Where’s Our Big Stick?
This is an excerpt from Marc Weinstein’s weekly newsletter, Look Up!, which addresses modern philosophy, consciousness, economics, and entrepreneurship.
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The Hopi word koyaanisqatsi means “world out of balance,” and I don’t believe there to be a more representative word in the English language to describe the current times in the United States.
This imbalance might seem obvious post-COVID19, but for the last ten years BC (Before Corona) we have seen an acceleration in economic imbalances driven by structural deficiencies in the systems (economic, political, philosophical) that were built to hold our society together.
In Tim Wu’s latest book, the Curse of Bigness, he argues that we have entered a new Gilded Age (roughly 1890–1905). The Gilded Age was the time of the robber barons JP Morgan, John D Rockefeller, and Andrew Carnegie. It was a period of unprecedented concentration of economic and political power.
Wu highlights the forgotten lessons that we learned from that era,
“Extreme economic concentration yields gross inequality and material suffering, feeding an appetite for nationalistic and extremist leadership.”— Tim Wu, The Curse of Bigness
The last ten years have seen unprecedented appreciation in almost all investment assets (like stocks). Much of this growth is due to aggressive monetary policies adopted by the US Federal Reserve Bank during the 2008 Financial Crisis.
Note: This essay won’t dive too deep into monetary policy, but This is Not Capitalism by Allen Farrington & Sacha Meyers offers a comprehensive view on what is broken.
As markets have risen, so to has the percent of income earned by the wealthiest Americans. Today, 23.8% of the US national income goes to the top 1%, a drastic increase from the 1960s when the top 1% only received 8% of our national income.
In more recent years, this concentration of economic power has accelerated: 75% of American industries now have fewer companies since the year 2000, and over the same time frame consolidation has led to a 50% decline in the number of publicly traded firms.
Concentration, Buybacks & Increased CEO Compensation
Concentration of economic power begets concentration of income begets concentration of economic power and so on.
Over the last decade, executives at America’s largest corporations have added substantial debt to their balance sheets and used the proceeds to buy back shares of their company’s stock. Buybacks reduce the number of shares in circulation and thus can have the affect of increasing the average price per share (reduced supply at a constant demand leads to increased prices).
Share buybacks in and of themselves are not “bad;” they are a financial tool in a company’s arsenal that can be used to re balance market inefficiencies (ie: the market is undervaluing a company’s stock). However, in recent years debt-driven share buybacks have accelerated to astronomical levels. In the last two years alone, public companies in the United States spent $880B and an estimated $710B, or $1.6 TRILLION total buying back shares.
Remember, that there is an opportunity cost to every economic action. The $1.6 Trillion used to buy back shares could have been used for another purpose like building cash and inventory reserves, or purchasing insurance all to weather an inevitable economic downturn. We’re all taught from a young age to save for a rainy day, aren’t we?
Well, unfortunately for the US taxpayer, our system offers perverse incentives that favor share buybacks over fiscal responsibility. Not only do buybacks benefit shareholders (mostly fund managers who are compensated based on the appreciation of their portfolios in a given year), but also the executives who are responsible for making these important capital allocation decisions.
CEO pay levels reached record highs in 2018 (2019 numbers have not yet been released) — $4.8 billion aggregate in 2018 across 346 S&P 500 companies surveyed in this executive compensation report by Harvard Law. The median CEO compensation reached $12.2m per year.
Stock grants have driven the majority of the 95% cumulative increase in median CEO compensation over the last decade. This has driven a massive wedge between executives compensation and that of their employees. Average CEO pay was 158x higher than that of their employees as of April 2019. Compare this to 14–15x in the 1960s or 40–50x in the 1990s.
“But Marc,” you ask, “what if CEO pay increased over the last decade because these executives have improved company performance?”
According to a 2016 study analyzing the returns data for 436 companies from 2005 to 2016, it is actually the opposite! There is a significant negative relationship between increased CEO pay and increased shareholder returns. It seems the more a CEO earns, the lower the returns to shareholders.
