The Wrong Way to Target Corporate Excess

Stock buybacks and lavish executive pay make easy targets for raising more tax revenue, but some proposals to curb them would create more problems than they solve

By Spencer Jakab of The WSJ. Excerpts:

"One proposal is an excise tax on companies that buy back a “significant” amount of their own stock."

"Stock buybacks are a sorely misunderstood punching bag. Uncommon before a rule change in 1982, they have exploded over the last couple of decades to overtake dividends as the most common way companies return money to shareholders. Companies in the S&P 500 paid out $178 billion via buybacks in the first quarter of this year. Analysts at DataTrek Research believe they could top $1 trillion in the next 12 months. In the last decade, Apple Inc. alone has bought back $442 billion of its shares and three other American companies have repurchased more than $100 billion apiece, according to S&P Global.

But a lot of criticism has been heaped on buybacks from people who get the most basic things wrong about them. For example, an incendiary article in a major magazine commenting on Apple becoming the first trillion dollar company in 2018 called the achievement a “scam” achieved through buybacks rather than great products like the iPhone. The writer, whose thesis was repeated elsewhere, got his math backward. Buybacks reduce the number of shares as they boost earnings per share. While this often helps to boost the share price, the same can’t be said for total market capitalization. Apple might have reached the $1 trillion milestone sooner by instead hoarding cash. Meanwhile, pension and retirement accounts that hold the shares were the overwhelming beneficiaries of those buybacks, not executives.

And, in a critique of the corporate tax cuts passed during the Trump administration, Americans for Tax Fairness pointed out that much of the windfall was used for buybacks and that they “mostly enrich the already wealthy, including CEOs, because rich people own most corporate stock.” Well, yes, but the same could be said of any dollar of profit earned by a company. The fact that it is used to buy back stock rather than pay down borrowings, invest in a new project or go into the company’s bank account makes no difference to the owner’s wealth.

What does make a difference is if it is misspent. A politician who would never think to tell a local restaurant owner who just had a good year to use the windfall to expand her dining room or keep the money in the bank earnings peanuts instead of giving herself a raise. Using tax policy to sway that sort of a decision by big companies could lead to lousy investments.

Capping executive pay at a certain ratio would raise problems too. Consider two similarly compensated CEOs, Daniel O’Day of Gilead Sciences and James Quincey of Coca-Cola. Mr. O’Day makes 76 times his average employee’s pay while the slightly lower-paid Mr. Quincey makes 1,621 times as much, according to executive compensation tracker Equilar. People who make and distribute soft drinks tend to earn a lot less than scientists so the ratio is skewed, but Mr. Quincey’s company earns more profit. Enforcing pay ratios would send the top executive talent to investment banks, software companies or biotech firms instead of retailers, trucking companies or restaurant chains."