We know what the solutions are. Because they were implemented in the 1930s, and removed in the 1980s and 1990s as "deregulation".
- The US needs Glass-Stegall back. That's the requirement that banks and brokerages must be completely separate companies. The argument for repealing Glass-Stegall was that banks were now so smart that they didn't need such severe restrictions to prevent collapse from bad investment decisions. The banks were wrong.
- Companies should only be allowed one class of voting stock. The New York Stock Exchange used to require that, back when the NYSE had real power. Allowing multiple classes of voting stock is what gives us President for Life CEOs such as Google and Facebook have.
- No stock buybacks. Illegal in the US from the 1930s to 1981. The US recently banned stock buybacks for 12 months for companies which received coronavirus funding.[1] But that was a one time thing. During periods of low interest rates, companies tended to buy back their own stock with borrowed money to prop up the stock price. This mostly benefits executives with stock options.
- Limits on complexity of corporate organization. This was a thing for utility companies until a decade or so ago. They were limited to a tree depth of 3 in ownership. This was to make regulation easier and reduce the risk of bankruptcy cascades. See "Enron".
- Utility deregulation. Regulated utilities used to be standard. They got a monopoly in exchange for regulation. Since they were allowed a fixed rate of return on investment for rate-setting purposes, they were not hugely profitable but were very stable. The argument in the 1980s for deregulation is that utilities tended to overspend on infrastructure, building about 10% more stuff than they really needed. With deregulation, that money could go to stockholders. When Pacific Gas and Electric was deregulated, the company went bankrupt in only a few years, leaving the stockholders with nothing. And consumer prices went up in deregulated states vs regulated ones.[2]
- Tax law favors debt, where interest is deductible as a business expense, over dividends, which are not deductible. This encourages taking on too much debt.
- US bankruptcy law allows "secured creditors" too much security. Bankruptcy is too easy on lenders and too hard on accidental creditors.
What we need is a return to conservative financial principles.
While some of these solutions are good, I don't think any of them will make it through congress until well after Citizens United is appealed. TBH, trying to fix any problem of consequence in the US requires a functional Supreme Court, which we don't have.
In this you are likely correct. It's really anything that is allowing unlimited money (goods or services) to flow into campaigns from industries or unknown origins. It's also the court which is limiting voting rights. Those are two good starts which will help shift power back to the electorate.
I mean, it's bad that in our country we have to consider boycotting companies that donate to or support politicians/legislation which work to undermine democracy and such. This is plainly indicative of a broken system, where participating at the ballot box is insufficient to overcome corporate interests.
It seems nobody cares about that sort of thing anymore. Voters vote “my guy” / “my tribe” and ignore the rest. And as long as the GOP can be blackmailed by the Trump faction, it won’t move a whole lot.
Approval voting is simpler to understand, simpler to implement, and leaves people more satisfied on the whole. I think it's a better and more achievable goal than ranked-choice systems as a replacement for our utterly broken FPTP system.
Those are all really good points. Each one has a real impact and has influenced the market.
It does not serve society to have competition in negative sum games. These suggested changes would close off various silly tricks, and improve meaningful competition.
>Tax law favors debt, where interest is deductible as a business expense, over dividends
Taxation is another reason why buybacks are preferred over dividends: dividends are taxed as ordinary income but selling stock held for more than a year is taxed at the long term capital gains rate.
The IRA added a 1% tax to buybacks, but to equalize it fully either you'd need to reduce tax on dividends, extend the LTCG horizon past one year, or just eliminate the lower LTCG rate.
More than 60 days out of the 121 days centered on the ex-dividend date.
Your point remains/is even stronger: In the overwhelming majority of cases, dividends and long-term gains have been taxed similarly for the last 20 years.
Banning buybacks without banning dividends is pure stupidity. The only reason the former is preferred is because of the tax effect on the shareholders. If you ban buybacks it will just go back to dividends with the exact same outcome (companies giving money to shareholders).
Buybacks give money to shareholders who sell. Dividends give money to shareholders who don't sell. That's a big difference.
Furthermore, the primary reason stock is worth what it is, originates from actual or potential dividends (if they stopped reinvesting or hoarding) companies (could) pay.
That money has to go somewhere. Either it's hoarded or reinvested in infrastructure or spent frivolously on sweetheart contracts to friends of corporate management. But, crucially, without dividends, none of that can be recaptured by current shareholders. In theory, if shareholders of a company wanted an actual, not virtual, dividend, a stable material return on their investment, currently they could force a change in management that would pay out a dividend. In what you propose, that's not an option.
The value of a stock without dividends is almost purely speculative: who's going to be holding the stock when the company's assets are liquidated and returned (minus liabilities) to the stockholders, and what those net assets will amount to when the company is voluntarily or involuntarily shut down—neither of which is a particularly good sign for the state of the company when that happens.
Doing away with dividends seems like it would lead to more instability: all the craziness of VC-style investing, but for public companies that are no longer early-stage growth. How could you have stable businesses or an economy when stockholders are driven, not by the promise of a share of profits this quarter or even an easily countable number of years from now, but by a share of the company's assets when the company is no longer a viable entity? How are those kinds of shareholders going to make good decisions about corporate governance?
I'm mostly on board with the essay, and the need to change things. However, getting rid of dividends (along with buybacks) without radically restructuring everything else... how does that work? How could it? What am I missing?
"Buybacks give money to shareholders who sell. Dividends give money to shareholders who don't sell."
