/product design is firmly established overseas, one could speculate that foreign countries will NOT follow the USA example and encourage movement back to the USA.
Perhaps the current political scene is indicative that the many of Washington DC elite do understand that it is far better to stir up the Russian threat as Russia, unlike China, is not a huge exporter to the USA.
Threatening China has some big downsides that must concern many in Washington DC.
But this is the USA, where we have a coddled financial industry that needs to be rescued at regular intervals while infrastructure and manufacturing are viewed as unimportant and left to rot.
I am not convinced rebuilding a capability to replace and refurbish the high voltage transmission lines of the US Grid is the best use of the time and capabilities that remain available. Best case, I think it were better to nationalize and consolidate the Grid and begin building robust inventories of the giant AC high voltage high power transformers and other components needed to maintain the Grid. A nationalized Grid could place responsibility for the repair and maintenance of the Grid towers and repair, clearing, and maintenance of the Grid rightaways. I do not believe the Grid, even the dreamed of ‘smart’ Grid, is the best solution for the future electric power.
I do believe the US needs to build a geographically spread capability to manufacture wire, cables, and lower power high voltage power components. The US needs to rebuild and protect a geographically spread ‘infant’ solar power and wind power industry given its false start under President Carter and dismantled with the solar panels Carter had had installed on the White House, when “Morning in America” dawned. We need to fill our electric power needs much closer to our homes. Our National Grid bundles risks not unlike those bundled with our ocean spanning supply lines.
I believe rebuilding a geographically spread US domestic electronic component, semiconductor, integrated chip, and circuit board manufacturing capability is possible and very necessary. The same can be said about die casting facilities, machine shops, assembly shops, plastic molding and similar supporting industries. These capabilities could be protected using DoD priorities and supported using money and from the existing DoD budgets.
Regarding the US saber rattling toward China, I recall a quip Matt Stoller made in one of his posts — something to the effect that a war with China could last only as long as China continued to sell bullets to the US.
Renewables and EVs require massive investment in transmission infrastructure, especially HVDC. The lead times for ordering large power transformers from Japan, China or Europe is a year or more. And they’re all upgrading their systems, too.
And nationalizing the mostly privately owned grid ain’t gonna happen. Who in Congress would draft such expropriation, much less vote for it. Which president would sign such a law?
I agree that renewables tied to the Grid and EVs require massive investment in transmission infrastructure, especially HVDC, and the lead time for large power transformers are quoted in multiples of years. The lead time for rebuilding industry to support the Grid is even longer than the lead time on a transformer order. I agree nationalizing the Grid has vanishingly small probability, although I do like to recall that FDR signed the Act creating the Tennessee Valley Authority in 1933 — but Biden is as much like FDR as Ann Rand is like Keynes.
I doubt Biden and Congress will do much to repair the Grid beyond painting pretty words. I believe Biden and Congress will fund hanging more large scale renewables to provide even more intermittent power to the Grid and open more Government Forrest lands to renewable clear-cutting to provide “renewable” biofuels, while continuing to support corn based ethanol production by Big Ag. I suspect US emissions of CO2 will most probably increase or at best remain the same.
I also believe this thread is verging elliptical to the post.
There is no need to use Biden’s ‘infrastructure plan’ to question stock buy-backs, shareholder value baloney, and the freedom of action and financial support afforded to private equity, corporate raiders, and Corporate plunderers looting and consolidating US business. Their powerfully negative impacts are self-evident. I do not understand how ‘Neutron Jack’ gets off so lightly after his deconstruction of General Electric and is now quoted for his judgements on “dumb ideas”.
Until the ‘plan’ finds shape as hundreds of pages of bloated legalize, lays out agencies and funding lines, and deals with possible funding cuts or new taxes to satisfy the Biden inclinations to balance revenues with expenditures — what is Biden’s ‘infrastructure plan’ beyond shiny words? Past state level infrastructure spending has already proven the high costs and poor performance of corrupt US construction contractors. The portion of the Biden plan allocated to the kind of research and development General Electric was once famous for appears to be earmarked for handling by a new “technology directorate” that would be created within a restructured National Science Foundation(NSF).
“…an unspecified portion of the total funding would go toward launching an Advanced Research Projects Agency focused on climate, ARPA–C, a proposal Biden first advanced during his campaign for president. The plan states the new agency would “develop new methods for reducing emissions and building climate resilience, as well as expanding across-the-board funding for climate research.”
“Biden Proposes Over $200 Billion for R&D in Infrastructure Plan”
https://www.aip.org/fyi/2021/biden-proposes-over-200-billion-rd-infrastructure-plan
ARPA already funds plenty of businesses large and small without worrying about the capabilities GE or Intel sold or outsourced years ago.
I don’t understand something: if you give a company money as part of a contract to deliver something specific, how can it be used for a stock buyback?
The problem the post raises is that US companies cannot manufacture the something specific the US Government might want to contract for.
I suppose US companies might act like Amazon as middlemen placing the order with part suppliers and assembly plants from across US borders but that would not do much to rebuild US production capability or bring back jobs. Stock buybacks provide a partial explanation for how and why US manufacturing capability has been deconstructed. Stock buybacks are related to the ways Corporate managers have designed the remuneration they earn for their hard work and brilliant management. Their bonuses are related to the Corporate stock price which can be pushed up by stock buybacks. The stock buybacks come at the expense of investment and dividends, often funded by monetizing Corporate cash flows. The shareholder value nonsense often rationalizes decimation of Corporate workforces to save money — this quarter — and the looting of Corporate Assets as Corporate productive capital is off-shored.
