Investors are salivating over possible US corporate tax cuts. But evidence suggests this excitement is misplaced, at least from the perspective of the end beneficiaries. Corporate tax cuts boost share price and CEO pay. Hence, they are good for concentrated owners.
And tax cuts are favoured by short-term investors who deliver ‘value’ by trading on share price. But there is no evidence that they have a positive impact on employment rates. Who says this? Among others, the Federal Reserve board of governors, the Economic Policy Institute and recently the Institute for Policy Studies.
The impact is the same whether investors are active supporters of tax cuts or remain silent. Politicians promoting this agenda get an easy ride and can pretend to be business and investor friendly.
So why do investors like tax cuts? The missing link seems to be share buybacks. Are share buybacks good for end beneficiaries? No, they destroy shareholder value and if you want more details how, read economist William Lazonick in the Harvard Business Review (Profits Without Prosperity, September 2014). I will return to this theme in a future column.
Why do mega investors collude with CEOs and boards on this capital allocation issue, and indeed other core corporate governance issues? Primarily, because it helps with asset gathering and the industry’s dirty secret is that this has become the de facto purpose of many firms. Indeed, a handful of investors have won this race and define how the herd operates, as academics have illustrated.
How do share buybacks help fund managers compete in the AUM arms race? Simply, they produce easy investment returns in a world where cap-weighted indices rule and where performance means relative to peers and over the short – or at best medium – term.
Most investors are therefore not willing to speak out about this in any explicit manner, which makes the comments – in 2016 and again in 2017 – by Larry Fink, the CEO of BlackRock, important.
According to The Principles for Responsible Investment (PRI), over one in every two investment dollars now says “we are integrating ESG”. Many investors also claim to be long-term. So you would think these investors would be all over this issue. But, when I asked a global fund manager for one example of where they had publicly rebuked a company for doing the wrong thing on buybacks, they were unwilling, or unable, to provide one. I will not name the investor because the whole sector is guilty of passivity.
Because I am a hopeful person, I can see two ways forward.
First, all those who are becoming concerned about corporate tax cuts could come to see that they have next to no chance of stopping the cuts unless they also address share buybacks. So, for the first time, there could be a public constituency in favour of addressing share buybacks.
Will this change investor behaviour overnight? Certainly not. But as with inequality and climate risk, we know that change from outside the investment world can influence fund managers. Institutional investors cannot afford to be lagging customers and retail investors on too many issues – its so embarrassing.
Second, investment leaders can start to explore this gap between walk and talk – acknowledging to each other what they know in private and exploring how they can raise the benchmark. The upcoming investor meetings of International Corporate Governance Network, PRI, the Strategic Investor Initiative and Focusing Capital on the Long Term – offer opportunities for such conversations. The trick will be to avoid the ‘blah blah’ but rather facilitate authentic discussions.
One way would be to give positive mavericks at these firms a voice.
Jim Stride, who recently retired from AXA, is a good example: “We are very against buybacks because they do not treat shareholders equally, which companies could do through, for example, extra-dividends or B share schemes. We also think that one perverse and negative effect of a buyback is to attract further selling of the stock. As a buyback decreases the number of shares in a company, in due course index funds will sell down as well.”
Ideally the organisers of these events will give formal space for this critical issue, but even an informal fringe meeting would be useful. Who is best to lead this? As with other issues where conflicts of interest prevent fund managers from taking leadership, this will have to be led by asset owners. As Dominic Barton, McKinsey’s global managing partner and Mark Wiseman, then CPPIB’s CEO have written: “The single most realistic and effective way to move forward is to change the investment strategies and approaches of the players who form the cornerstone of our capitalist system: the big asset owners… If they adopt investment strategies aimed at maximising long-term results, then other key players – asset managers, corporate boards, and company executives will likely follow suit.”
Dr Raj Thamotheram is co-chair of Preventable Surprises and a visiting fellow at the Smith School, Oxford University