Feast for investors sells workers short
As US companies spend billions repurchasing shares, employees and economy may pay the price
BOXBOROUGH — Bob Ordemann’s team of 80 software developers and engineers filed into a conference room here one day last September at the offices of the giant networking company Cisco. The room was deep within the company’s bucolic campus, nestled amid woodlands where employees brainstorm while strolling along tranquil creeks and ponds.
The news this day was anything but serene. Ordemann and his team were laid off, along with 100 others in Boxborough, part of a sweeping cut of 6,000 employees that hit 8 percent of Cisco’s overall workforce.
“Cisco was so easily willing to let us go; it just seemed mad to me,” Ordemann said in an interview, as he recalled the “dead quiet” reaction to the layoffs.
This was not, however, the case of a company cutting back because it was struggling to make a profit. To the contrary, Cisco’s chief executive officer, John T. Chambers, this month called the California-based company a “cash and profit machine.” Cisco has a cash stockpile of $53 billion, the fifth-largest among US companies, according to Moody’s Investors Service.
How Cisco spends that cash is another matter.
The Boxborough workers learned that at the same time they were being laid off the company was continuing to spend billions of dollars to buy back its own stock, a move designed to reduce the number of shares on the open market and perhaps boost its relatively stagnant share price.
Many other major companies are similarly spending much of their profits repurchasing their own shares, making April the biggest month for buyback announcements in US history.
This stock buyback boom, while obscure to much of the public, has become one of the most pervasive and divisive practices in corporate America. It affects jobs, investment, and the health of the economy, all in the search for higher share prices. It is also a major driver of the widening economic divide in this country, which could make it a prominent issue in the 2016 presidential election.
It boils down to a basic question being asked more and more these days, and not only by workers in Boxborough: Why are so many companies spending record sums of money buying back their shares instead of reinvesting more of their profits in their business and their workers?
The raw numbers are startling and revealing. Since the early 1980s, the nation’s top publicly traded companies have gone from having 70 percent of their profits available to reinvest in their business to just 2 percent in 2014.
The rest is being plowed into dividends and stock buybacks that mostly enrich a select group of investors and executives, according to William Lazonick, a University of Massachusetts Lowell professor whose research was published last fall by Harvard Business Review.
“Stock buybacks should be illegal,” Lazonick said in an interview at his Cambridge home. “They are manipulation of the market.”
Buybacks are booming because US companies have earned record profits and are hoarding a vast amount of cash. The companies use buybacks to share some of that wealth with their executives and shareholders. Many CEOs were given record compensation, and shareholders may have benefited from higher stock prices.
But most stock is owned by the nation’s wealthiest 10 percent; about half of Americans don’t own a single share, directly or indirectly. And buybacks can squeeze the economy in another way: Dollars not reinvested by a company in expanding their business can also mean fewer jobs in construction and other fields.
Supporters of buybacks stress that the nation’s top non-financial companies spent a record amount on capital expenditures in 2014 before declaring their profits. They say that the best way to benefit the average non-stock-holding American is to make sure companies are financially strong enough to withstand Wall Street corporate raiders who might have less allegiance to employees. And they say that shareholders spread wealth throughout the economy.
“The reason [companies] buy back their stock with cash is because they don’t have productive ways to invest the money,” said Peter Morici, a University of Maryland business professor who has written about buybacks. Boosting the share price through buybacks enables “individuals to reinvest in the economy more productively.”
But in recent weeks, Lazonick’s scathing criticism of the buyback trend has been echoed by a growing cast of politicians and business leaders. Laurence Fink, the head of the world’s largest money management company, condemned the practice as short-term thinking that often backfires.
Senator Tammy Baldwin, a Wisconsin Democrat, urged the Securities and Exchange Commission to investigate the practice. SEC commissioner Kara Stein, in turn, warned that many large publicly traded companies this year are in line to spend all of their profits on dividends and buybacks instead of reinvesting those funds in their businesses — possibly a tipping point in the nation’s history.
Cisco, which declined comment for this story, provides a road map of how the practice has skyrocketed, and how it affects executives, shareholders, and workers.
It is a tale of unforeseen consequences, one that began at the tangled intersection of politics and economics, with obscure rule changes in Washington that insiders and others saw and seized on.
Stage is set
Bevis Longstreth was serving as a commissioner on the Securities and Exchange Commission in 1982, when the rule change that launched the buyback boom came up for a vote.
