News & Our Thinking

(St. Louis Post Dispatch)

Ken Crawford, a managing director at Argent Capital Management in Clayton, says some companies should be buying back shares while others should be reinvesting every spare cent in the business. It all depends on what kind of return the company can generate.

April 24, 2015 (David Nicklaus)

You might think the world’s largest asset manager would be happy that companies are trying to be investor-friendly.

Yet Laurence Fink, chief executive of BlackRock, is not pleased. He recently sent a letter to 500 of his fellow CEOs bemoaning the emphasis that many of them have placed on returning cash to shareholders through dividends and stock buybacks.

Companies have bought into this “short-termist phenomenon,” he wrote, “while underinvesting in innovation, skilled workforces or essential capital expenditures necessary to sustain long-term growth.”

The tension between shareholders and managers over corporate cash is age-old, but shareholders do have the upper hand recently. Buybacks totaled a record $900 billion last year, all of which is money that could have gone to build new research labs or hire more salespeople.

William Lazonick, a University of Massachusetts economist,studied 454 large companies over 10 years and found that they used 86 percent of their earnings for buybacks and dividends.

Corporate America, Lazonick concludes, has largely abandoned the old “retain and reinvest” model, where profits were plowed back into the business. In its place is a system of “downsize and distribute,” where shareholders’ short-term interests are paramount.

Lazonick, like Fink, paints a dire picture of what this shareholder-value movement is doing to our economy. Both of them, however, overlook an important point: It’s also bad if executives engage in empire-building at their investors’ expense.

If a company’s officers are hoarding cash or, worse, investing it in projects that have a low expected return, they’re depriving investors of the chance to do something more productive with that money. “The debate is a little bit silly,” says Mark Leary, an associate professor of finance at Washington University. “You can’t make a recommendation without thinking about what the alternate uses for that cash are.”

Research shows, for example, that firms step up repurchase activity when they’re in danger of missing a quarterly earnings forecast. “That’s when you would worry about what is being cut to meet short-term targets,” Leary explains.

On the other hand, many companies have sound reasons for putting cash in shareholders’ hands. Apple, for instance, has spent $100 billion on dividends and buybacks since 2012, and it still ended December with $178 billion of cash on its balance sheet.

“Certainly they have investment needs, but it’s inconceivable they could have better uses for all of that cash,” Leary said.

Or take General Electric, which plans to fund a $50 billion buyback by selling most of its finance business. The move not only rewards shareholders, it also makes GE a higher-margin, and hence more valuable, industrial company.

Ken Crawford, a managing director at Argent Capital Management in Clayton, says some companies should be buying back shares while others should be reinvesting every spare cent in the business. It all depends on what kind of return the company can generate.

“It’s one of the core aspects we look at when we invest,” he says. “What is the best use of the company’s capital?”

Buybacks dried up during the financial crisis, when there was no such thing as too much cash. They’re soaring now, fed by a combination of record profits and low interest rates.

It would be nice to see executives gain confidence and start finding more profitable opportunities for using their cash. That could kick economic growth into a higher gear.

What they can’t do is simply wish those opportunities into existence, even if the CEO of a $4 trillion investment firm seems to think they’re already there.