What is financialization and why does it matter? – Part 2

Changes in the behavior of nonfinancial corporations – the real economy

In Part 1 we reviewed the definition of financialization and “Changes in the structure and operation of financial markets”. Go back to that first post in this three-part series, “What is financialization and why does it matter? – part 1” to review the definition and those changes.

Shareholder Value Theory and Changes in Management Focus

The financialization of corporations is a natural extension of the finance sector’s focus on extracting money rather than producing products and services. Traditional business management practices dominated the first 75 years of the 20th century and focused on customers, markets, products, innovation, a stable workforce, and longer-term business strategy. The 1980s brought shareholder value theory, which states that the only job of a corporation is to increase shareholder value.¹ This shifted top management’s attention to the next quarter’s financial report to Wall St. Compounding this attention’s power was a shift in management compensation to include stock options and other compensation directly tied to immediate financial results. Filling one’s bank account became a perverse incentive that top management could not ignore. These developments produced an environment of shedding employees and squeezing out benefits, including eliminating traditional retirement plans and lowering capital investment in the company’s future. One obvious outcome is the top management pay ratio compared to the average worker rose from 21 to 1 in the 1950s to over 350 to 1 today.

Stock Buybacks

One regulatory change, in particular, has dramatically impacted corporate behavior. Before 1982, stock buybacks² by corporations were essentially forbidden. Lawmakers and regulators saw it as stock price manipulation. In 1982, the Federal Exchange Commission issued Rule 10B-18, which legalized the practice.³ Stock buybacks in 2021 in the US reached over $850 billion.⁴ These are corporate profits that might otherwise have been invested in new plants, equipment, and personnel, or returned to shareholders as dividends. Combined with the addition of stock options as a key feature of corporate chieftains’ pay packages, this creates enormous perverse incentives for these chieftains to act for their benefit, not for the longer-term interests of shareholders, employees, customers, and the public.⁵

Stock buybacks are not small potatoes. My favorite computing company, Apple, has engaged in this practice on a large scale. “Over the last ten years, it has repurchased $604 billion worth of its stock. For context, that’s about how much the company was worth 10 years ago. Or put another way, it’s roughly the current value of Netflix and JPMorgan Chase combined.”⁶ It is difficult to find exact data about stock buybacks since there are inconsistent reporting requirements. But here is a flavor of the scale of this phenomenon: “….between 2009 and 2018, S&P 500 companies spent $4.3 trillion on buybacks — more than half of their income. In 2018, the first full year under the 2017 Tax Cuts and Jobs Act (TCPA), S&P 500 companies spent $806 billion on buybacks. In 2019, the banking industry alone bought back $156 billion shares⁷ In 2022 over $1 trillion was devoted to stock buybacks.

Reinvestment versus Shareholder Payouts

A good indicator of impactof

In the next post in this series, we will review Changes in Policy and summarize this topic.

Footnotes

In a 1970 piece in the New York Times, Milton Friedman declared, “There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” (see Milton Friedman, “A Friedman Doctrine‐- The Social Responsibility Of Business Is to Increase Its Profits,” The New York Times, September 13, 1970, sec. Archives, https://www.nytimes.com/1970/09/13/archives/a-friedman-doctrine-the-social-responsibility-of-business-is-to.html.)
A stock buyback occurs when a company uses company financial resources to buy its own shares on the market. The reduction in the number of shares outstanding in the market produces a rise in the price of the remaining shares.
Lenore Palladino and William Lazonick, “Regulating Stock Buybacks: The $6.3 Trillion Question” (Roosevelt Institute, 2021)
https://www.cnbc.com/2021/12/30/buybacks-are-poised-for-a-record-year-but-who-do-they-help.html accessed 2.29.2022
See William Lazonick et al., “US Pharma’s Financialized Business Model,” Institute for New Economic Thinking Working Papers, no. No. 60 (July 13, 2017): 28. for a discussion of big pharma’s use of financialized strategies.
Daniel Foelber, “Apple’s Annual Buybacks Hit a 3-Year Low. Should Investors Be Concerned?” The Motley Fool, November 8, 2023, https://www.fool.com/investing/2023/11/08/apple-stock-annual-buybacks-3-year-low-buy-sell/.
https://ourfinancialsecurity.org/2021/11/fact-sheet-tax-corporate-stock-buybacks-that-enrich-executives-and-worsen-inequality/?utm_source=chatgpt.com