ImpactAlpha, May, 19 – Buy back this.
That’s the increasingly loud message from employees, suppliers, communities and customers – all essential stakeholders in the new corporate purpose that CEOs declared with some fanfare last summer.
With those stakeholders facing hardships and financing challenges on a scale never seen, they are starting to lay claims to an obvious stash of capital that could be deployed to preserve that corporate purpose: hundreds of billions of dollars held as cash or marketable securities on corporate balance sheets.
Some companies, of course, had depleted their cash reserves even before the COVID shutdowns, through years of stock buybacks and dividend payments. American Airlines, which spent about $12.4 billion on stock repurchases since 2014, has taken nearly $11 billion in government aid under the CARES Act. In the past three years, companies that make up the S&P 500 companies spent $3.5 trillion on such buybacks and dividends, equal to their entire net income.
But U.S. non-financial corporations still are sitting on over $4 trillion in cash, up from $2.7 trillion a decade ago and just $1.6 trillion in 2000, according to the latest Flow of Funds estimates. There’s more than $700 billion still in the cash reserves of just 10 companies, including tech giants Apple, Microsoft, Alphabet and Amazon. Apple’s $200 billion hoard makes it, effectively, the nation’s 13th-largest bank. (Just 20 years ago, Microsoft’s $20 billion in cash reserves was considered an eye-popping sum.)
How companies deploy their capital before, during and after the pandemic is becoming both a political and management issue that could shape the economy for decades. Those hoping for a brighter corporate future have watched in dismay as U.S. companies have cut thousands of workers during the pandemic while continuing to reward shareholders. Tax cuts embedded in the sprawling CARES Act are projected to transfer another $275 billion from federal tax coffers to corporate bottom lines over the next ten years.
The annual shareholder meeting season now underway is putting a spotlight on corporate accountability in the Age of COVID. Companies are finding their use of the corporate treasury under scrutiny not only as a key part of ‘G,’ for governance, but for ‘S’ as in social and ‘E’ for environment, in the new era of ESG investing.
Even President Trump said in March he doesn’t want to see companies use federal aid for stock buybacks, though safeguards are lax. Already, Royal Dutch Shell, HSBC, Barclays, and other corporations have suspended buybacks or dividends.
Stakeholders are finding allies even among shareholders for proposals that suggest cash reserves can be deployed to enhance the broader corporate ecosystem. Among the ideas: shifting dividends and shares to essential workers via employee ownership funds, greening corporate data centers and fleets, investing in solutions that reduce systemic risks, and building new markets for products in emerging markets.
In the textbooks, companies invest their profits for capital investments, research and development, bringing products to market, hiring and retaining talent and other productive uses.
The era of ‘shareholder primacy,’ dating to at least the 1980s, eroded such quaint notions of corporate behavior. The doctrine’s apotheosis may have been the Tax Cuts & Jobs Act, ostensibly intended to spur investment and higher wages. In 2018, the law’s first year, corporations collectively saved more than $100 billion. Nearly all of it went to juice share prices via buybacks and dividends.
The dozen biggest U.S. pharmaceutical companies spent a total of $69 billion on share buybacks in 2018, more than their combined R&D spending that year.
The COVID crisis has shown the dangers of such stock-market stunts. The massive reallocation of money from public good to private gain left the nation’s social infrastructure, from healthcare facilities and virus testing to social safety nets, ill equipped to respond to the pandemic. Many of the biggest buyback proponents have lined up for federal bailouts.
Cost-saving policies that short-change worker health and safety have put those now-essential workers at greater risk. And underinvestment in research & development and resilient supply chains have left companies scrambling to retool to address the pandemic.
“Now more than ever, we see how their decisions about how they spend their cash affects all of us,” says Nicholas Lusiani, a senior advisor at Oxfam, a network of nonprofits that works to alleviate poverty. “There’s an opportunity cost for where that capital goes.”
The hardships caused by the global shutdown, and the liquidity needed for the recovery, makes that opportunity cost all the more stark. In particular, the COVID-19 crisis has shone a harsh light on the treatment of low-paid “essential” workers, from warehouse workers and retail staff to healthcare workers.
“There needs to be a shift of corporate cash to supporting and valuing workers,” says Josh Zinner of the Interfaith Center Corporate Responsibility. That, he says, could “help to create a systemic environment that’s going to be good for businesses and good for investors.”
ICCR is among more than 300 institutional investors representing over $9.2 trillion in assets under management that signed onto a statement asking companies to prioritize the welfare of employees and other stakeholders in the face of the coronavirus. They recommend steps such as providing paid leave, protecting worker and public safety, maintaining employment as much as possible, paying suppliers promptly, and forgoing share buybacks and limiting executive pay for the duration of the crisis.
