Governments must change the rules of the game on cash for bailouts
Corporate stock buyback debate takes on new significance as Covid-19 public-health crisis becomes economic crisis
Should governments impose bonus clawbacks on executives of coronavirus-hit companies that were among those that squandered trillions on self-enriching stock buybacks in recent years and which now stand to receive taxpayer-funded support? Corporate governance rules definitely need to be tightened.
The topic of buybacks in the current environment seems to have cropped up more and more as government support measures have emerged as the coronavirus crisis has taken hold, and as we enter a period of reflection in parallel with the fear and panic that is still gripping financial markets and the community at large.
Buybacks have become an emotive topic. Why? Because they artificially inflated earnings per share and other metrics and built a false impression of ever-growing profits. They helped push the stock market into overblown bubble territory, were funded by cheap debt that sharply pushed up corporate leverage and, in certain cases, were carried out in amounts that exceeded free cash flow.
Or perhaps more pointedly, because they massively enriched CEOs, boards and in certain cases activist investors, drained R&D spend, contributed nothing to employees or communities, and deprived companies of cash they could sorely use right now.
The buyback debate has raged for years and there are proponents and opponents of the practice and its impact on stock markets. But the debate has taken on a new significance now as the public-health crisis quickly becomes an economic crisis as world-wide government actions to stem the spread of contagion start dismantling the functioning of the global economy brick by brick.
The immediate and short answer to the bail-out question is if companies with weak balance sheets are decimated by the impacts of contagion and contagion prevention measures, and are unable to protect employees’ jobs, governments should step in to guarantee incomes and livelihoods. But government support can only be temporary.
So again, I ask: should there be consequences for the executive boards of big companies that have run their companies in such a brittle manner and who won’t put in a cent while taxpayers step in to provide a backstop? Should wealthy executives be forced to put up some ‘hurt money’ to gain access to government cash? Should their stock mountains be transferred to taxpayer-owned vehicles in return for support?
I get that we’re in a crisis of epic proportions that will devastate businesses. It’s a crisis that has shone a light on the fragility of global supply chains and the companies that feed those supply chains. But it’s a crisis where once again taxpayers are standing on the front line.
This time around, the crisis was not set off by extreme risk-taking by banks and investors. But it’s highlighting how reckless corporate executive teams and boards have been in running their companies in such a way as to flatter quarterly numbers using financial engineering in order to make money for themselves.
In the US, SEC Rule 10b-18 – the one allowing equity buybacks – was only enacted in 1982. The very wording of the 2003 amendment – that the rule “provides issuers with a safe harbour from liability for manipulation” – tells you everything you need to know. It makes no effort to mask the fact that the act of buying back your own shares is market manipulation.
The eye of the storm is maybe not the time or place to impose conditions; it’s about getting the job done, ensuring people get back to work and the impact on the global economy is minimised to the extent possible. But millions of people are going to lose their jobs and one suspects that returning to normal for them may not happen for years. When the economy does rebuild after this crisis, one wonders whether governments should look at retrospective action.
There have been growing calls for regulators to ban excessive leverage (however defined) at the level of both corporates and institutional investors. It is not the job of government to dictate how companies are run. But the flagrant practice of engaging in self-serving financial engineering by pumping the stock price and the size of executive bonuses, while employee salaries stagnate or decline and while corporations are left vulnerable to downturns or crises, is just unfair.
Government money needs to protect the most vulnerable. Would a rule that forced companies to maintain a fixed proportion of revenue as cash on the balance sheet (again, however defined) as some sort of rainy-day fund (i.e., not to pursue glory-hunting M&As) be so bad?
Or a rule stopping companies raising prodigious amounts of debt exclusively to fund buybacks?
Or a rule similar to the one the banks have putting regulatory restrictions on leverage and liquidity?
Every crisis ends with a promise that next time it’ll be different. It never is. Time for change.
23 Mar 2020