October 2018

As long-term investors, we want corporations to be thinking about the future. Unfortunately, from our vantage point, short-term thinking has become endemic on Wall Street. While CEOs publicly profess their commitment to the long-term interests of shareholders, too often we see how their actions directly contradict their words.

First, let’s consider a major factor of short-termism: stock buybacks. The immense buyback boom of 2018 is truly staggering. This year, S&P 500 companies are on pace to spend a record-breaking $1 trillion on stock buybacks, according to an analysis by Bloomberg. While executives often pitch these buybacks as a “return of capital” to shareholders, plenty of research suggests the truth is more complicated for long-term investors.

When executives choose to spend shareholder cash on buybacks, it’s a rather simple process: A company executive decides that “extra” cash on the balance sheet is better off being spent repurchasing shares. Without the input of shareholders—and often without any rigorous explanation to shareholders—CEOs then buy up stock, which drives up EPS, which, in turn, helps drive up the stock price. That’s the short-term view.

In the long-term, however, companies that spend billions on buybacks—like GE, Cisco, Oracle, and IBM to name a few—they effectively siphon money away from innovation, research and development, worker training, and reinvestment into new lines of business.

Earlier this year, I spoke with economists at INSEAD University who found that long-term shareholders pay the price when companies spend too much on buybacks. “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,” wrote Michael Olenick and Robert Ayres in their findings. Ultimately, Ayres and Olenick now call buybacks a form “corporate suicide.”

But perhaps even more insidious still is that there are staggering levels of conflicts of interest at play.

In June 2018, the Securities and Exchange Commission released

a report exposing how, in the days following a buyback announcement—in which the company buys shares and drives the stock price up—executives themselves sell their own shares at higher rates, effectively cashing out while simultaneously using shareholder cash to drive up stock quotes.

The SEC found: “…in the days before a buyback announcement, executives trade in relatively small amounts—less than $100,000 worth. But during the eight days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day—a fivefold increase.”

To be clear, buybacks are currently legal, so long as they are disclosed to shareholders each quarter. There’s also nothing in corporate law that forces companies to ask for shareholder approval before executing the purchase.But perhaps that should change.

Recently, I spoke with James McRitchie, a longtime shareholder activist and the founder and publisher of CorpGov.net. After reading our own study

and report on buybacks, McRitchie decided to launch a shareholder proposal at Walgreens, which just announced a $10 billion buyback, in order to address CEO pay and long-term performance.

McRitchie’s shareholder proposal doesn’t ask Walgreens to stop the buyback. Rather, he suggests a simple solution, one that mirrors our own conclusions in our report: Simply let the shareholders decide. When executives decide to

“return capital to shareholders,” his proposal suggests, bring it to a vote.

We don’t have any positions in Walgreens, nor do we plan to, but we were glad to see McRitchie take an action on behalf of long-term shareholders, and we expect others follow in his lead.

In general, over the next few years, we anticipate seeing a wave of shareholder activism—through proposals and campaigns that align with the interests of long-term shareholders and target short-term mindsets. This isn’t just about buybacks, either. We expect long-term shareholders to fight for corporate issues surrounding fossil fuels, board diversity, worker pay, and so on.

Many of these fights have already begun, and that’s a positive development. Shirley Westcott,  a senior vice President at Alliance Advisors LLC, recently noted that proposals are indeed on the rise. “Calls for various types of climate action have resonated strongly with investors as have social initiatives on gun violence, sexual misconduct and the opioid epidemic,” M. Westcott writes. “Pay programs have faced more frequent rebukes and even auditors, in isolated events, have been challenged over independence and performance.”

Corporate democracy may seem like an oxymoron in today’s top-down corporate structures, but the truth is that in a healthy economic system, corporate directors listen to and respond to feedback from all shareholders. Very often, we’ll see that conversation being dominated by short-term-minded activist hedge funds, whose managers buy up large positions in a stock, and then push management into short-term decisions that drive the stock up—but leave little left for reinvestment that create value over the long-term.

“Armed with their huge war chests,” writes Bill Lazonick, an economist at UMass, “these new-style corporate predators use a corrupt proxy-voting system, “wolf pack” hook-ups with other hedge funds, and once-illegal engagement with management to compel corporations to hand over profits that the hedge funds did nothing to create.”

True, but we believe activist hedge funds will have an increasingly major force to contend with: Major institutional shareholders, long-term investors, and, especially, pension funds.

This summer, I spoke with David Webber, a corporate law professor at Boston University and author of The Rise of the Working-Class Shareholder: Labor’s Last Best Weapon.

As noted in his excellent book, American pension funds hold up to $6 trillion of wealth, and own up to 15% of the stock market at any given time. Webber’s essential point throughout the book is that pension funds—along with other large, long-term shareholders—can (and should) become more active in their fights for better corporate transparency, accountability, and actions that affect the long-term value of companies.

“In my view, the global capital market is the most powerful institution on earth,” Webber told me in my conversation with him. “These corporations are the most powerful institutions—even more powerful than the US president or than the federal government of the United States. But for the same reasons that anybody cares or follows what’s going on in politics, we need to follow on what’s going on in the politics of the corporation, in shareholder elections, in litigation, in what folks are being paid, and the decisions that get made in the corporate boardroom or by hedge funds or by private equity funds. They have absolutely enormous effect on our lives—at least as much as the politics that we follow every day.”

On that point we can agree. Millions of Americans hold stock in American companies for the long-term, and need corporate directors to act in the interest of long-term value creation. Too often, their decisions focus on short-term profits, but that needs to change. We’re committed to promoting that change, and welcome input for other long-term shareholders interested in this cause.