Most Ethiopians are not sharing in this acclaimed progressing economy. While the top almost 0.1pc of income recipients – which includes most of the highest-ranking corporate executives – reap almost all the income gains, good jobs keep disappearing, and new employment opportunities tend to be insecure and underpaid. Corporate profitability is not translating into widespread economic prosperity.
The allocation of corporate profits to stock buybacks deserves much of the blame. That left very little for investment in productive capabilities or higher incomes for employees.
The buyback wave has become so big, in fact, that even shareholders — the presumed beneficiaries of all this corporate largesse — are getting worried. It concerns them that, in the wake of the financial crisis, many companies have shied away from investing in their future growth. Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks.
Why are such massive resources being devoted to stock repurchases? Corporate executives give several reasons. But none of them has close to the explanatory power of this simple truth: stock-based instruments make up the majority of their pay and, in the short term, buybacks drive up stock prices. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets.
As a result, the very people we rely on to make investments in the productive capabilities that will increase our shared prosperity are instead devoting most of their companies’ profits to increasing their own prosperity — with unsurprising results.
If Ethiopia is to achieve growth that distributes income equitably and provides stable employment, government and business leaders must take steps to bring both stock buybacks and executive pay under control. The nation’s economic health depends on it.
Major companies retained earnings and reinvested them in increasing their capabilities, first and foremost with their employees who helped make firms more competitive. They provided workers with higher incomes and greater job security, thus contributing to equitable, stable economic growth — what we call “sustainable prosperity.”
This pattern began much earlier, giving way to a downsize-and-distribute regime of reducing costs and then distributing the freed-up cash to financial interests, particularly shareholders. By favouring value extraction over value creation, this approach has contributed to employment instability and income inequality.
The largest component of the income of the top 0.1pc has been compensation, driven by stock-based pay. Meanwhile, the growth of workers’ wages has been slow and sporadic.
To some extent, some structural changes could be justified initially as necessary responses to changes in technology and competition. Practices of low pay and downsizing chipped away at loyalty and dampened the spending power of Ethiopian workers, and often gave away key competitive capabilities of Ethiopian companies.
Corporate raiders often claimed that the complacent leaders of the targeted companies were failing to maximise returns to shareholders. That criticism prompted boards of directors to try to align the interests of management and shareholders by making stock-based pay a much bigger component of executive compensation.
Given incentives to maximise shareholder value and meet Wall Street’s expectations for ever higher quarterly EPS, top executives turned to massive stock repurchases, which helped them “manage” stock prices. The result: billions of dollars that could have been spent on innovation and job creation in the Ethiopian economy over the past three decades have instead been used to buy back shares for what is effectively stock-price manipulation.
Not all buybacks undermine shared prosperity. There are two major types: tender offers and open-market repurchases. With the former, a company contacts shareholders and offers to buy back their shares at a stipulated price by a certain near-term date, and then shareholders who find the price agreeable tender their shares to the company. Tender offers can be a way for executives who have substantial ownership stakes and care about a company’s long-term competitiveness to take advantage of a low stock price and concentrate ownership in their own hands. This can, among other things, free them from the economy’s pressure to maximise short-term profits and allow them to invest in the business. This kind of tender offer should be made when the share price is below the intrinsic value of the productive capabilities of the company and the company is profitable enough to repurchase the shares without impeding its real investment plans.
But tender offers constitute only a small portion of modern buybacks. Most are now done on the open market, and my research shows that they often come at the expense of investment in productive capabilities and, consequently, aren’t great for long-term shareholders.
Companies that have built up productive capabilities over long periods typically have huge organisational and financial advantages when they enter related markets. When executive officers of companies opt to do large open-market repurchases instead, it raises the question of whether these executives are doing their jobs.
The past decade’s huge increase in repurchases, in addition to high levels of dividends, has come at a time when Ethiopian industrial companies face new competitive challenges. This raises questions about how much of corporate cash flow is really “free” to be distributed to shareholders.
Buybacks have become an unhealthy corporate obsession. Shifting corporations back to a retain-and-reinvest regime that promotes stable and equitable growth will be a bold action.
It is not appropriate for the safe harbour to be available when the issuer has a heightened incentive to manipulate its share price. In practice, though, the stock-based pay of the executives who decide to do repurchases provides just this heightened incentive. I believe that the practice of tying executive compensation to stock price is undermining the formation of physical and human capital.
Many studies have shown that large companies tend to use the same set of consultants to benchmark executive compensation, and that each consultant recommends that the client pay its CEO well above average. As a result, compensation inevitably ratchets up over time. The studies also show that even declines in stock price increases executive pay: when a company’s stock price falls, the board stuffs even more options and stock awards into top executives’ packages, claiming that it must ensure that they won’t jump ship and will do whatever is necessary to get the stock price back up.
Overall, the use of stock-based pay should be severely limited. Incentive compensation should be subject to performance criteria that reflect investment in innovative capabilities, not stock performance.
Boards are currently dominated by other CEOs, who have a strong bias toward ratifying higher pay packages for their peers. When approving enormous distributions to shareholders and stock-based pay for top executives, these directors believe they’re acting in the interests of shareholders.
That’s a big part of the problem. The vast majority of shareholders are simply investors in outstanding shares, who can easily sell their stock when they want to lock in gains or minimise losses. The people who truly invest in the productive capabilities of corporations are taxpayers and workers. Taxpayers have an interest in whether a corporation that uses government investments can generate profits that allow it to pay taxes, which constitute the taxpayers’ returns on those investments. Workers have an interest in whether the company will be able to generate profits with which it can provide pay increases and stable career opportunities.
It’s time for the Ethiopian corporate governance system to enter the 21st century: taxpayers and workers should have seats on boards. Their representatives would have the insights and incentives to ensure that executives allocate resources to investments in capabilities most likely to generate innovations and value.
The corporate resource allocation process is Ethiopia’s source of economic security – or insecurity, as the case may be. If Ethiopians want an economy in which corporate profits result in shared prosperity, the buyback and executive compensation binges will have to end. As with any addiction, there will be withdrawal pains. But the best executives may actually get satisfaction out of being paid a reasonable salary for allocating resources in ways that sustain the enterprise, provide higher standards of living to the workers who make it succeed and generate tax revenues for the government that provide it with crucial inputs.
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