Did INSEAD Just Bring Us French Revolution Of The 21st Century?

BROAD STROKES GIVEAWAY

In 1789 the world was preoccupied with the decline of absolute monarchies. In 2017, it’s the genuine concern for liberal democracies — that took the central stage.

Although the call to action in many of my previous posts was not as dramatic as The pitchforks are coming — by Nick Hanauer — the message was equally clear. You might as well dust-off an old copy of Shakespeare’s Hamlet — and conclude that “something is rotten in the state of Denmark”.

According to Bloomberg research, more than half of corporate profits (56%) in the United States go toward share buybacks — instead of reinvesting it to facilitate growth, as well as job creation.

For the sake of a healthy middle class, and sound economic systems — I call on governments to restore a total ban on share buybacks. After all, prior to 1982 — share buybacks were considered illegal, and treated as market manipulation by SEC. There is enough evidence 35 years later — that tinkering with SEC rules didn’t work. So, pull the plug, por favor! “You want it darker — we kill the flame” — Leonard Cohen

PROBLEM

Less than 220 years ago, French Revolution “overthrew the monarchy, established a republic, experienced violent periods of political turmoil, and brought many of its principles to Western Europe and beyond. Inspired by liberal and radical ideas, the Revolution profoundly altered the course of modern history, triggering the global decline of absolute monarchies while replacing them with republics and liberal democracies”

In 1789 the world was preoccupied with the decline of absolute monarchies. In 2017, it’s the genuine concern for liberal democracies — that took the central stage. And while the problems are many — the proposed solutions are few, and far between. So, what gives?

Let’s name some of the most frequent social media observations I spotted in 2017. All relate to extremely disturbing trends, such as:

· The 1% of the wealthiest is getting richer, day by day, or even “Night And Day” — as per Cole Porters’ memorable calendar reference. This, of course, happens at the expense of everyone else — which started We Are The 99% Social Movement

· The disappearing middle class and the well-paying jobs that come with it. Many well-paying jobs are predicted to vanish into a thin air, any day now — depending on which Singularity prophecy you endorse

· Even bigger fears are linked to an all-mighty Artificial Intelligence (AI) — which will take away even more jobs — if not our lives (courtesy of Elon Musk’s apocalypse theories)

· Increasing involvement of Internet giants in spreading fake news, and their concentration of power in technology sector. BTW, Internet era monopolies are much bigger than any past concentrations of wealth within the regulated financial industry, media, or the proverbial telephone industry — combined

· Sexual harassment scandals in Silicon Valley, and THE TOXIC BACKLASH OF SILICON VALLEY’S BOYS’ CLUB

· Sexual harassment scandals in Hollywood, and #MeToo social movement in the wake of sexual misconduct allegations against Harvey Weinstein, etc., etc.

Now, I wrote about the link of economic growth to a strong security foundation, before. My point in: “Kill Switch & The Winter of Our Discontent” — Part 1 was quite straightforward: no amount of innovative technology, equitable financial networks, and ample clean energy can sustain prosperity — while existential/terror threats linked to safety & security, still exist.

In: “Kill Switch & The Winter of Our Discontent — Part 2”, I recommended some of the specific policy-level interventions — to deliver and maintain well-paying jobs.

You can also review my recommendations on lowering corporate taxes. Instead of unilateral, and universal reductions for all — I recommended highest cuts to corporate entities spending predefined percentage of their revenues on innovation & training. A predefined innovation strategy could involve:

· Corporate Venture Capital (CVC) investments

· R&D spending

· Training of existing and new employees, etc., etc.

The point I was making is this: a pat on a back, and looking into a rear-view mirror — doesn’t help driving forward toward prosperity of 21st Century. Although the call to action in many of my previous posts was not as dramatic as “The pitchforks are coming” by Nick Hanauer — the message was equally clear. You might as well dust-off an old copy of Shakespeare’s Hamlet — and conclude that “something is rotten in the state of Denmark”.

And among all the disturbing causes listed in: And You Thought We Lost Manufacturing Jobs & The Middle Class Forever — Here Is How To Bring It Back! — I keep zeroing-in on the S&P 500 love affair with….share buybacks!

In a recent INSEAD post entitled: Share Buybacks Are Corporate Suicide the authors conclude:

“At first glance, stock buybacks may seem a good way to enhance value for the shareholders. By reducing the number of shares outstanding, firms can hike up their earnings per share and inflate share price, to the benefit of hedge funds and other short-term investors. Other winners are top corporate managers who are allocated a large proportion of their pay through stock-based instruments and receive bonuses triggered by a rise in the share price. If things look solid, long-term investors may have no problem with this, but what if the money spent on buybacks is money that would otherwise be spent on new product development and innovation? Worse, what if that money is borrowed?

In a loose translation: INSEAD’s data clearly indicates that buybacks affect firm’s ability to survive and grow — offering nothing more but a life support, to incompetent CEOs!

“To get a better understanding of the impact of buybacks, we set out to compare the performance of companies that rely heavily on repurchasing shares with those that do not. Our study, “Secular Stagnation”, examined 1,839 public companies in the United States over a five-year time‐scale. We found that the more money a firm spends on buybacks, the less likely it is to grow over the long-term. In fact, as the chart below makes clear, we discovered that not only do buybacks not lead to growth in a company’s market value, they are strongly correlated to a declining market value.

