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BUYBACKS, DIVIDENDS AND UNEMPLOYMENT (PART II)

January 8, 2014

BUYBACKS, DIVIDENDS AND UNEMPLOYMENT (PART II)

We saw in Part I of this essay that corporate America has historic shiploads of cash, and better, access to even far more cash via historically low interest rates due to the Fed’s “quantitative easing,” aka corporate welfare for the bond and stock markets. We saw that the Dow and other measures do not describe the economy the vast number of us live in it and that our “economic growth” is actually in part a measure of the overseas economies in which our multinationals operate.

Perhaps most importantly, we saw that wage inequality is not only affecting consumer aggregate demand with its underpaid labor; we saw that such lack of demand is adversely affecting corporate profitability. The poor man cannot afford the rich man’s goods and services. The stock market was up 26% this year, but the so-called “wealth effect” did not reach those not in the investment class. There was change in our inequitable wage structure, to be sure, but it was a downward change as inflation outstripped such puny wage increases as there were for the year. Once again (and for every year since 1974), the newly created wealth produced by our economy (such as it is) went unshared as the rich and corporate class hogged all such newly created wealth for the 39th consecutive year.

Since corporate profitability from its core activities is falling because the hoi polloi has less money to spend, corporations have to make other moves to keep dividend-hungry shareholders happy. So what to do? How can a given corporation keep its shareholders from selling its stock and buying elsewhere, and since some of its shareholders may be sophisticated and noisy hedge fund investors who want a piece of the cash corporations are hoarding and are threatening shareholders’ suits if they don’t get it, what is a particular corporation’s alternative to giving up its own cash or borrowing even if interest on such loans is negligible? The answer to holding off the dividend wolves may be found in buyback of its own stock. There is no change in net position since the stock bought back is worth the money paid for it, of course.

When a corporation buys back its own stock, such stock does not participate in dividend payouts. Let’s say a corporation buys 25% of its total stock outstanding; that translates into a 25% increase in potential declaration of dividends to shareholders of record. It also translates into happier shareholders, even though the corporation may have spent some of its cash or has borrowed funds used in the buyback. There are ways to correct that temporary cash imbalance, however, as we shall see later in this essay.

Shareholders may not be the only happy ones in this corporate exercise. Higher dividend payments are likely to increase the value of the outstanding stock remaining, which means that bonus-hungry corporate executives whose compensation is tied to the value of such stock or an increase in earnings will profit as well. Higher values of stock also translate into enhanced capital gains if the stock is the subject of sale or other disposition. Such enhanced valued stock likewise increases its pledge value as collateral for loans shareholders may wish to make, perhaps for acquisition of additional stock.

Such a happy announcement at an annual shareholders’ meeting creates another problem, however, to wit: How can such a corporation recover its former cash position after payment of dividends when demand for its goods and services is flat both here and in a weak global economy and with shareholders certain to be demanding dividends at the next annual shareholders’ meeting? I will discuss some of the depressing means corporations are employing to solve this problem in Part III. Stay tuned.  GERALD  E

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