Proposed by Reagan administration officials who favored deregulation, the change enabled corporations to repurchase much larger amounts of their stock on the open market. The measure was intended partly to offset stock options and awards granted to company employees and partly to pump up the stock market. Companies were assured that they would not be prosecuted for price manipulation, as they had feared, and the measure was approved unanimously.
It happened in a simpler time for corporate America, when investors typically held stock for the long term. Many companies viewed their commitment to their employees as a measure of their success. Profits were heavily reinvested into business expansion. If a company had excess cash to return to shareholders, it typically was paid out in dividends.
Gradually, however, the freedom of corporations to make massive buybacks of their stock changed the calculation. The more stock that was bought back, the fewer shares were on the open market. The shrunken stock pool meant share prices often went up. Stock buybacks were now seen as a quick way to boost share prices — without the hard work of increasing investment in the company or coming up with a breakthrough product.
Today, Longstreth is aghast at what the rule change has wrought. He is appalled that the S&P 500 corporations last year spent all but 2 percent of their profits on buybacks and dividends. He said none of that was anticipated when he voted for the proposal.
“It is a terrible thing for the economy because the growth of the economy and the growth of individual companies depends upon their reinvesting in their business and expansion into other lines of business, and paying 98 percent of your earnings out as dividends or stock buybacks implies that you have no future,” Longstreth said in an interview. “It is a stunning number no matter how you say it. It is pathetic.”
A second obscure rule, approved in 1993, played a key role. This one came on then-President Bill Clinton’s watch.
Clinton railed against what he called “excessive pay of chief executives” in a way that now seems almost quaint, decrying CEO pay that reached $1 million or more. He urged Congress to pass legislation that he hoped would discourage high salaries by making amounts paid to executives above $1 million not deductible as a business expense.
But the measure, as it rattled through the congressional gantlet of politics and influence, gained a Wall Street-backed proviso that made any amount of compensation deductible if it was tied to a measure of the executive’s performance, such as stock price.
Thus was launched an era of sky-high CEO pay. Companies handed out enormous options and awards to CEOs that were tied to the value of their stock. Companies found that making a stock buyback, as allowed under the decade-old SEC rule change, could at least briefly boost share prices, perhaps increasing the value of stock options given to top executives. The result: CEOs now had a vested interest in buybacks that could quickly boost the value of their own personal options.
Today, thanks largely due to stock options, the 200 top-earning CEOs at large publicly traded companies made more than $12 million in 2014, and the top 20 made more than $33 million apiece, according to compensation analysis firm Equilar.That helps explain why CEOs today earn 354 times as much as rank-and-file workers, compared with 20 times as much in 1965.
Christopher Cox, who was a Republican House member at the time the measure was passed and who later served as SEC chairman, said the legislation should be enshrined in “the museum of unintended consequences.”
“It was a populist impulsive act, a way for Congress to advertise that it thought that executives were overpaid and to apparently do something about it,” Cox said in a telephone interview. “In fact, even at the time, it was clear enough to some that this was not going to have a prayer of achieving its intended effect.”
(Clinton, for his part, got over his aversion to big paydays after leaving office, collecting $105 million in speaking fees between 2001 and 2013, including from many corporate sponsors, according to a Washington Post analysis.)
For many on Wall Street, buybacks are a natural outgrowth of an economic theory that says a company is run for the benefit of its shareholders — not its workers and not society. Under this “shareholder value” theory — pushed aggressively by hedge funds and activist investors who want quick returns on their money — stockholders pressure management to boost share prices regardless of the consequences for workers or their communities.
The theory holds that such pressure will ensure that companies are managed efficiently and dispassionately — that what is good for the shareholder will be best for the company, and society in the long run.
But critics say the theory has no basis and is a way of rationalizing excesses and inequities that threaten to undermine the nation’s long-term economy.
Lynn Stout, a Cornell Law School professor of corporate finance, said in an interview that Washington policy makers created “a perverse incentive” for corporate leaders to cut investment in factories and research and development in order to put aside billions of dollars to repurchase shares.
“You have CEOs whose pay is tied to share price,” said Stout, author of “The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public.” “You have, sadly, a lot of pension funds and mutual funds who are only thinking two or three years ahead. An investment bank shows up and explains to these people, ‘You know, if you borrow a bunch of money, you can repurchase shares and drive your share price up.’ Who is going to say ‘no’ to that? The problem is when all of our companies are doing that, no one is investing in the future.”