There are many high-profile examples of the impact of excessive buybacks at the expense of healthier re-investment. Take IBM Corp, which has spent US$125 billion on buybacks since 2005, and $32 billion on dividends, while laying off large numbers of employees and investing only $69.9 billion in R&D. We wonder: What If the 20th century computer giant had spent a lot less money on share buybacks and more on pre-empting the innovations stemming from its nimbler competitors in Silicon Valley?

General Electric is another case in point. The world is electrifying, but without GE. It repurchased US$114.6 billion of its own stock and by the end of the first quarter of 2016 had a market capitalisation of $253.25 billion, a ratio of 45 percent. Its stock underperformed both on the S&P 500 and in comparison to competitors such as United Technologies (40 percent), Honeywell (22 percent), and Danaher (2 percent), all of which grew their market value faster than GE while spending less on buybacks.

And there’s more. Sears spent US$6.92 billion buying back its own stock. The company is now only worth $729 million. Over the past five years Sears has seen its market value contract by 87 percent. Consider HP, the grandfather of Silicon Valley, which spent US$81.56 billion on buybacks but contracted 25 percent in market value over the five-year period. Or Xerox, which spent US$8.6 billion on buybacks and is now worth only $7.2 billion, having contracted by 30 percent.

In fact, 64 companies in our review, including retailers The Gap, JCPenney and Macy’s, spent more buying back their own stock than their businesses are currently worth in market value. The management at Target spent 95 percent of its current market value buying its own stock.

On the flip-side, we identified 269 companies that repurchased stock valued at 2 percent or less of their current market values, (including Facebook, Xcel Energy, Berkshire Hathaway and Amazon). All are strong market performers. To say the least, the evidence does not suggest that buybacks are good for long-term growth. In fact, far from suggesting that buybacks are a sign of confidence in the future by top executives, the evidence suggests the opposite: Buybacks are a way of disinvesting — we call it “committing corporate suicide” — in a way that rewards the “activists” and executives but hurts employees and pensioners”

In the most recent article by The Intercept, David Dayen concludes that: “U.S. CORPORATIONS ARE already beginning the process of pocketing the winnings from the tax bill jackpot they expect to hit any day now, undercutting, in a remarkably public fashion, the pretense that the corporate tax cut will lead to greater investment in job creation. Since the Senate passed its version of the tax bill on December 2, 29 companies have announced $70.2 billion in stock buybacks.

There were $120 billion in buybacks in the entire second quarter of 2017, among all companies. The new figure — $70.2 billion in just 10 days, from just 29 companies — suggests that a surge of buybacks is in the offing.

The companies announcing buybacks include some of the biggest in the world, like Home Depot, Oracle, Honeywell, Bank of America, Anthem, Boeing, MasterCard, and United Airlines (elow). All of the announcements have come since December 5.

SOLUTION

Share buybacks by big, publicly traded companies need to become more expensive. Much more.

Simply put, if corporate profits are to be reinvested in developing new products, building factories, or opening new stores — they can’t be redistributed, instead. Otherwise, we will be stuck with the economy characterized by income inequity, dwindling employment, and diminished capacity to innovate.

Yes, growth is all about identifying new opportunities, managing new initiatives, and waiting for the investments in innovation and R&D to pay off. In stark contrast, the gains offered by stock buybacks are nothing but a short-term benefit to activist investors, hedge-funds, and corporate executives. This, of course, at the cost of long-term prosperity and viability of a going concern.

For the sake of a healthy middle class, and sound economic systems — I call on governments to restore a total ban on share buybacks. After all, prior to 1982 — share buybacks were considered illegal, and treated as market manipulation by SEC. There is enough evidence 35 years later — that tinkering with SEC rules didn’t work. So, pull the plug, por favor! “You want it darker — we kill the flame” — Leonard Cohen

There is no doubt in my mind, that any attempt to regulate buybacks will require significant political will. And, yet, the damages buybacks are doing to western economies — are growing at an alarming rate. As is economic inequality!

Interestingly enough — European companies distribute corporate cash to shareholders as much as US companies do. As a result — INSEAD’s message resonates well, everywhere.

When companies are increasingly becoming the biggest buyers of their own equities, instead of retail, or institutional investors — you may officially declare: Houston, we have a problem!

For a while, it looked that gradual tightening of credit markets will lead to a reduction in share buybacks through cheap debt issuance. Such hopes, however, quickly evaporated — with the recent tax cuts.

So, if share buybacks are now officially described by INSEAD as Corporate Suicide — perhaps a graphical association to a French guillotine, and its proverbial swooshing sound — will finally drive the message across?

Oleg Feldgajer is President & CEO of Canada Green ESCO Inc. Oleg is positioning the company to become a leader in financing AI enhanced green energy projects and ventures. CGE’s mission is to guide DISRUPTIVE businesses in ENERGY & TRANSPORTATION toward profitable business models. Oleg is passionate about such mission, and firmly believes that without AI based innovation, we will all prematurely choke on polluted air and dirty water. CGE delivers 100% financing (levered and unlevered) to its clients — and utilizes large equity pools, and non-recourse debt. Oleg offers creative, fresh ideas to open-minded businesses — that embrace both: logic AND opportunistic intuition. CGE stands against mediocrity & its modus operandi is quite simple: If CGE is not invited to join your BOD, or Advisory Board — we failed!