Many of us see the stock market as an investment engine for building companies and generating wealth, but the truth is that the stock market works more like an extraction engine. It depletes corporations while contributing to the concentration of wealth.
The Stock Market is an Aftermarket
Our distorted view of the stock market starts when we believe that buying shares in a publicly-traded company actually invests money in a company.
There are situations when buying shares results in money flowing into a corporation: it’s called the “primary market,” and it includes Initial Public Offers (IPOs) and issuances of new equity by existing companies. The primary market is surprisingly small, however. As Robert Higgens notes in his book, Analysis for Financial Management, at their peak in 2000, IPOs accounted for just 5% of external sources of corporate capital. Similarly, only 5% of existing, publicly traded corporations issue new equity in any given year.
The Extraction Engine of Shareholder Primacy
If you’re not buying shares on the primary market (and again, very few investors do), then you’re not really investing in a company; you’re investing in a token that grants you rights to the future earnings of that company.
Marjorie Kelly first helped me see this simple truth about the stock market in her book, The Divine Right of Capital. That book also introduced me to “shareholder primacy,” the idea that corporations exist, first and foremost, to maximize returns for shareholders. Lynn Stout also focused on this idea in her book, The Shareholder Value Myth. The picture that emerges from both these books is of the stock market as a powerful engine for extracting corporate wealth and concentrating it into the hands of shareholders.
The extraction process works primarily through dividend distributions and corporate purchases of stock, and it is massive in scale.
Dividend Distributions
Between 1952 and 2020, U.S. corporations distributed $12.760 trillion in inflation-adjusted dividends to shareholders, with more than 60% of that total occurring just between 2010 and 2020.
Corporate Stock Purchases
When a corporation purchases a large amount of a certain stock, it decreases the supply, which puts upward pressure on the price and creates a nice windfall for existing shareholders.
The Federal Reserve regularly calculates something it calls “New Net Equity.” This relatively unknown measure takes IPOs and new issues of equity from existing firms and then subtracts corporate purchases of their own shares (buybacks) as well as purchases of shares of other companies (mergers and acquisitions). The result is a good measure of how money flows between corporations and shareholders. When it’s positive, money is flowing in from investors. When it’s negative, it’s flowing out.
Until the early eighties, New Net Equity was almost always a positive number, which meant that, up until that time, equity really was flowing from investors into corporations. Things started to to change with the financial deregulation ushered in by the Reagan administration, after which time, New Net Equity turned mostly negative. As Robert Higgens notes, that initial shift was likely triggered by the hostile takeover craze in the 1980s.
Mergers and acquisitions are never a sure thing though; sometimes they create shareholder value and sometimes they destroy it. When it comes to maximizing returns for shareholders, stock buybacks are more reliable than acquisitions, and by the nineties, buybacks began to surpass acquisitions as the primary driver of corporate equity purchases.
Echoing this shift, corporate raiders like Carl Icahn have transformed themselves into the friendlier term, “shareholder activists” in order to encourage corporations to carry out stock buyback plans. In the process, they make themselves very rich: pressuring Apple to carry out its buyback just recently netted Icahn some $3.4 billion over the course of several months.
In May 2020, I captured an update of these numbers. Unfortunately, I was not able to keep the historic numbers going back to 1952, so I have have kept the above chart. Here is the update:
Over the last thirty five years, corporations have transferred an inflation-adjusted $9.292 trillion to shareholders through various forms of corporate stock purchases. The amount is accelerating, with nearly four trillion dollars of that occurring in just the last ten years.
Massive Wealth Transfer
When you combine dividends and corporate stock purchases, you get a huge stream of wealth flowing from corporations to shareholders. Over the last 30 years, this transfer of wealth from corporations to shareholders totaled an inflation-adjusted $17.474 trillion. Last year alone, dividends and corporate stock purchases transferred nearly a trillion dollars to shareholders.
Since the year 2000, this flow of wealth has amounted to an average 5.5% of the United States Gross Domestic Product – every year.
Our Distorted View of Shareholders
The idea that this scale of reward is warranted given the contributions that shareholders make is based on a view of shareholders that no longer maps to today’s reality. It’s as if we hold a mental archetype that mistakenly fuses “investor” with “entrepreneur.” Part of it is probably a holdover from the days when owners still retained significant executive functions. Our view of shareholders is probably also distorted by high-profile founders like Larry Page and Mark Zuckerberg who retain management control along with their huge stock holdings.
But these individuals are far from typical shareholders: they are intimately involved in the ongoing success of their business.
What, then, are the actual contributions of today’s shareholders? The vast majority of shareholders have long since shed management responsibility, and as we’ve seen, since the eighties, they no longer provide actual capital.
