WASHINGTON (MarketWatch) — There’s something seriously wrong with an economy that nurtures a few billionaires but can’t sustain the middle class.

Many factors have been blamed for the plummeting fortunes of the American middle class: globalization, technology, deregulation, easy credit, the winner-take-all economy, and even the inevitable tide of history.

But one under-appreciated factor is a pervasive business model that encourages top managers of American corporations to loot their company for short-term gains, depriving those companies of the funds they need to build and enlarge, and invest in their workers for the long haul.

How do they loot their company? By using large stock buybacks to manage the short-term objectives that trigger higher compensation for themselves. By using those stock buybacks to manipulate the share price, which allows them to use inside information to time their own stock sales. By using buybacks to funnel most of the company’s profits back to shareholders (including themselves).

They use the stock market to loot their companies.

“The ‘buyback corporation’ is in large part responsible for a national economy characterized by income inequality, employment instability, and diminished innovative capacity,” wrote William Lazonick, an economics professor at the University of Massachusetts at Lowell in a new paper published by the Brookings Institution.

Lazonick argues that corporations — which once retained a sizable share of profits to reinvest (including investing in their workforce by paying them enough to get them to stay) — have adopted a “downsize-and-distribute” model.

It’s not just lefty academics and pundits who think buybacks are ruining America. A few months ago, the CEOs of America’s 500 biggest companies received a letter from Lawrence Fink, CEO of BlackRock BLK, +1.55% , the largest asset manager in the world, saying exactly the same thing.

“The effects of the short-termist phenomenon are troubling both to those seeking to save for long-term goals such as retirement and for our broader economy,” Fink wrote, adding that favoring shareholders comes at the expense of investing in “innovation, skilled work forces or essential capital expenditures necessary to sustain long-term growth.”

Other CEOs are beginning to agree.

In April, Wisconsin Sen. Tammy Baldwin wrote to the Securities and Exchange Commission, asking the agency to re-evaluate its policies that encourage buybacks. “There is mounting evidence to suggest that buybacks have a negative effect on jobs, wages and investment, which in turn have negative impacts on innovation and long-term national economic growth, competitiveness, and security.”

How did we get here?

In the early 1980s, in response to a crisis of non-competitiveness in American industry, a theory of “shareholder value” began to dominate American business, law and regulation.

According to this theory, anything that didn’t maximize the value of shareholders’ ownership was just a waste of time and money. The idea was that American companies couldn’t compete against the Japanese because managers weren’t doing what was in the interest of the owners.

To get managers to think like owners, corporations made them owners. Top-level managers began to receive more of their compensation in the form of stock grants and options. In the 1980s, most CEOs and other top executives received most of their compensation in the form of an annual salary and a bonus, but by 2013 the highest paid executives received more than 80% of their compensation via stock options and grants.

The pay of top executives has tripled in real terms since the early 1990s because of those options and grants.

Top managers are paid according to how well the company’s share price is doing, especially in the short run, not on how well the company itself is positioned for long-term profits.

Why does this matter?

Because one big reason for the increase in inequality in America since the 1980s is the explosion of compensation to top corporate executives, who now make up about 60% of the top 0.1% of earners.

And because corporations are increasingly short-sighted, focused on maximizing the company’s share price over all other pursuits.

So, when it comes to deciding whether the company should use its profits for risky investments that would pay off only in the long run, or whether that money should be used to buy back shares to boost the stock price and give managers a huge payday, the company’s managers often do the easy thing and take the money now.

Even managers who are initially resistant to authorizing stock buybacks often succumb to the pressure of outside “activist investors” such as Carl Icahn, Daniel Loeb or T. Boone Pickens to “unlock” shareholder value by buying back as many shares as possible.

Let’s be clear about our terminology here: Icahn is not really an investor in Apple Inc.; he’s a speculator in Apple shares AAPL, -3.17% . Icahn has never contributed any financial or human capital to Apple’s success, unlike its original investors or its workers and executives, who provided the money and brains that made Apple the world’s most successful corporation. Or the taxpayers, for that matter, who funded the research that invented almost all the technology that makes an iPhone work.

Staggering sums

The sums involved are staggering. In 2014, S&P 500 companies bought back $553 billion in shares, in addition to paying shareholders $350 billion in dividends. Total returns to shareholders equaled $904 billion, a bit shy of reported earnings of $909 billion.

It’s not as if companies are raising lots of new capital from the stock market to replace the money they are handing over to shareholders. Banks are raising capital in the stock market, but net issuances of nonfinancial equities have been negative for 21 straight years.

The companies that are doing the most buybacks — Exxon XOM, -1.61% , IBM IBM, -1.72% , Apple, Microsoft MSFT, -1.24% and Cisco CSCO, -1.38% — frequently return most of their annual profits to shareholders, leaving very little to invest in the future. From 2004 to 2013, Pfizer PFE, -0.51% returned 137% of profits to shareholders, Merck MRK, +0.19% returned 104%, and Hewlett-Packard HPQ, -0.99% returned 168%, according to Lazonick’s analysis.

Stock buybacks are making a few people fabulously wealthy, but they are impoverishing the economy and the workers.

Lazonick argues that innovative companies need to invest time and money in facilities, equipment and especially in workers. Innovation and incremental productivity improvements come mainly from people who’ve learned how to work together and when a company allows itself to think in time periods longer than the next quarter or the next year.

But buybacks hollow out a corporation’s ability to innovate. Workers don’t get the chance to learn how to solve problems together, because the managers need to downsize the company to make their short-term earnings targets and collect their millions.

“The disappearance of this career employment in major business enterprises is central to the erosion of the American ‘middle class’ over the past three decades,” Lazonick concluded.