The statement, says Zinner, “is a signal to companies that investors are viewing their management of COVID, and in particular treatment of workers, as fundamental to the value of the companies they’re running.”
Corporate cash has only recently been elevated to a core ESG issue. In the past, shareholder resolutions have focused on narrower issues of executive compensation and lobbying expenditures.
The pharmaceutical giant Merck is being asked at its May 26 shareholder meeting, in the form of a shareholder resolution filed by Oxfam, how it plans to allocate the savings from the 2017 tax reform. (Trillium Asset Management tried unsuccessfully to put a similar question to the biotech company Gilead).
Merck reaped an estimated $1.2 billion tax windfall in 2018, and stands to save nearly $7 billion in repatriating offshore profits thanks to other tax changes. At the same time, the pharma company more than doubled its share repurchases from $4 billion in 2018 to $9 billion in 2018, and cut R&D by some $450 million.
“That’s $1 billion that was being spent on roads, schools and the public good that is now under the discretion of senior management. Our question is, how have you been using that money?,” says Lusiani. “Will it be spent on R&D? Lowering drug prices? Could that cash be used for decent quality, safe jobs or capital expenditure that can drive wealth creation across the economy?”
Amazon’s increasing clout makes its use of cash a bellwether for the proposition that sharing the corporate wealth with all stakeholders can boost a company’s value more than a narrow focus on stock buybacks for shareholders.
Those issues will be front and center at Amazon’s (online) shareholder meeting on May 27, when the e-commerce giant will face scrutiny for its treatment of workers in the pandemic. Amazon was slow to put in place protections for workers scrambling to fulfill a surge in online orders, and has fired workers who have spoken out about workplace conditions. Seven Amazon workers have died from COVID.
Amazon chief Jeff Bezos said last month the company would spend $4 billion in the current quarter on COVID-related health and safety measures, including boosting worker pay and developing its own COVID-19 testing capabilities — and the company’s stock fell.
Last week, New York City pension funds and Dutch pension asset manager APG fired off a letter to the board chair who oversees Amazon’s human capital management policies asking her to address how she will monitor and measure the $4 billion investment. The two pension funds, with a combined $4.2 billion invested in Amazon shares, said they were concerned “by the potential disconnect” between the company’s announced employee initiatives and media reports of widespread COVID-19 health and safety concerns among employees.
The pension funds said they “share the belief that effective management of human capital is a driver of long-term value creation and thus an essential topic of board strategy and oversight.”
Companies that prioritize workers outperform those that don’t, according to a recent analysis by Just Capital.
Amazon also faces shareholder resolutions, prepared months in advance, which center on environmental, diversity, privacy and other issues. And it’s not lost on tech executives that the Justice Department and Federal Trade Commission in the last year have launched antitrust probes into Apple, Amazon, Facebook and Google.
Share the wealth
Buybacks ostensibly benefit at least one stakeholder group: shareholders. Despite the Business Roundtable rhetoric of valuing all stakeholders equally, the business group’s top 10 members spent 90% of their 2019 pre-tax profits on buybacks, according to an Oxfam analysis.
But the practice may not even benefit shareholders in the long run.
“Once senior executives adopt a value-extracting approach to corporate resource allocation, they lose the ability (if they ever had it) to envision opportunities for new types of value-creating investments that their company could and should make,” says William Lazonick, professor of economics at University of Massachusetts Lowell. Lazonick calls buybacks “legalized looting.”
The broader asset-management shift from active stock-picking to passive index investing has contributed to the corporate cash crisis. Active managers would balk if a company grossly misallocated capital, explains Green Alpha Advisors’ Garvin Jabusch. Now, index investors have to buy those companies’ shares anyway.
“This culture of indexing is making us define our risks wrong, taking us off of systemic risk, and creating demand for shares that wouldn’t otherwise be there,” Jabusch says.
Green Alpha, actively, identifies public companies addressing major systemic challenges, such as climate change, health, inequality, and resource degradation. Cash stewardship is one telling signal. “One of the key things I look for is how much of their revenues they are throwing back not just into the firm but into research & development,” says Jabusch. “You identify your future leaders and juggernauts.”
Last year, with system level risks in mind, the firm did a deep dive into biotech and added names such as Moderna, Gilead and Crispr to its portfolio. Those companies are now at the vanguard of developing COVID treatments and vaccines – and not coincidentally tended to prioritize R&D and other investments over financial engineering.
Says Jarbusch: “Watching out for those buyback pigs has paid off.”