While many on Wall Street support and benefit from buybacks, one of the most prominent critics has been Fink, the chairman of BlackRock, the world’s largest asset management firm. Fink, whose company invests long term, in April wrote the CEOs of the top 500 publicly traded companiesabout his concern that corporate leaders are too focused on trying to “deliver immediate returns to shareholders [through means] such as buybacks or dividend increases, while under-investing in innovation, skilled workforces, or essential capital expenditures necessary to sustain long-term growth.”
Few companies have been more aggressive in the buyback boom than Cisco and its longtime chief executive officer, John T. Chambers — who, as it happens, has a long history in Massachusetts.
A leader in buybacks
Chambers grew up in West Virginia, became an IBM salesman, and by 1983 worked for a Lowell-based company, Wang Laboratories. Wang then was one of the world’s dominant computer firms, anchored by its iconic set of three 12-story towers in the former mill town, one of the most visible symbols of the “Massachusetts miracle.”
But the company failed to foresee the shift from minicomputers to the personal computer. Chambers, in his role as executive vice president, was given the responsibility for laying off 5,000 people, after which he resigned. The Wang towers, built for more than $50 million, were later auctioned off for $525,000, according to a Globe story at the time , a sign of how far the company and the state’s fortunes had fallen.
Chambers’s distress over having to lay off his employees was emblematic of the times. Layoffs were an admission of failure, as he described it.
“We let down our customers. We let down our employees. We let down our shareholders,” Chambers said in an ABC-TV interview about ordering the Wang layoffs. “I’ll do anything to avoid that again . . . You look at people in the eye and you realize that you’re wrecking their lives and their families’.”
Chambers left Wang for a job at a then-obscure company named Cisco, which had 254 employees in 1990. Chambers became executive vice president in 1991 and chief executive officer four years later. As Cisco’s CEO, Chambers foresaw earlier than most that the fast-digitizing world needed better ways to connect computers. The company specialized in routers and other devices, as well as software, that connected this world. Sales took off.
By 1999, Chambers was being glowingly profiled in prime-time television shows. ABC-TV’s Diane Sawyer asked Chambers how much he made.
“Couple million,” he answered.
That apparently was a reference just to his salary and bonus. His stock options that year were worth an astounding $121 million, with an incentive clause for another $179 million if the stock rose 10 percent annually for the following eight years, according to a report at the time by the Los Angeles Times.
In other words, Chambers had an extraordinary incentive to keep the stock price going up.
Chambers seemed on a path to make that happen. In March 2000, Cisco was the world’s most valuable company, with a market value of $555 billion, surpassing Microsoft. Its stock price reached an all-time high of $80. But then the tech bubble burst and by September 2001 the stock sank to $14. Investors clamored for Chambers to boost the price. Unveiling a new product or buying another company — which Chambers did frequently — wouldn’t be enough.
So it was that Chambers put Cisco on the path to becoming one of the nation’s leading practitioners of stock buybacks. The company has spent $91 billion on stock buybacks since 2001, according to its latest securities filing. The company’s share count has dropped from 7.3 billion in 2001 to 5 billion this month.
In some years, the buybacks helped boost Cisco’s share price. But over the long run, the effect has been modest. The share price was $20 shortly after the first buyback was announced in late 2001, rose to $27 in January 2004, and closed at $29 Friday.
While the stock price stagnated, the company’s profits have consistently been among the best in the tech world, including record profits last year. Chambers was well rewarded. He received $680.3 million in compensation from 1993 to 2014, mostly from stock options and awards, according to Lazonick’s research.
But to get to those profits, Chambers has had to scale back some plans, including his vision that Boxborough would be home to one of Cisco’s biggest facilities.
Focused on share values
The future couldn’t have seemed brighter for Cisco’s New England Development Center when Chambers opened the Boxborough campus in 2003. Here he was, 18 miles from the scene of his disastrous last days at Lowell’s Wang headquarters, hoping to bring 5,000 jobs to Massachusetts. Five years later, he returned to Boxborough and assured the assembled workers and politicians that his grand vision for the campus would still come through.
Over time, however, it became apparent that Boxborough might shrink, not expand. Employees often debated the wisdom of Chambers’s strategy of spending billions of dollars on buying back stock. Some employees vented in online discussion groups about whether the company should be spending some of the funds on long-term innovation instead of chasing short-term boosts to the share price.
In 2010, amid investor concern about the company’s stock price, Chambers urged President Obama and Congress to give companies such as Cisco a huge tax break — known as a “tax holiday” — that would allow them to bring overseas profits to the United States at a tax rate of just 5 percent. Otherwise, under US law, a company has to pay the 35 percent corporate tax rate, minus credit for whatever foreign taxes have been paid.
