By now, there should be no doubt about who to thank for the record highs US stocks have put in this year. Investors should direct their appreciation first to the FOMC and second to corporate management teams, who stepped in to provide the all important “flow” once the Fed began to scale back its asset purchases.
Of course the Fed has been a powerful enabler when it comes to corporate buybacks. Ultra low rates have sent investors searching far and wide for yield, which in turn makes corporate credit an attractive option in a world where risk free assets often yield an inflation-adjusted zero or worse, have a negative carry. The strong demand for corporate issuance coupled with investors’ Fed-induced “beggars can’t be choosers” mentality means companies have been able to issue debt at rock-bottom rates.
The proceeds from debt sales have been funneled into buybacks and dividends as myopic (not to mention price insensitive) corporate management teams have focused squarely on artificially boosting the bottom line and of course, on boosting their own equity-linked compensation.
We’ve recounted this narrative ad nauseam this year and we’ve also gone to great lengths to explain how this dynamic serves to undermine top line growth by curtailing capex and thus ensures that if a real, demand-driven recovery ever does actually materialize, companies will be ill-prepared to capitalize on it.
But again, that’s just fine for corporate management teams because it’s all about instant gratification these days and if you needed further proof that US equity markets have become the preferred channel for transferring debt sale proceeds directly into the pockets of top management, Bloomberg has all the evidence you need. Here’s more:
Buybacks and dividends are rising to records in the U.S., and for many chief executives, that means a fatter pay check -- even if sales aren’t growing.
Eleven of the 15 non-financial U.S. companies that spent the most on buybacks last year base part of CEO pay on earnings per share or total shareholder return, or both, according to data compiled by Bloomberg. These metrics get a boost when businesses return cash to investors, giving companies like International Business Machines Corp. and Cisco Systems Inc. added incentive to dole out cash to stockholders.
Linking compensation to buybacks and dividends can encourage managers to sacrifice funds that could be used for long-term investments, economist William Lazonick said. It also raises the prospect that executives are being paid for short-term returns rather than running a business well.
Tying pay to performance has long been considered a shareholder-friendly move that gives executives an incentive to ensure that the company is on solid footing. Investors such as Warren Buffett have applauded payouts when they consider shares to be undervalued. Large pension funds have welcomed pay incentives, like when Walt Disney Co. in 2013 changed the way it calculates CEO Bob Iger’s stock awards.
Yet dividends and buybacks can prop up per-share earnings and total shareholder return -- lifting CEO pay as a result -- even in cases where sales are falling.
The focus on shareholder value has “led to this really corrosive feedback loop between executive compensation and corporate behavior,” said Nick Hanauer, co-founder of venture capital firm Second Avenue Partners LLC. “When everyone around a board room can justify essentially any behavior to generate a higher stock price, no stone shall go unturned.”
Average CEO compensation for the top 350 U.S. firms by revenue has climbed to $16.3 million last year, according to data from the Economic Policy Institute. That’s up from $15.7 million in 2013.
Overall in 2014, non-financial companies returned almost $1 trillion in share repurchases and dividends. As a percentage of gross domestic product, that’s among the largest payouts on record.
Not all investors are applauding the bonanza.
Amid a bull market, shareholders may not be as concerned as they should about the potential boost that buybacks and dividends can give to CEO pay, said Robert Barbetti, head of compensation advisory for J.P. Morgan Private Bank in New York.
“Boards and compensation committees should be thinking very carefully about the incentive plans and objectives that work long term.”
Yes, maybe they should, but when the Elio Leonis of the world are setting the standard by raking in $1.8 million without ever having to work a day (or an hour for that matter), expecting executives to think beyond next week may be asking far too much.