The Corner

Economy & Business

Rising Stock Prices Don’t Just Benefit CEOs

Traders at the New York Stock Exchange (Brendan McDermid/Reuters)

Our friends at the New York Times continue to look for a way to class-war up the tax cuts. From Matt Phillips:

Those so-called buybacks are good for shareholders, including the senior executives who tend to be big owners of their companies’ stock. A company purchasing its own shares is a time-tested way to bolster its stock price.

But the purchases can come at the expense of investments in things like hiring, research and development and building new plants — the sort of investments that directly help the overall economy. The buybacks are also most likely to worsen economic inequality because the benefits of stocks purchases flow disproportionately to the richest Americans.

There isn’t anything in this that is exactly wrong, but the bias — the attempt to create an artificial us-and-them narrative — is transparent. Yes, CEOs tend to have a lot of their money tied up in their companies’ stocks, largely because that’s how many of them get paid. But most U.S. households own stock, either directly or indirectly through retirement accounts. (The Federal Reserve puts the current rate of ownership at 52 percent.) One of the worrisome developments of the 21st-century U.S. economy is the declining rate of stock ownership: Everybody was buying stocks in the go-go 1990s, but risk-aversion and a bias toward short-term gains has changed that. The share of U.S. households that directly own shares has fallen by a third since the 1990s. That wouldn’t be worrisome if it represented a move away from casino wagering on individual shares and toward index funds and other more sober investments, but the share of American households owning stocks indirectly has declined, too, though less dramatically. It is true that wealthier households are vastly more likely to own substantial stock portfolios than are those with more modest incomes, but that’s partly because the middle earners have partly ceded the field. If middle-class Americans want to benefit more from rising share prices, there’s a pretty straightforward way to do that. But they should be prepared for the reality that stock prices go up and down.

Even given all that, the biggest owners of U.S. shares aren’t CEOs and the yachts-and-Krug set: They are institutions, ranging from government-worker pension funds to familiar investment powerhouses such as Vanguard to TIAA, a nonprofit with for-profit subsidiaries. About 25 percent of U.S. shares are held in taxable brokerage accounts and about 25 percent are held by overseas investors, and almost all of the rest, about half, are held by IRAs, retirement plans, defined-benefit plans, nonprofits, and insurance companies. (See breakdown here.) Rising share prices make the pinstripes richer, but they also bolster the financial position of teachers’ retirement funds in California, mutual insurance companies in Wisconsin, and fancy universities in Massachusetts. I don’t think it’s obvious that having a better financial footing for retirement funds and insurance companies fails to “directly help the overall economy.” I have a vague recollection of ailing financial firms, including an insurance company, being in the news a few years back, part of a very unhappy story.

Sometimes, buybacks are a sign of confidence that corporate managers think their shares are a good investment. (After all, buybacks don’t come for free.) Sometimes, they are a naked maneuver by managers looking to increase their bonuses by hitting certain targets related to earnings per share. Investors have to sort that out for themselves, as with everything else related to business performance. That’s part of being an active investor (and it’s part of what clients theoretically are paying their investment managers to do).

It is true, as the Times says, that buybacks can come at the expense of things like R&D or business development. But that doesn’t seem obviously to be the case right now. From the Phillips report: “In the fourth quarter, American companies’ investments in things like factories and business equipment grew by 6.8 percent. That was the fastest growth rate since 2014, but far from the giant surge in capital spending that was promised ahead of the tax overhaul.” Apple’s R&D spending is at an all-time high, more than $3 billion for the first time. R&D spending is up at chip-makers, though it may be the case (as some industry insiders say) that buybacks are cutting into R&D spending at pharmaceutical companies. (If buybacks are a better use of capital, a surer source of returns, than developing new drugs, perhaps that tells us something about the pharmaceutical industry that has little to do with tax policy.) R&D spending is also up abroad in places such as China. It’s a complicated issue — much more so than the New York Times accounts for.

I don’t think the tax cut was a very good idea, inasmuch as the costs of higher deficits are likely to exceed the short-term benefits associated with the cut. (Some of the structural changes to the corporate tax code I very much favor, irrespective of tax rates.) But the fact that corporate tax benefits are going largely to the people who own those corporations is the least newsy news item of the day. (In much the same way, it’s very difficult to design an income-tax cut that doesn’t primarily benefit high-income people, who, you know, pay most of the income taxes.) I myself think American households, especially those that are not already rich, should invest more. But, as it turns out, the people in those households, given the opportunity to make their own decisions with their own money, choose differently than I think they should. It’s like they have minds of their own.

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