This is a huge matter for Cisco: It currently has 94 percent of its $53 billion stockpile overseas, where it typically is much more lightly taxed than in the United States, according to a report issued earlier this year by Moody’s Investors Service.
While Cisco had one of the largest offshore cash hoards, it was hardly alone, the Moody’s report said. The nation’s non-financial companies now hold a record $1.73 trillion in cash, including $1.1 trillion overseas — money that in another era might have been partly spent on hiring US workers and building facilities and expanding product lines. But many companies today are so averse to paying tax on their offshore cash that they borrow billions of dollars to buy back their stock rather than tap foreign reserves.
In 2004, when Congress granted a tax holiday by charging only 5.25 percent on repatriated profits, companies were expected to use the liberated cash to create US jobs. But a US Senate report found that companies created relatively few jobs. Instead, they used some of the money to repurchase their stock. Still, Chambers was one of the leading voices calling for a new tax holiday, publicly threatening to ship jobs overseas unless he could bring Cisco’s overseas cash to the United States with little taxation.
“I prefer to have the majority of my employees right here in America. That’s the right decision for us. But if we can’t bring our cash back, we’re going to grow dramatically overseas in terms of job placements,” Chambers told CNBC in 2013 .
Congress did not declare the tax holiday that Chambers sought. Soon, he was announcing rounds of layoffs, while stressing that he was “focused on shareholder value creation.”
Years earlier, Chambers had said he never wanted to go through anything again like the 5,000 Wang layoffs. But now Chambers made it clear he had gotten over his aversion, announcing the August layoff of 6,000 employees in what he called a realignment of company priorities.
“I oversaw five rounds of layoffs during a period of 18 months” at Wang, Chambers wrote in a recent issue of Harvard Business Review. “It was a painful time, but I learned what happens when companies lack the courage to disrupt themselves.”
The disruption began hitting Boxborough last September.
But the trip never happened. Chambers had made up his mind. The Boxborough facility would be among those hardest hit.
Massachusetts taxpayers have a stake in all of this. The state and town of Boxborough lured Cisco to its current location with tax breaks that so far have been worth $39.2 million, according to the Massachusetts Office of Business Development.
In return, Cisco promised to retain 824 jobs and create 669 in Boxborough, for a total of 1,493, according to the state. Cisco told the state it had 1,344 employees in Massachusetts as of last June. The state said it will reevaluate the tax breaks later this year, taking the layoffs into account.
Chambers, who is slated to step down as CEO in July but remain chairman of the board, didn’t come to Boxborough to deliver the news to workers. He sent a recently installed senior vice president from San Jose to lay off 182 employees.
William Stoner, who oversaw a 14-person team, was among those who got the news he dreaded. Abruptly out of work at 52, and carrying the college loans of two children, he faced the challenge of restarting his career. Many laid-off employees did find work elsewhere, and some relocated within Cisco. Stoner, as a mid-level manager, faced higher odds; he often competed against 100 other applicants. He eventually got work as an IT consultant, with fewer benefits and a much longer commute, 62 miles to Connecticut.
He and other Boxborough workers spent weeks asking each other questions that are surely being asked at other companies making similar choices. Would it have been different if Cisco had invested more in its business? Would the layoffs been necessary if there wasn’t so much focus on the stock price?
“There was a lot of debate about stock buybacks,” Stoner said. “Years ago there was a lot more loyalty to employees. Now there is more to shareholders than the employee.”
Ordemann, who had spent 16 years working for Cisco, including the last 11 in Boxborough, watched movers load his team’s gear on trucks headed to Cisco operations in Canada, California, and North Carolina. Then he left behind the corporation’s meticulously tended grounds and headed into the wilderness. Traveling to the northern Massachusetts border, he put on a pair of backcountry skis and shouldered a backpack. For the next five weeks, he skied the spine of Vermont, taking the 300-mile Catamount Trail to the Canadian border.
Somewhere along his journey, as he bundled against temperatures that dropped to 9 degrees below zero and glided atop snow that was often more than two feet deep, he decided he would switch careers and set new goals. He could try to use his background to develop solutions to cope with the Earth’s changing climate.
“Cisco has been a very, very good place to work,” he said, sitting in a Starbucks recently built on land that Cisco once eyed for expansion. “It’s hard to walk away from a position like this, so when they show you the door, you can decide to be upset or you can treat it as an opportunity, and I chose the latter.”
At summer’s end, after time with his family, Ordemann plans to begin his job search in earnest.