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Corporate executives use stock buybacks to increase their pay

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On Friday, Ingedion Incorporated, a maker of starch and sweetener ingredients, announced that its Board of Directors authorized a stock repurchase program permitting the company purchase of up to 4 million of its outstanding common shares. Stock buybacks are on the rise. Today The Washington Post reports that the 30 companies of the Dow Jones stock index authorized $211 billion to buy back company stock in 2013

Why the increase in buybacks?

What if you are head of a large corporation and want to a pay increase? Your pay is partly tied to the earnings per share of outstanding company stock. You can increase earning the hard way by improving quality and appeal of what the company sells, or by investing in research and development to improve the product, or you can invest in training to improve the productivity of your labor force or invest in other countless ways that improve your product.

But there is an easier way.

Use cash on hand to buy back shares of company stock, thereby decreasing total shares. Voila! Earnings per share rise and so does your executive compensation. Here is a real kicker. In today's near zero interest rates, engineered by the Federal Reserve in part to encourage investment by corporations, CEO's can use borrowed money to buy back stock. It's good for CEO pay and good for short term holders of company stock, as share prices rise; but it's not so good for the economy and the long term growth of the company.

Buybacks at all companies this year are on track to reach $754 billion, not quite as high as the record $863 billion in 2007, but way above the recession low in 2009.

Last month Yahoo Finance reported that the high tech company behemoth Cisco announced that $15 billion would be authorized for company buy backs.

The Washington Post story reported that Home Depot authorized a $17 billion buyback in February; Goldman Sachs $10.8 billion in April, Pfizer $10 billion in June and Wal-Mart authorized $15 billion in June.

As an example of what a stock buyback can do for a corporate executive, The Wall Street Journal reported in May that Steve Burd, the CEO of Safeway Inc., got a $2.3 million stock award in March because there was a 61% increase in earnings per share. Safeway sales hadn't increased nor did profits per share. But with fewer shares outstanding, earnings per share increased. WSJ quoted Robin Ferracone, of pay consultant Farient Advisors as saying, "If you're a CFO or a top executive, you can determine if the EPS goes up or not based on a stock buyback,"

Do company buybacks offer executives too easy a way to boost their pay at the expense of the hard work of plowing back earnings into research and development and investment in employee training and product development? The Washington Post article quotes Ben Inker, co-head of asset management GMO investment management firm, “Corporate profits are very high, but corporations are not expecting a huge burst of growth. So they're finding ways of getting money back to shareholders."

Why invest if you are not expecting growth of sales? This doesn't bode well for the economy in 2014. Buybacks are out pacing investment.

AT&T, spent $11.1 billion this year buying back shares, while spending only $1.3 billion on research and development last year. Pfizer's original $10 billion buyback program increased to $11.5 billion. It only spent $7.9 billion in research last year.

Something seems not right with executive pay being tied to a measure so easily manipulated by CEOs and their boards. As reported in the WP story, Keith Johnson, former legal counsel to Wisconsin’s public pension fund said, “It’s just a really bad way to run an economy. It perverts the allocation of capital.” And Roger Martin, former dean of the Rotman School of Management at the University of Toronto, “In football, they have this absolute rule, which is if you’re ever caught betting on football if you’re a player or manager, you get punted out for life,” Martin said. “In the world of business, it’s a different rule.”

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