What shareholders do provide is “liquidity” – which is to say, their buying and selling makes it easier to trade shares. That’s important because it enables existing shareholders – including the firm’s original entrepreneurs – to cash out their investments of time and energy.
Market liquidity is clearly important, but there are real reasons to question whether it’s worth more than five percent of our annual Gross Domestic Product on an ongoing basis.
Impacts on the Concentration of Wealth
As Thomas Piketty has shown in his book, Capital in the 21st Century, capital is once again becoming concentrated into fewer and fewer hands. When you combine the Federal Reserve data on dividend distributions and corporate stock purchases with Piketty’s wealth distributions for the top 10% and the top 1% of the U.S. population, you end up with the following graph:
By overlaying these datasets, I estimate that last year some $680 billion of corporate profits went to just the top 10% of individuals in the U.S. The top 1% got nearly half of that, or some $320 billion.
In other words, corporate earnings aren’t just being extracted through the stock market; they’re being concentrated into fewer and fewer hands.
What is Being Extracted?
As profits are extracted from corporations with increasing efficiency, companies have fewer resources to invest back into the employees, suppliers, customers, communities and other stakeholders who are critical to their long-term success. The pressure to cut, or externalize, costs shows up as efforts to skirt environmental protection, squeeze suppliers, skimp on customer support and other behaviors that alienate companies from their stakeholders and weaken them over time.
Nowhere is this pressure more obvious than the pressure that shareholder primacy puts on containing labor costs. Indeed, since 1979, the vast majority of American workers have seen their hourly wages stagnate or decline. While factors such as declining union membership and the rising cost of healthcare and other benefits may also play a role, there is an uncanny similarity between the below graph charting the stagnation of hourly compensation and the above graphs showing the rise of corporate wealth distributions to shareholders.
Automating Wealth Extraction
One of the interesting things about the above chart from the Economic Policy Institute is that it contrasts stagnating wages with rising productivity. When companies succeed with automation, output may increase or labor may decrease, but either way, productivity rises. In The Second Machine Age, Erik Brynjolfsson and Andrew McAfee make a solid case for technology’s role in generating this wage and productivity gap.
I’ve also argued in Technology and the Distribution of Wealth that what we’re seeing today is our largest, most powerful corporations automating with an increasingly singular focus on maximizing returns for shareholders. In this sense, shareholder primacy is the “code behind the code” in the artificial intelligence and robotics that will increasingly drive these firms.
Automating processes for extracting and concentrating wealth could very well lead us to a future dominated by highly intelligent, highly automated organizations ruthlessly executing their shareholder primacy mandate, with little regard for the fallout.
These are the perfect profit-extraction machines, and they are the stuff of nightmares.
“The ideal business is one that earns very high returns on capital and that keeps using lots of capital at those high returns. That becomes a compounding machine.”
— Warren Buffett
Closing Thoughts
I am neither an economist nor an expert in financial matters. I have nevertheless invested the time to understand and try to explain these issues because I believe they are extremely important. My hope is that this article will catalyze those with more expertise in these areas to undertake a deeper analysis.¹
My hope in exposing the way the stock market extracts value from corporations and their stakeholders is that it will help make the case for a different vision for business. Shareholder primacy is not the same thing as capitalism. In their book, Firms of Endearment, Raj Sisodia, Jag Sheth and David Wolfe have shown that firms that invest in their stakeholders outperform the S&P 500 Index by a factor of fourteen-to-one. I call this “regenerative business” and I believe it is the primary way we get ourselves out of this current mess.
One final thought centers again on automation. Investing corporate earnings in ways that care for stakeholders will be even more important in a world where automation leaves us with fewer jobs and fewer wages. We need to actively prepare for that world, now.
Resources:
Originally published August 25, 2015 and updated in June 2021.
Federal Reserve data on New Net Equity and Dividends: 2010-2014 data (PDF) and 1952-2010 data (Excel spreadsheet)
Top 1% and 10% of wealth pulled from Thomas Piketty’s website
Robert Higgens’ book, Analysis for Financial Management
¹ One of the holes in the above analysis is that I use the wealth concentration data from Thomas Piketty to estimate how the Federal Reserve data on dividend distribution and corporate equity purchases benefit the top 1% and the top 10% of wealth holders. That assumes wealth concentration amongst the population of shareholders is similar to that of the general population, which is unlikely. Knowing how what actual percentage of benefits go to the top 1% and 10% of shareholders could shed important light on just how much dividends and equity purchases contribute to the concentration of wealth. Another area worth deeper examination is the apparent correlation between shareholder income gains and wage stagnation. Is there data to show actual causation here?
