CRITICAL REVIEW

FINANCIAL MANAGEMENT - II

Group Name- Akshay Chandran T (028), Mohd.

Asim khan (042)
Section-B
TOPIC PROFIT WITHOUT PROSPERITY
The economic built for profits not profit. Why are such massive resources
dedicated to stock buybacks? Because stock-based instruments make
up the majority of executives pay, and buybacks drive up short-term
stock prices. Buybacks contribute to runaway executive compensation
and economic inequality in a major way. Because they extract value
rather than create it, their overuse undermines the economys health.
To restore true prosperity to the country, government and business
leaders must take steps to rein them in. One of the major causes:
Instead of investing their profits in growth opportunities,
corporations are using them for stock repurchases. Take the 449 firms
in the S&P 500 that were publicly listed from 2003 through 2012.
During that period, they used 54% of their earningsa total of $2.4
trillionto buy back their own stock. Dividends absorbed an extra 37%
of their earnings. That left little to fund productive capabilities or better
incomes for workers.

Todays Perspective
Buybacks in General- Companies are in business to make money. The question is how
companies return the money they make to shareholders. Historically, this has been
through dividends, but as the author notes, as of late it has been through share buybacks.
Note that buybacks are more of an American phenomenon than a Canadian one. In the
US, dividends are double taxed, whereas in Canada the dividend tax credit offsets the
double taxation of personal dividends. In the US, the buyback eliminates the taxation of
the return on capital that befalls an individual owner.

Given the double taxation of dividends in the US, it is little wonder that buybacks are the
preferred route to return earnings to shareholders. The problem is less the buyback than it
is the tax code. Return of shareholder funds is bad for growth-The author is clearly
against the role of maximizing shareholder value (MSV). This is religion, so I wont
address the issue. However, the premise that money paid out (via dividends or buybacks)
are money that could be reinvested in the business is fallacious.
Good stewardship dictates that managers should only invest in projects that can return
above the cost of capital. If that is not the case, then the managers should return the
monies to shareholders. If this is not adhered to, overinvestment occurs, and ultimately
capital is destroyed. Let the owner, the shareholder, decide what to do. The author
suggests that $2Trillion or so could have been invested in the economy had monies not
been used for buybacks or dividends. This is fallacious. Monies were invested in the
economy, just not by the companies that earned the profits. Thank heavens that GM paid
a dividend; even more monies would have been wiped out had they built even more
capacity in the 80s and 90s.The GM money, conceptually, financed the capital raised by
Apple on its IPO. That is a pretty good thing. Dividends are not bad -Today; the
demographic demand for income is greater than ever. Companies that return monies
regularly have achieved increasingly higher valuations. There is consumer preference for
dividends, so let the consumer have what the consumer want. Short term-The bigger
problem which is the short-termism of linking compensation to short term performance.
A company that buys back shares can increase EPS by pure math. If compensation is
linked to EPS growth, then there is a real incentive to do whatever it takes to increase
short term EPS. Buybacks would exacerbate this problem. The solution to short-termism
is the ownership model vs. the compensation model. Todays Perspective-We live in a
low cost of capital environment. With government bonds yielding 2%, conceptually there
should be lots of projects which could earn such a low cost of capital. The problem is
there is very little demand for the products that would be created by the investment.
Hence, companies are not investing.