What’s the Point of Profits?

October 30th, 2014 by Phil Mattera

mrmoneybagsAccording to conventional economic theory, corporations earn profits in large part to finance expansion, which means both additional investment and more hiring. How old fashioned. As an article the other day in the Wall Street Journal points out, today’s executives at publicly traded firms increasingly think that the most important use of excess cash is to buy back portions of the company’s stock from investors. The Journal notes that one in four companies in the S&P 500 index have recently carried out stock buybacks.

This practice, which was once limited to troubled companies seeking to prop up a faltering stock price, is now becoming an epidemic. In an earlier article, the Journal reported that buybacks in the first half of this year totaled $338 billion, putting 2014 on track to break last year’s figure of $600 billion.

Out-of-control buybacks are symptomatic both of rampant executive greed and the growing unwillingness of large corporations to grow in a way that will bring about broad-based economic prosperity. The greed comes into play because the buybacks automatically increase corporate earnings-per-share figures, which are widely used as a basis for determining executive compensation levels.

In addition to lining their own pockets, executives who carry out buybacks are refusing to invest in growth. As the Journal put it: “While the economy has crawled back to life, many businesses remain reluctant to buy new equipment, build factories or hire workers.” For these top managers, all that matters is their personal enrichment.

It’s significant that the company listed by the Journal as one of the most aggressive users of buybacks is Ingersoll-Rand, which has employed the technique to boost its EPS figure about 90 percent over the past year. What the Journal does not mention is that Ingersoll-Rand is one the corporations that has reincorporated abroad to dodge U.S. taxes, moving on paper first to Bermuda and then to Ireland.

Like other companies going through so-called inversions, Ingersoll-Rand did not change where it did its actual business. The purportedly Irish company derives 59 percent of its revenues from the United States and has 80 percent of its long-lived assets there.

Apologists for inversions claim they help generate higher net profits that companies use for investment and job creation, yet Ingersoll-Rand shows how such a firm is instead using its ill-gotten gains to buy back stock and thus propel its top executives higher into the 1 Percent.

The edition of the Journal with the buyback article also ran a piece with the headline “As Life Span Grows, So do Worries on Pensions.” The fact that people are living longer is apparently seen as a problem for those companies that still provide defined-benefit retirement plans. New actuarial data show that the average 65-year-old will live more than two years longer (to 88.8 years for women, 86.6 years for men) than was estimated in 2000. This is expected to increase retirement plan liabilities by about 7 percent.

Experts quoted in the article expect that corporations will respond to the change primarily by accelerating their move into 401(k)s and other defined-contribution benefits which relieve the employer of long-term financial responsibilities. It does not seem to occur to business leaders that all that excess cash going into stock buybacks could instead be devoted to pension plans that now have even more need for better funding.

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