Disappearing act of US middle-class (II)

By Jang-Sup Shin and William Lazonick

While pressing for restructuring, value extractors and academics who justified this activity argued that U.S. corporations held on to too much "free cash flow" that should be "disgorged" to shareholders as buybacks and dividends. However, what the corporations actually gave away was much more than free cash flow. Many of America's largest corporations routinely distributed more than 100 percent of net income to shareholders. They then generated the extra money by further restructuring of their workforces, selling off businesses or taking on more debts.

Shareholders are supposed to be "residual claimants" who get part of profits as dividends after expensing wages, business costs, taxes and so on. However, they have made their claims the first priority and have instead made wages and other business costs residual. Moreover, on top of receiving dividends for holding shares, they now get massive stock buybacks that will increase their gains from selling shares. In draining trillions of dollars out of business corporations that are vital to the wealth of the nations, they have engaged in predatory value extraction that can only be called the looting of U.S. business corporations.

There are several factors that made shareholders such strong value extractors. One of them is the ever-strengthening trend of fund capitalism. Shareholding by institutional investors in the U.S. passed the 20% mark in 1970 and has continued increase to reach about the 70% level currently. Moreover, the shareholding is extremely concentrated with a small number of investors. The top five institutional investors held 31% of the value of U.S stocks and the top 10 held 42% in the middle of 2016. BlackRock, the largest institutional investor with $4.7 trillion of assets under management is the single largest shareholder in one of every five U.S. companies and had 5% or higher shareholding in 2,610 companies.

Substantial revision of U.S. financial regulations in the 1980s and early 1990s increased the power of institutional investors to extract value. Heavily influenced by the rhetoric of "maximizing shareholder value", federal regulators rapidly increased the proxy voting power to institutional investors acting in concert, treating them as, individually, weak "minority shareholders" who should be allowed to act together to challenge "autocratic corporate management".

Currently, activist hedge funds are financiers that are making use of the collective proxy voting power of institutional investors most effectively for their own profit. Buying a small fraction of a company's outstanding corporate shares, they criticize incumbent management and request restructuring and cash disbursement to shareholders, with the threat of mobilizing proxy votes if management does not accede to their demands. More often than not, other institutional investors and proxy advisory firms support the hedge-fund activists' demands. "Wolf pact attacks" and "co-investments" have rapidly become a convention in the U.S. system of corporate governance and resource allocation. From the 1980, stock-based pay made corporate executives growing advocates of maximizing shareholder value. Since the mid-2000s, hedge-fund activism has been responsible for the acceleration of predatory value extraction from U.S. business corporations.

The U.S. economy is now run as a "shareholder dictatorship", not as a "shareholder democracy". Among shareholders, only a few grab the lion's share of the benefit of value extraction. As the looting of industrial corporations intensifies the U.S. middle-class has disappeared, with "the 1% versus the 99%" becoming the new normal.

Trump won the presidential election only because he was in a better position than Clinton to exploit this dismal state of the disappearing middle-class, not because he had leadership qualities to correct the current situation. He was born into a family of "1% of 1%" and has been a master of value extraction including large-scale tax avoidance, breaking contracts, and shifting losses onto other participants in his businesses to maintain his luxurious, flamboyant, and egotistical life. He is supported by hedge-fund billionaires such as Robert Mercer, John Paulson, and Carl Icahn.

As President-elect, Trump is revealing that he represents the interests of the value-extracting class. Contrary to his criticisms of Wall Street bankers during his election campaign, he is currently filling his cabinet with ultra-rich financiers, including Steven Mnuchin, a former Goldman Sachs executive, for Treasury Secretary and Wilbur Ross, formerly a corporate raider and currently a private-equity investor, for Commerce Secretary. Under Trump's administration, a small number of value-extractors will find ample opportunities to enrich themselves while an increasing number of workers, who are the actual value-creators, will wonder how, in voting for Trump, they were so thoroughly conned.

Shin Jang-sup is an economics professor at the National University of Singapore and former advisor to Korea's finance minister, and William Lazonick is professor of economics at University of Massachusetts Lowell and president of the Academic-Industry Research Network.