Opinion pieces and speeches by EPI staff and associates.
THIS PIECE ORIGINALLY APPEARED IN THE ATLANTA JOURNAL-CONSTITUTION ON JULY 25, 2002.
Safeguards Mustn’t Be Just For Shareholders
On a recent business trip to Las Vegas, finding myself with some time to kill, I dropped a few quarters into a slot machine. It was an exercise of faith orchestrated by the casino using what has become the watchword of the day: transparency. I could trust the casino not to have rigged the game, the reasoning went, since it had posted my odds of winning on the machine.
Now, with financial scandals roiling the market, political and corporate leaders want to rekindle this same faith among investors — by telling shareholders the real cost of stock options. Transparency is a virtue in a casino or a corporation, no question. But it’s important to understand that transparency will not, by itself, cure what ails our economy.
Today’s corporate scandals are a direct consequence of the reorganization of our economy during the 1990s primarily to serve shareholders. If we succeed at re-instilling faith in the stock market, not only are we likely to encounter a new wave of corporate scandals in a few years, but we won’t be doing our economy, our workers and our families any favor either.
Many say what’s good for the stock market is good for the economy. That isn’t what the numbers say. As the market rose ever higher, more and more corporate dollars were used to prop up stock prices, in legitimate ways, leaving less money for employees and productive investments. The shift to shareholder dominance began in the late 1970s, when institutional investors (mostly pension funds and insurance companies) became dissatisfied with low rates of return. These big investors traced the fault to corporate executives’ failure to maximize shareholder value. To align CEO and shareholders’ interests, performance-based compensation was created, with stock grants, stock options and bonuses to inspire executives to work harder.
It seemed too easy. In hindsight, it was. In the new world of stock options, high stock prices not only made exorbitant compensation possible, they also gave executives a currency to purchase other companies and a defense against hostile takeovers. But wishing for a high stock price doesn’t make it so.
Executives used share repurchases and dividend payouts to keep stocks higher. In every single quarter from 1994 through 1999, U.S. corporations repurchased more shares than they issued and spent about $700 billion more buying up their own shares than they made from new issues.
During the 1990s, corporations also paid out an unprecedented 48 percent of profits as dividends. A 1999 Federal Reserve study found that to compensate for the negative effect of stock options on their stock prices, America’s corporations would have to dedicate all future profits to repurchasing their shares and paying out dividends.
Keeping shareholder value high required lots of cash. To generate it, corporations adopted a “downsize and distribute” strategy, increasing cash flow by cutting workers and operations and parceling out the take to shareholders through dividends and higher stock prices.
Money once spent cannot be re-spent for something else, such as productive investments. Companies invested mostly in quickly depreciating products, such as computers and software.
For solving these problems, transparency is an important start. Once shareholders see the real cost of stock options reported as expenses, they will be less eager to approve them. A lasting solution requires more, though. An equally important step is to safeguard workers and the economy against “downsize and distribute” strategies. This requires a conscious effort to rebalance the focus of corporate decision-making to include all stakeholders, including workers, not just shareholders.
Some avenues worth exploring are employee representation on corporate boards, pension plan boards and accounting committees. Others are abandoning policies that interfere with workers’ rights to form unions that can give workers an effective voice.
Ironically, pressure for reform is flowing again from institutional investors as alarmed shareholders watch their investments fall. But if we try to solve the problem with only the shareholders’ interests on the table, we will only perpetuate it. Making the stock market attractive to investors may be the way to run a casino, but it is no way to run the world’s largest economy.
Christian E. Weller is an economist at the Economic Policy Institute.
[ POSTED TO VIEWPOINTS ON JULY 29, 2002 ]
