Buyback backfire
The popular media are at it again with their attempt to frame Boeing’s problems as a defect of capitalism. The evil pursuit of profits put quality and safety in the back seat.
But that simplistic caricature doesn’t stand up to the facts. As it turns out, Boeing’s profits are under siege. Reputational damage alone is costing it billions.
A more honest assessment would be that it put the short term in the driver’s seat and the long term in the back. It’s more accurate to say decades of commitment to quality once helped make Boeing one of the world’s largest and most profitable aircraft manufacturers. Profitability wasn’t the reward for cutting corners; it was its casualty.
What happened? A full exploration of the underlying causes would be beyond the scope of a blog post, but we can say with confidence that the depiction of it as a competition between quality and profits is no closer. Some likelier culprits; years of easy money and the consequent financialization of what was once the world’s greatest manufacturing economy, and the rise of corporate share buybacks as a means of “returning cash to shareholders” and compensating corporate insiders. When the occupants of the board and the C-suite have at their fingertips the means of immediate gratification, it’s almost hard to fault them for exercising it. The temptation must be powerful.
Rampant resort to share buybacks wasn’t always there. Once upon a time they were heavily restricted, viewed as market manipulation.
”The use of stock buybacks to distribute excess cash has increased significantly since the early 1980s, both in absolute terms and in comparison with the payment of dividends. In 1980, U.S. corporations repurchased $6.6 billion of their own stock. By 2000, that amount had grown to roughly $200 billion— still a far cry from the over $1 trillion in buybacks announced last year. Moreover, although 80 to 90 percent of cash payouts by publicly traded corporations took the form of dividends before the early 1980s, S&P 500 companies spent 54 percent of their net income on buybacks between 2003 and 2012, while paying out only 37 percent as dividends.”
https://crsreports.congress.gov/product/pdf/LSB/LSB10266
This was a similar disease to that which plagued General Electric.
https://www.tbwns.com/2024/09/23/the-bears-lair-the-british-leylands-in-our-midst/
A case for liberalizing the use of buybacks may have been valid in the early 1980s. Stocks had been in a grinding secular bear market since the late 1960s and were at some of their lowest valuations in decades. We could hardly make the same case now.
Buybacks and dividends are often characterized as virtually equivalent channels of shareholder returns. But they’re not. Dividend payments go to all shareholders equally. Buybacks only to those shareholders who sell. The latter disproportionately includes corporate insiders, many of whom receive compensation in the form of stock options. They encourage short termism. Dividends are a longer term commitment … once established, a reduction or elimination of dividends is perceived negatively.
The US tax code tilts the financial playing field. Interest on debt is tax deductible to corporations. Dividends on equity are not. The 2017 Tax Cuts and Jobs Act was a missed opportunity; instead of rectifying this distortion of incentives it threw salt into the wound by cutting rates instead. It also stripped the rate structure of progressivity. Yet as far as I’m aware, no one has made the case as to why a progressive rate structure is fine for individuals but not corporations. Nor why the world’s biggest and richest corporations should pay a lower rate than individuals with far less income. A case could have been made – and was – that some form of corporate tax relief was called for. But had it come in the form of dividend deductibility instead of lower rates, it’s likely we would see less self serving by corporate insiders and more responsible corporate stewardship. We can only hope this mistake is corrected in future tax legislation.
With a lot of or maybe most corporations, I feel the problem is the management being wholly unqualified to run the company. They have absolutely zero experience or knowledge of how the company makes the products on which it makes its profits. As a result, they “know the price of everything and the value of nothing.” They’ll replace a highly capable, highly paid western worker with 10 or so lowly paid workers from third world countries thinking that surely, 10 less capable people can do the same amount or even more work than the one highly capable person. That is not the case at all because the 10 less capaple people typically turn out to be 10 utterly incompetent people who will never become competent.
But, in the short term, the momentum behind what was a well-run company with a competitive advantage built over decades of hard work, highly capable workers, and intelligent management can keep the company going for decades even as rotten management hollows out the company and replaces the highly capable workers with incompetent morons and grifters. While its missteps have not had the obviously catastrophic effects of Boeing’s mismanagement, Intel is yet another poster child for what happens when unqualified management is put in charge of a company for a long period of time.
Another factor in Boeing’s demise is the corrosive influence of federal government welfare programs for corporations. When government contracts are cost-plus, and enforce peculiar hiring requirements on the contractors, the corporation is no longer capable and has no incentive of knowing how much time and capital are necessary to create a product. Don’t believe me? Take at look at the recent Boeing fiasco with its Starliner spaceship and compare Boeing’s performance on this one project with that of SpaceX, the other company the federal government funded for the exact same project.
I really wish that dividends were not double taxed, that they only are taxed once at the corporate level (shareholders pay no taxes on dividends) or that they only are taxed once at the shareholder level (corporations pay no taxes on profits they pay out as dividends). That would greatly eliminate excuses a lot of management and Wall Street make for buying back shares in the name of capital “efficiency.”
Either that or bring back the ban on corporations buying back their own shares.
That still doesn’t fix the problem of unqualified management but at least they would not reap especial reward if they intentionally destroy a company.
They’ve come close before … the TCJA wasn’t the first missed opportunity. IIRC the GW Bush administration considered making dividends tax deductible to corporations in its tax reform initiative, but ultimately decided instead to tax them to the recipients at a favorable rate. Probably a political optics calculation. Putting principle second has consequences.
Between the two ways of fixing dividend double taxation, making dividend payments deductible at the corporate level would have the advantage of correcting distortions in the incentives corporations face. It would also avoid the optics of making them tax free to recipients … viz Warren Buffett’s “complaint” about paying a lower tax rate than his secretary. Dividends on equity could be taxed like ordinary income, just like interest on bonds, and tax deductible to payers the same way.
It would also obviate whole sections of the tax code dedicated to special structures like REITs, which escape taxation at the corporate level provided they meet a raft of special conditions like paying out 90% of the taxable income to shareholders and owning real estate. The tax code could be industry agnostic and each corporation would have the flexibility to adopt a dividend policy appropriate to its unique business model.
Fixing the tax code wouldn’t solve all the bad management problems, but it doesn’t help that the incentive structure disproportionately rewards short termism. Monetary policy has also made capital unnaturally cheap for corporations, providing a tailwind for your stock even if your management is negligent. It may not be a cure all, but it couldn’t help but help to weed the perverse incentives from the tax code and eliminate the free ride of easy monetary policy, at least giving market discipline a fair chance to work.
Another way to reduce these problems would be to clean up the inbreeding between management and the board. Executives report to the board, the board reports to shareholders. You can be the CEO or Chairman of the Board but not both. This again is a responsibility of government … corporations are publicly chartered entities and it’s the public’s prerogative to make the ground rules.
One other thing that would help: Shareholders are frequently asked to give a non-binding vote on executive compensation packages. Make it binding.
in 1997 boeing merged with mcdonnell douglas. although boeing was the name of what emerged, the c-suite was taken over by finance people from md, and the engineers who had historically run boeing were displaced. i’m afraid that in this case the profits and cost cutting vs quality story actually has some merit.
No, that would be missing the forest for the trees. Did you read the post? It’s exactly as I explained it. Boeing may have appeared to benefit at first but it’s in the doghouse now. The short term came at the expense of the long term.