Stock repurchases, economic growth and inequality

Earlier this week, University of Chicago Booth School of Business professor Douglas Skinner published a column at FiveThirtyEight documenting an important trend in the U.S. economy: corporations are increasingly using their profits to reward stockholders instead of making new investments in their businesses. As Skinner points out, this trend has significant effects for growth but it also has consequences for economic inequality.

Skinner’s piece documents an increasing trend in corporate finance: increased repurchases of company stock. Traditionally, corporations would pay stockholders regular annual dividends, but now companies increasingly just buy stocks outright, which gives money directly to some stockholders (by buying their shares) and increasing the overall price of the stock for other shareholders (by reducing the amount of stocks in circulation). Importantly, as Skinner points out, these buybacks are increasingly large compared to the investments companies make in their future growth.

Increasing the price of stocks is a positive development in the short-term, but the gains aren’t evenly distributed. The gains will help the balances of pensions and 401(k) plans owned by a broad swath of the population, yet most stocks are owned by wealthy households. According to calculations by Atif Mian, economist at Princeton University, and Amir Sufi, Skinner’s colleague at the Booth School, the top 20 percent of the U.S. wealth distribution owns more than 85 percent of all stock. And that concentration has been increasing for decades.

Is this larger class of investors driving demand for stock buybacks? Well, the causes for the increasing payouts compared to investment aren’t exactly clear. But one potential cause is short-termism. Corporate executives are increasingly judged by how well their stock price performs over the short term by activist shareholders. Responding to these incentives, executives may not make adequate long-term investments because they are seeking short-term gains in the stock market.

Whatever the case, one recent study by Beatriz Garcia Osma, of the Universidad Autonoma de Madrid, and Steven Young of Lancaster University, finds that public companies that don’t show earnings growth (most likely the result of reinvesting in the business) are more likely to cut research and development spending later.

Another possible answer, and a more unsettling one, is that corporations can’t find or think of productive uses for their reserves of cash. The stock repurchases are a sign that companies think stockholders would be better served by cash in the present over potential returns from growth in the future.

These trends in share buybacks do not paint a pretty picture for corporate growth and perhaps for overall economic growth. The din and high-speed movement of Wall Street investing can be distracting, especially when the focus is more and more on short-term returns. But as the research of Skinner and others show, we need to pay attention to long-term shareholding trends. The decisions made over fiscal quarters add up to decades-long consequences.

July 18, 2014

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