Where did all this money go?

The answer is as simple as it is surprising: Much of it went to stock buybacks—more than $6.9 trillion of them since 2004, according to data compiled by Mustafa Erdem Sakinç of The Academic-Industry Research Network. Over the past decade, the companies that make up the S&P 500 have spent an astounding 54 percent of profits on stock buybacks. Last year alone, U.S. corporations spent about $700 billion, or roughly 4 percent of GDP, to prop up their share prices by repurchasing their own stock.

In the past, this money flowed through the broader economy in the form of higher wages or increased investments in plants and equipment. But today, these buybacks drain trillions of dollars of windfall profits out of the real economy and into a paper-asset bubble, inflating share prices while producing nothing of tangible value. Corporate managers have always felt pressure to grow earnings per share, or EPS, but where once their only option was the hard work of actually growing earnings by selling better products and services, they can now simply manipulate their EPS by reducing the number of shares outstanding.

So what’s changed? Before 1982, when John Shad, a former Wall Street CEO in charge of the Securities and Exchange Commission loosened regulations that define stock manipulation, corporate managers avoided stock buybacks out of fear of prosecution. That rule change, combined with a shift toward stock-based compensation for top executives, has essentially created a gigantic game of financial “keep away,” with CEOs and shareholders tossing a $700-billion ball back and forth over the heads of American workers, whose wages as a share of GDP have fallen in almost exact proportion to profit’s rise.

To be clear: I’ve done stock buybacks too. We all do it. In this era of short-term-focused activist investors, it is nearly impossible to avoid. So at least part of the solution to our current epidemic of business disinvestment must be to discourage this sort of stock manipulation by going back to the pre-1982 rules.

This practice is not only unfair to the American middle class, but is also demonstrably harmful to both individual companies and the American economy as a whole. In a recent white paper titled “The World’s Dumbest Idea,” GMO asset allocation manager James Montier strongly challenges the 40-year obsession with “shareholder value maximization,” or SVM, documenting the many ways that stock buybacks and excessive dividends have reduced business investment and boosted inequality. Almost all investment carried out by firms is financed by retained earnings, Montier points out, so the diversion of cash flow to stock buybacks has inevitably resulted in lower rates of business investment. Defenders of SVM argue that investors efficiently reallocate the profits they reap from repurchased shares by investing the proceeds into more promising enterprises. But Montier shows that since the 1980s, public corporations have actually bought back more equity than they’ve issued, representing a net negative equity flow. Shareholders aren’t providing capital to the corporate sector, they’re extracting it.