How to end the financialization of corporations

ending the tsunami of money into the hands of the rich

As I have noted many times here, the financialization of corporations, that is the shift from the production of goods and services to the extraction of money as the core corporate activity,is a central driver of the huge increases in income and wealth inequalities in the US over the last 50 years.

There may be no immediate way to change the thinking of shareholders, corporate management, Wall St., and business schools about the primacy of increasing shareholder value. This was most famously articulated in Milton Friedman’s 1970 declaration in the NYTimes, “A Friedman Doctrine: The Social Responsibility of Business is to Increase Its Profits in which he declared that corporations had no social responsibility to the public or society. Corporations are only beholden to their shareholders.

Professor Bill Lazonick critiqued shareholder value theory:

The truth is that a corporation’s profits are not the shareholders’ profits. They’re the people’s profits. The people who do the work, like the employees. The people who fund the infrastructure and the education of the employees, like us, the taxpayers.

Shareholders don’t do any of those things. They don’t even really take on much risk; they can sell their shares in an instant. An employee takes on a lot of risk, investing time and know-how to help the company succeed.¹

And, this transformation of corporate behavior reversed the classic management tasks of strategic long-term planning, a focus on customers and new products and services, a stable workforce, leading to profitable results.

Steps to Reverse Financialization of Corporations

Shareholder value theory would have remained just a talking point among economists and business school professors but for a number of changes in laws and regulations favoring the rich and corporations.

Management compensation drives financialization

The facts of CEO and other top management compensation as a multiple of average worker pay are well known. In the 1950s the ratio was in the low to mid 20s. A CEO might be paid 25 times the average worker’s pay. Today it is well north of 290. However, this compensation is largely in the form of incentives directly tied to achieving specific financial results during a given year. These come in the form of stock grants, stock options, and other compensation that is directly tied to the price of the company’s stock. This means that C-level and other top managers are driven to achieve these immediate financial objectives even when they impede long-term strategy, investment in new products and services, and paying employees well. There is no planning horizon beyond next quarter’s financial results reported to Wall Street.

These changes in management compensation were made possible by changes in government policies. See IRS Rule Change in 1993 (Section 162(m)) that limited cash payments to managers up to $1 million as a business expense. This drove an explosion in stock compensation schemes.

Stock Buybacks – 1982 SEC Rule 10b-18

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. Before this 1982 change in regulations, it was illegal for a company to purchase its own shares on the market. It was considered to be illegal price manipulation.

Stock Buybacks have diverted $ trillions from investments in new products and services into the pockets of shareholders who are predominantly the rich.

In reviewing this chart, keep in mind that US GDP in 2023 was $27.3 trillion.

Changes in taxes on corporate dividends

Until 2003, dividends received by individuals from holding shares of corporations were taxed at regular personal income tax rates. So,in 2002, a person in the highest tax bracket paid a 35% tax rate on dividends.² In 2003, this became 15%. So, corporations favored paying dividends to shareholders over reinvesting in the business.

Combined impact of stock buybacks and increased dividends on US corporate reinvestment

The ratios of capital expenditure to total assets for U.S. firms in 1980–2020.

There has been a long-term downward trend of corporations reinvesting profits in new products and services.”U.S. firms have reduced their capital expenditure by almost 80% since 1980s. The decline is also pervasive: It occurs in almost every industry and is not concentrated in firms with certain characteristics.”³

What to do?

Eliminate stock buybacks – roll back Rule 10b-18. Make this illegal AGAIN.

Return taxes on corporate dividends to pre-2003 levels. Stop this tax break.

Eliminate stock grants and stock options as a form of executive compensation. Return to the compensation packages pre-1975.

Footnotes

In Lynn Parramore, “After Over Three Decades, Rebel Economist Breaks Through to Washington. Here’s How He Did It.,” Institute for New Economic Thinking, https://www.ineteconomics.org/perspectives/blog/after-over-three-decades-rebel-economist-breaks-through-to-washington-heres-how-he-did-it.
In 1979 that would have been 70%. This reflects the long-term decline in taxation of the rich. At its peak in 1959, the top rate was 91% under Republican President Eisenhower.
Fu, Fangjian, Sheng Huang, and Rong Wang. “Why Do U.S. Firms Invest Less over Time?” Journal of Empirical Finance 69 (2022): 15–42. https://doi.org/10.1016/j.jempfin.2022.07.012.