OK, I think you get the point.
What does this have to do with COVID-19?
Last week, I asked you to keep a vigilant eye on how our government would respond to the #COVID19 crisis. This week we had our first opportunity to do so, when Congress passed a $2 TRILLION stimulus package known as the CARES ACT (man they just love those hokey acronyms!) For those brave enough to pour through 880 pages of regulatory jargon, the full text of the act can be found here.
About 1/4th of the stimulus, or $500B, will be allocated to rescuing large corporations including airlines. On the surface, this policy makes sense, because these companies employ hundreds of thousands of people and manage critical infrastructure. There is an argument to be made that allowing these companies to go bankrupt poses “systemic risk” to our nation’s economy.
In addition, the CARES Act requires companies that receive federal loans to halt all share buybacks and limit CEO compensation until one year after the loan is repaid (a maximum of 6 years).
And of him who comes early to the wedding-feast, and when over-fed and tired goes his way saying that all feasts are violation and all feasters lawbreakers?
- Khalil Gibran, The Prophet
Agreeing to forgo future share buybacks once you have already spent trillions to benefit your executives and shareholders is basically playing a “heads I win, tails you lose” game. Executives and shareholders get to privatize their gains and socialize their losses. No wonder we saw a record numbers of CEOs leave the wedding-feast last year.
If these companies were truly, “too big to fail,” then there should have been restrictions placed on their risk-taking ability before the crisis.
Free markets PUNISH fiscal irresponsibility. Had corporations acted responsibly, rather than participating in a debt-fueled buyback binge to perpetuate their addiction to “number go up,” they would have had nearly $1.6 trillion more cash on their balance sheets to weather the current storm.
But who can blame these executives? They are playing this game in a system whose incentives are fundamentally broken.
The players of the game all believe that the aggregate market capitalization of the Dow Jones reflects economic reality; that financial engineering like synthetic debt issuance should contribute to Gross Domestic Product (GDP); and that GDP is the appropriate metric for measuring economic activity in the first place (even though it completely ignores wealth inequality).
“At least executive compensation for those companies who take Federal loans will be capped, right?”
Yes, at $3 million + 50% of the excess compensation received above $3m in 2019.
Let’s break this down with an example.
One airline CEO used $13.6 billion to buy back stock from 2015–2019, which helped drive a +$15m compensation package for him in 2019. Three months later he is in negotiations with the US government hat in hand, threatening massive layoffs if his company doesn’t receive a multi billion dollar bailout.
According to the “restrictions” under the CARES Act, how much can he personally earn over the next 5 years?
$45 Million!!!
The rest of us will have to wait a month or two for our $1,200 checks. Oh but wait, if you make $75,000 per year, NO CHECK FOR YOU!
So for all you doctors, lawyers, and mid-level managers paying $3,500 / year for that studio apartment in New York and $350/month for your Oscar health insurance that comes with a $6,000 deductible — good luck!
So Where is Our Big Stick?
“We are in a position, after the experience of the last twenty years, to state two things: In the first place, that a corporation may well be too large to be the most efficient instrument of production and of distribution, and, in the second place, whether it has exceeded the point of greatest economic efficiency or not, it may be too large to be tolerated among the people who desire to be free.”
- Louis Brandeis
We live in a time of unprecedented concentration of economic power and political capture. At the end of the Guilded Age, men like Louis Brandeis and President Teddy Roosevelt, had to muster immense courage to change the system.
This crisis is an opportunity for a new age of political activism.
“Too big to fail” or “systemic risk” should not exist. If the failure of one company or industry might lead to the destruction of the US economy, measures should be put in place ahead of time to protect against inordinate risk-taking, to encourage fiscal responsibility, and to avoid moral hazard.
Roosevelt & Brandeis were not anti-capitalist, but in fact pro-business. However, they understood that imbalances left unchecked had potentially dire consequences.
After all, there is only so much injustice that a nation’s people can tolerate before turning to authoritarian strong men who promise them the world.
