Share Firms enriching shareholders isn't a problem. It's why they exist

Firms enriching shareholders isn't a problem. It's why they exist Is it really bad news that cash is leaving large corporations?

Is it really bad news that cash is leaving large corporations? Payouts to investors allows the allocation of capital to newer firms

There’s nothing so dangerous to the public interest as the entire political class agreeing on a single idea. Yet this is what is happening in Washington, DC, about the issue of share buybacks and dividends. That Bernie Sanders or Elizabeth Warren don’t understand how the capitalism works is hardly a surprise. But, as The Telegraph reports, the Republican side is making the same error, with companies enriching their shareholders being labelled by shareholders as “corporate cocaine”. And by that they don’t just mean expensive and boring.

The contention is that if a company makes a profit then it should use that to invest again in what was making that profit. By this logic, returning money to shareholders through dividends, or by buying back outstanding shares, is a waste of that cash that should righteously be used to expand the economy. It’s certainly true that companies are returning money. It depends whose estimates you use but a very large share of corporate profits are flowing to investors. But how serious a problem is this?

The first and most obvious foolishness is the thought that companies shouldn’t be enriching shareholders. That, of course, is the point. People put money into collective endeavours in the hope of gaining more out over time. This is, after all, what funds our pensions and retirements. Given the usual human propensity for greed, the more that’s paid out in such profits the more we’d expect to see being put into investment.

The assumption made by those complaining is that money paid out to investors somehow disappears from the economy. To the extent that there are Scrooge McDucks out there this is true, capital stashed into basements is indeed taken out from general circulation. Thankfully, however, Mr. McDuck is a comic book character, and this doesn’t happen very often in the real world. Those successful investors who receive income from their holdings can only do one of two things with it. They can spend it – creating demand in the economy – or they can invest it again. That it has moved out of a corporate structure does not change this, it just changes who is making that decision.

Even a complaint that the cash will just buy more second-hand stocks or bonds rather than build new productive assets fails – for the decision is just moved one further iteration down the line. There is no leakage, the resources continue to circulate.

The basic contention, that money leaving corporate structures fails to be investment in the future is thus wrong. But we are talking about politics here so of course the situation is worse.

In fact, we positively desire that money move out of large corporations. They’re rather inefficient users of it, you see?

It’s entirely true that we’d like to see investment happening. It’s one of the GDP components for example, it boosts the economy. Investment today creates that economy of the future – we’ve got to build what we want to use tomorrow. We’d like that research, those new products. We also know what it is that raises wages, jobs and lots of them. Given that we like rising wages we’d therefore like to see that investment in those jobs of tomorrow. Which brings us to the great truth about job creation, invention and innovation.

It’s long been known, from William Baumol, that large companies – large organisations really – aren’t all that good at invention. They are pretty hot at innovation, the incremental improvement of something we already know about and make. But that radical new thing not so much. It’s small companies that do the work there. Some part of it is just the risk aversion of large bureaucracies. Some is that by very dint of being large, an organisation is heavily invested in the current manner of doing things. But more than this, it’s not large companies that create job growth. In fact, on balance, they tend to destroy jobs as they continually become more productive in their use of labour. It’s not even small companies that employ ever more workers. It’s new ones.

Given all of this well-known – in the trade that is, if not in politics – background, what we’d like is a system which does the following. Those bets on processes and products of the last generation that worked, which produce profits, we’d like that surplus to leave those organisations. We’d like it all put into the hands of those who can and will select the next big new thing. A reasonable guess as to who might do that well being those who chose right last time around – the investors who own those successes. We’d like, that is, a system whereby corporate profits were paid out to investors so they can reinvest again in the inventions which will make the future richer, those new jobs which will raise wages.

That is, we want, positively desire, the system that the politicians are all complaining about. Such delusions being only one of the reasons why politics isn’t a good way to run an economy.

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Tim Worstall works for the Adam Smith Institute and the Continental Telegraph.

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