As Layoffs Rise, Stock Buybacks Consume Cash
New York Times
By NELSON D. SCHWARTZ
November 22, 2011
When Pfizer cut its research budget this year and laid off 1,100 employees, it was not because the company needed to save money.
In fact, the drug maker had so much cash left over, it decided to buy back an additional $5 billion worth of stock on top of the $4 billion already earmarked for repurchases in 2011 and beyond.
The moves, announced on the same day, might seem at odds with each other, but they represent an increasingly common pattern among American corporations, which are sitting on record amounts of cash but insist that growth opportunities are hard to find.
The result is that at a time when the nation is looking for ways to battle unemployment, big companies are creating fewer jobs, and critics say they are neglecting to lay the foundation for future growth by expanding into new businesses or building new plants.
What is more, share buybacks have not fulfilled their stated purpose of rewarding investors over the last decade, experts say. “It’s a symptom of a deeper problem, which is a lack of investment in the long term,” said William W. George, a Harvard Business School professor and former chief executive of Medtronic, a medical technology company. “If we’re not investing in research, innovation and entrepreneurship, we’re going to be a slow-growth country for a decade.”
Liberal critics insist the trend is another example of top corporate executives raking in an inordinate share of the nation’s wealth, even as their employees suffer.
“It’s an extraordinarily unimaginative way to use money,” said Robert Reich, a former secretary of labor under President Clinton who now teaches public policy at the University of California, Berkeley. After diving in the wake of the financial crisis, buybacks have made a remarkable comeback in recent years, with $445 billion authorized this year, the most since 2007, when repurchases peaked at $914 billion.
But spending on capital investments like new plants and infrastructure has stagnated more broadly in corporate America, confounding efforts by the Obama administration to spur economic growth. Capital expenditures by companies on the Standard & Poor’s 500-stock index are expected to total $546 billion in 2011, down from $560 billion in 2008, according to data compiled by Thomson Reuters Eikon.
The principle behind buybacks is simple. With fewer shares in circulation, earnings per share can rise smartly even if the company’s underlying growth is lackluster. In many cases, like that of the medical device maker Zimmer Holdings, executives are able to meet goals for profit growth and earn bigger bonuses despite poor stock performance.
“It’s clear there’s a conflict of interest,” said Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “Unless earnings per share are adjusted to reflect the buyback, then to base a bonus on raw earnings per share is problematic. It doesn’t purely reflect performance.”
In addition, executives, who are often large shareholders, stand to benefit from even a small, short-term jump in stock prices.
Earlier this month, Pfizer increased its estimate for stock repurchases this year to between $7 billion and $9 billion — essentially spending in one year nearly all of the money it set aside in February for multiyear buybacks. There has been a steady drumbeat of other companies laying off workers even as they have disclosed plans to buy back more stock. On June 23, Campbell Soup said it would buy back $1 billion in stock; five days later it announced plans to eliminate 770 jobs. Hewlett-Packard announced a $10 billion stock repurchase in July, and jettisoned 500 jobs in September after it discontinued its TouchPad and smartphone product lines.
Last month, the first layoffs began at Zimmer’s plant in Statesville, N.C., which is due to shut early next year. The company made splints and tourniquets there for more than three decades. For the sewing machine operators and the rest of the 124 workers at the plant, it is bad news, but it is a different story for Zimmer’s top executives.
Powered by huge stock buybacks — the company bought $500 million worth of its own shares last year, more than twice what it spent on research and development — Zimmer posted earnings growth of 10 percent a share, even though operating income and revenue grew by less than 5 percent in 2010.
That helped its senior management, including the chief executive, David C. Dvorak, collect millions in cash and stock incentive payments by meeting earnings-per-share goals. For example, 50 percent of Mr. Dvorak’s $1.03 million cash bonus was tied to achieving per-share earnings of $4.28 in 2010. The company earned $4.33, but without the share repurchases the company would have made $4 to $4.10 a share.
Investors have not rewarded the strategy, however: Zimmer’s shares have dropped 32 percent in the last five years, while Pfizer’s are down 30 percent in the same period.
Over the last decade, in fact, companies that spent the most on repurchases had a total shareholder return of 37 percent versus 127 percent for companies that spent the least, according to research by Gregory V. Milano, chief executive of Fortuna Advisors, which consults with companies on how to raise their share price over the long term.
In the cases of Pfizer and Zimmer, analysts say the rush to buy back shares crimped development of new products, a prime reason that both companies are experiencing slow revenue growth.
Despite the looming expiration of the patent for its best-selling drug, Lipitor, Pfizer spent more than $20 billion repurchasing shares from 2005 to 2010.
“In that era, it wasn’t the best use of cash,” said Catherine Arnold, an analyst with Credit Suisse. “They should have been doing more to fix the company.”
Matthew Dodds, an analyst with Citigroup, said, “Zimmer has shown little appetite for acquisitions or diversification, yet they don’t sport a pipeline that can drive investor interest.”
Nevertheless, Zimmer is on track to repurchase $1 billion worth of its shares this year, double last year’s pace, and it actually borrowed money last quarter to achieve its goal.
In a statement, Zimmer said its bonus programs were “designed to pay for performance,” and that overall compensation strategy was “designed to align the interests of its employees and stockholders.” Zimmer is committed to research and development and the introduction of new products, the company said, adding that the factory closure in North Carolina, while difficult, “is in the best interest of the company’s stockholders.”
Pfizer declined to make an executive available to discuss its policy. But in a statement, the company said it “remains committed to returning capital to shareholders through share buybacks and dividend payments.”
As for the cut in research spending in February, Pfizer said it has “accelerated our research strategy and made important changes to concentrate our efforts to deliver the greatest medical and commercial impact.”
In a conference call with analysts this month, Pfizer’s chief executive, Ian C. Read, said his company would “continually look” for acquisitions that would increase revenue growth. But in deciding how to use the proceeds from recent asset sales, he said “the case to beat is share repurchase.”
Financial institutions, which bought back huge amounts of stock over the last decade at share prices far higher than they are today, do not seem to have learned their lesson either. JPMorgan Chase, for example, spent $4.4 billion repurchasing shares in the third quarter even as its stock fell more than 25 percent.
Jamie Dimon, the bank’s chief executive, actually apologized for the move last month, conceding: “It would have been wise to wait. We’re sorry.”