Interesting to model the effects of that. Buybacks tend to concentrate ownership among the shareholders that are most optimistic about the company's future. Since the only way to take your cash out is to sell, the most marginally-attached shareholders will sell, leaving only the shareholders who believe the company is worth much more in the future. This could have much more dramatic effects on stock price than is financially rational, because it decreases the liquidity of the stock and decreases the pool of people who might sell in response to rational analysis (because they already sold, and their stock is now retained by the corporation itself, which is not a disinterested party).
It also increases the ease of corporate governance but decreases the efficiency of it. Buybacks flush out the most marginally-attached shareholders, those most pessimistic about the company, and so they give company management a shareholder population that is largely on-board with company strategy and not inclined to exit, because they've already had plenty of chances to exit. But the whole point of markets is to aggregate the opinions of many independent parties and avoid groupthink. If the shareholder base is self-selecting, it's particularly vulnerable to groupthink, and by definition has a higher opinion of the company's prospects than the market as a whole.
Multiplied across thousands of stocks, that probably makes the market less efficient than without buybacks, also congruent with the declining liquidity. We don't observe declining liquidity, but much of that is because of market makers and passive investors that don't have an opinion or vested interest in the future of the stock itself.
> Buybacks give money to shareholders who sell. Dividends give money to shareholders who don't sell. That's a big difference.
This is incorrect. Buybacks appreciate the equity for everyone. The gains are real either way, just one (dividends) is immediately realized and is used to frequently invest in more of the stock.
The net effect is exactly the same. One delivers company capital to shareholders in direct cash, the other delivers it to them in increased ownership stakes.
The rest of your post is based on your misunderstanding that buybacks only help sellers, so I won’t dig into the details unless you’re still convinced of that.
I wasn't too concerned about secondary effects. Maybe I should have been, but I believe the way you consider it is incomplete as well, failing to account for the reduction in the company's liquid assets (and thus shareholder equity or ability to reinvest assets to grow) due to the buyback.
Suppose a company has 1T market cap, 10 billion shares at $100/share, and wants to buy back 1% or 100 million shares for $10 billion. They have a cash hoard of 100 billion, and another 100 billion in other assets. What happens, ignoring stock market changes from the buy back or reaction (i.e. hypothetically, this couldn't happen, but to isolate the effects assume OTC buyback at current market price, and no public announcement)?
Before: shareholders get a share of future potential profits. To avoid adding more hypothetical numbers for dividends, I'll simply index this notional dividend stream to 1, or 100%. In parallel they have a claim on the company's assets: $20/share worth.
After: shareholders get an increased share of future potential profits: 100/99, or roughly 1% more than without the buyback. In parallel they have a claim on the company's assets, but those assets have dropped the $20/share equity by 5% to $19/share, evaporating $1/share in equity (conveniently in this example, outstanding shares and buyback dollar amount are equal). Furthermore, the company has lost 5% of its assets, and even more than that percentage of its liquid assets, that it could've used to grow the company.
What effects dominate? That depends on how investors see future investment by the company as a driver of future profits, doesn't it?
So basically - capitalism is broken. The evidence of our current situation agrees with you.
And the US style of democracy, where the rules are written by the powerful, is broken and won't fix capitalism. Pity other (Euro) styles of democracy are so intolerable to the US style.
Why is there nothing on regulating all the investors that are supposedly buying and financing the wrong things? If the demand is unchanged, why expect much of a change in what is financed?
Investors wanted to buy CDOs, they want to be in VC and so forth.
- The US needs Glass-Stegall back. That's the requirement that banks and brokerages must be completely separate companies. The argument for repealing Glass-Stegall was that banks were now so smart that they didn't need such severe restrictions to prevent collapse from bad investment decisions. The banks were wrong.
- Companies should only be allowed one class of voting stock. The New York Stock Exchange used to require that, back when the NYSE had real power. Allowing multiple classes of voting stock is what gives us President for Life CEOs such as Google and Facebook have.
- No stock buybacks. Illegal in the US from the 1930s to 1981. The US recently banned stock buybacks for 12 months for companies which received coronavirus funding.[1] But that was a one time thing. During periods of low interest rates, companies tended to buy back their own stock with borrowed money to prop up the stock price. This mostly benefits executives with stock options.
- Limits on complexity of corporate organization. This was a thing for utility companies until a decade or so ago. They were limited to a tree depth of 3 in ownership. This was to make regulation easier and reduce the risk of bankruptcy cascades. See "Enron".
- Utility deregulation. Regulated utilities used to be standard. They got a monopoly in exchange for regulation. Since they were allowed a fixed rate of return on investment for rate-setting purposes, they were not hugely profitable but were very stable. The argument in the 1980s for deregulation is that utilities tended to overspend on infrastructure, building about 10% more stuff than they really needed. With deregulation, that money could go to stockholders. When Pacific Gas and Electric was deregulated, the company went bankrupt in only a few years, leaving the stockholders with nothing. And consumer prices went up in deregulated states vs regulated ones.[2]
- Tax law favors debt, where interest is deductible as a business expense, over dividends, which are not deductible. This encourages taking on too much debt.
- US bankruptcy law allows "secured creditors" too much security. Bankruptcy is too easy on lenders and too hard on accidental creditors.
What we need is a return to conservative financial principles.
[1] https://smartasset.com/financial-advisor/stock-buyback-ban
[2] https://ceepr.mit.edu/deregulation-market-power-and-prices-e...