Yeah, It's Still Water
Epsilon Theory
October 25, 2019·25 comments·Money
Companies are generating real earnings growth and massive free cash flows, yet they're investing almost nothing back into their business. The paradox deepens when you examine where that money actually goes: not to workers, not to innovation, not to long-term capacity, but to one place. The question is not whether this is happening, but whether we've stopped noticing it's happening at all.
- Real cash is being generated but real decisions aren't being made. Texas Instruments generated $25 billion in free cash flow over five years while spending only $3.3 billion on factories and equipment. That gap isn't an oversight. It's the strategy.
- The buyback narrative masks a wealth transfer that's become invisible. When a company buys back its own stock at higher prices while simultaneously issuing shares to executives at lower prices, something is being hidden in plain sight. The math reveals that 40% of one company's buybacks were used to neutralize compensation to its own leadership.
- Management is being rewarded at a scale that has no historical precedent. A single executive team extracted $6.2 billion in stock value over five years while their company performed identically to an index fund. This isn't about merit or market forces working correctly.
- The system is self-reinforcing because everyone involved benefits from it. Board members approve the buybacks that enrich executives who control their reelection. Shareholders don't complain because the stock price rises. Institutional investors say nothing because everyone else is silent.
- The question that matters is whether this is sustainable as a model for organizing an entire economy. If every public company optimizes for management enrichment rather than future growth, what happens when that becomes the only game in town?
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Comments
On first read, I don’t disagree with anything here. However, I hope you are being sarcastic when you say you would have done the same thing in their shoes. I do consider that behavior unethical when the actors (management and a board that’s aware or MIA) know damn well it’s a misallocation of capital/transfer of wealth.
This is a great article. I could feel this happening for some time based on the news and internal announcements at work. This put it perfectly into words.
It feels like the pilots (management) are flying the plane straight up. We’re just along for the ride. Eventually, the plane is gonna stall.
The whole management-serving edifice here is a consequence of well-meaning attempts to align incentives. Management’s job should be maximizing shareholder value, right? (Setting aside ESG/CSR type discussions for the moment.) So focus management compensation on stock performance metrics and pay them in stock. Then management will look out for the shareholder, right? Sure. THAT IS HAPPENING. As long as the shareholder’s desired investing time horizons align with the manager’s career timeline horizon! In that case, it is 100% ethical for management to get paid in stock and then game the stock price. They’re gaming it for shareholders’ benefit, too.
The financialization and self-rewarding behavior here is public and transparent, and many shareholders surely see it and choose to own the company’s stock anyway. It’s only really unfair to shareholders that want to own the company longer than the manager intends to be employed there, and aren’t as sophisticated as Ben…
To the extent everyone involved is acting in accordance with the incentive structure and ethical guidelines they’re given by whoever is one step up the chain, it’s not necessarily unethical, just not well-aligned with society’s broader interests. The bigger issue to my mind is the collection of structural issues with our economy/society/laws that make financialization more rewarding than real business growth. Growth compounds exponentially so it should be preferable to financialization over even the 5-10 year timeframes we would expect managers to worry about.
I think Ben is right in saying that he would do the same thing. This is a system and you don’t get to join the system unless you are going to play the game their way. After all, we’re not communists. If you could take a top position with a publicly traded company and set your family up for at least the next 3 generations without breaking any laws, how could you pass up that opportunity? Every C Suite executive has spent their life preparing for that exact position or higher. It’s why they fought to get into the elite university and put in the hours at the big accounting or consulting firm and did the stint overseas when it meant time away from the kids. It’s why they bought the ticket and made sure to get it stamped at every destination. It’s like Sally in the Peanuts Christmas Special. I just want what’s mine. I deserve everything that I got because America is a Meritocracy. If you were better than me, you would have this. It’s another example of tragedy of the commons, the benefits accrue to the few, but the costs and consequences flow to all. How can this be unethical when everyone is doing it, the “market” is rewarding us, and if I didn’t do it, the board would fire me and bring in someone that would. Besides, if I don’t do this look at the 100 people around me that would miss out. They deserve this too.
The plane has already stalled. If you are in coach or economy, you are not gaining any altitude. If you are in Business, First Class, or the Cockpit, you still feel like you are rising, but really, you’re just being pulled into that black hole. It’s just a matter of time before the gravity well and time dilation catch up with you. It’s fun while it lasts, but the consequences are murder.
In the words of a great country song … falling feels like flying / for a little while.
All true and yet, suppose management had used more of the ~25bn to invest in new PPE, R&D etc. They’re still a mature, cyclical business with some far more innovative competitors who probably would’ve still eaten their lunch. Most of the shares are held by giant institutional investors who know what’s going on. From a policy standpoint it seems to me that while you’re right about the managerial class its better to make policy that promotes competition and creative destruction than to penalize them for buybacks.
If you want to run off the company for cash (perfectly reasonable IMO), then:
Amazing. Somebody’s noticed what an utter swindle stocks buybacks are.
This article reminds me of the saying. “It’s never as bad as it seems, but always worse than it appears”
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