From what you say, it sounds like the root problem is that companies will be given money with no specific deliverable in mind.
I can’t see how this can possibly succeed.
Do not worry. Government procurement rules should prevent contracting for a non-specific deliverable or a deliverable a Corporation has no hope of delivering, although some deliverables — like the F-37 — can be a little problematic.
The root problem is that the shiny words in the Biden plan lack substance beyond their gloss. I cannot see how the ‘plan’ can succeed or fail as a plan. I do believe it has succeeded as a temporary public relations event.
After reading several articles on tis subject I am still wondering how the hedge fund managers with control of .02% of a companies stock can force the company to do it’s bidding even if it changes the whole direction of the companies business plans. What is the leverage and how is it exerted.
This seems to be another example of Dr. Hudson’s observation that financial capitalism is shrinking the real economy of goods and services.
The net worth of Intel as of today is $260B, so if you bought $50B that’s about 20% of the company, assuming the net worth hasn’t changed from when you bought it, which is not true, but still.
.02% of 260 billion is 5.2 billion. My question is how do the hedge fund people have the power to tell the corporation what to do? That hasn’t been revealed by this article or others I have read. Yet it is sated that the financial sector can force the company to their bidding. Should I suppose there is no explanation and we the readers should just accept this claim based on faith. There must be some basis for this claim and I would like to know what it is.
The $50 billion figure is flat wrong. The stake isn’t quite $1 billion, or less than 0.4% of the company.
The general basis for the power an activist fund has is that it can rally other shareholders to its side to pressure management. The truly heavy stick is what is known as a “proxy fight.” Depending on a corporation’s charter, an activist can nominate directors to the board. If they combine their voting power with that of other shareholders, they can replace some or all of the directors, which then in turn leads to the board removing some or all of the executives.
The problem with bringing up Intel here is that there’s simply no way Loeb could execute a proxy fight. Intel is too big. Passive holders like index funds hold a huge number of shares. Loeb has a name and can make some bad press, but that’s about it. And everyone who owns Intel stock already knows the company has been doing a terrible job of running their business for years now.
The problem with the thesis of this article in general is that the stock market itself disproves it. The claim that “hedge funds” want short-term returns driven by share buybacks instead of capital expenditures or R&D is *ridiculous* when you look at share prices.
The returns for the market and for hedge funds since the financial crisis have been concentrated in growth companies. Think Amazon, Tesla, software companies, etc.
And for all of those companies, the market (which is simply the sum of investor preference) clearly has said, time after time after time, we don’t care about short-term profits. Invest in the business. Tesla, build plants. Amazon, spend up to offer same-day delivery. Software companies are rewarded for spending massive amounts of current revenue on sales and marketing efforts, because they’re acquiring customers that will be massively valuable over the long haul.
This “short-termism” story gets told a lot. Empirically, it’s obviously and flatly ridiculous.
MOAR!!!!
click
Taking your assertions as true, then Wall St would surely not mind banning stock buybacks, which makes your protest of this article somewhat peculiar.
no, Wall St would mind, because for some companies stock buybacks make sense. Tesla should be investing in manufacturing capacity. Companies that make more cash than they can properly invest should be returning capital to shareholders. They can do that through a dividend or through a share buyback — which are the same thing via different methods.
that has nothing to do with the thesis of the article: that, broadly speaking, spending on stock buybacks is *displacing* needed R&D or capital expenditures. Again, there is zero evidence for that thesis. Certainly, some management teams miss opportunities and make mistakes, but the idea that stock buybacks are a part of the admittedly myriad problems with the US version of capitalism is foolish.
Yet Tesla itself continues to buyback stock. One bad aspect of buybacks is that they make the company fragile, Radio Shack an example. And what justification can there be to borrow money to buyback stock? My most personal example is Boeing, which instead of investing in infrastructure and people, persists in hollowing out itself with buybacks. The ludicrous penny pinching in development of the 787 and now 737 MAX has cost them market share. If it did not do defense work and thus is assured of bailouts, it would eventually go bankrupt. Even worse, Boeing has used its own employee’s pension plan to buyback stock. That is part of my retirement.
In the mean time Wall St. in it’s inescapable wisdom is now trying to figure out how to finance money losing tech companies and still call it “capitalism”. Using money to bully your way into market share and combining that with massive lobbying of congress to set up your grift is not capitalism and it’s not productive.
Re Dirk77 and his pension being gambled by boeing…
imagine when they get their hands on social security.
Russ West paints a pretty and false picture of wall st. as responsible and data driven when really it’s scoundrels stealing fire from anywhere they can get it using any method available.
Intel’s market cap was about $262 Billion a few days ago so the ” $50 billion in Intel stock on the market—0.02% of the company’s outstanding shares” is a major type/math-o of some sort
Otherwise I whole heartidly agree with the general gist of the article.
On top of serious regulation and no patents on publicly funded research, public ownership of a portion of each sectors productive capacity is needed just to keep the bastards honest. Operation Warp Speed and the need for batteries or whatever would happen better with us, the people, owning a third of the market/factories. Of course we do own a big chunk of it but that is held in the likes of CalPERS so…. If we owned a few generic pharma factories and some testing labs we would have long since determined whether Ivermectin or other off patent meds were good COVID medications.
How do we pay for it, MMT instead of banks creating the money supply by loaning to rich folks to fuel asset inflation, of course