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Stock Buybacks, Over-paid Executives & Accounting Rules: continued

The Boeing Buyback

Debt-Heavy and Employee-Lite

The practical manifestation of the asset-lite philosophy for Boeing was the decision by the board in 1998 to withdraw nine billion dollars in cash from the company in order to pay a minority of shareholders who wanted to sell out at a high price.

The reduction in equity temporarily boosted statistical performance, but by 2002 this quick-fix had dissipated – ROE had dropped to a modest six percent, and return-on-assets was less than one percent.

Long-term shareholders were poorer, while company executives and a few ex-shareholders were richer.

Boeing’s headstrong drive to temporarily increase ROE resulted in a measurable decline in the financial strength of the enterprise, as debt was taken on, and current assets were drained to scrape up the nine billion dollars needed to fund the buyback program.

This left the company more exposed to the vagaries of financial markets.

Buybacks Can Weaken Companies

In 1997, the year before the board approved the nine billion dollar buyback scheme, the ratio of long-term-debt to capital had already reached a high of forty-seven percent – about double the relationship of the previous three years.

Although leverage was increasing, working capital was shrinking. The current ratio was only 1.4, even before the buybacks started. In other words, when the board approved the buyback program, Boeing was not sitting on excess cash idling in money market funds.

Even an amateur financial analyst might have deduced that the company would need to borrow to repurchase twenty-five percent of company stock.

An argument is sometimes made that buybacks favor long-term investors because they end up with a larger claim on the corporation.

However, investors benefit only if the buybacks are executed at a price that is below intrinsic value.

There is no evidence that this happened in the Boeing case. In fact, the opposite seems to be true.

The High Price of Stock Buybacks

The price of Boeing stock was not particularly cheap when buybacks were authorized – the price-earnings ratio (PE) at year-end 1998 was 28.2.

The ratio soared to a high of 32.4 during the buyback program and then fell to below ten in 2003, once the company stopped buying its own stock.

There are other indications that Boeing was worse off after the great buyback binge.

Between 2000, the peak of the buyback activity, and 2002, when the effects were beginning to be felt,

The latter cut was equal to seventy-three percent of net earnings in 2002 and shows how management may reduce discretionary, but vital, expenditures to improve the ratios that excite Wall Street analysts.

Over-Paid Executives, Disgruntled Engineers

In the first quarter of 2000, about the same time CEO Albaugh was publicly promoting asset-lite ideas, and just before the buyback program significantly pumped-up Boeing stock prices, the company’s seventeen thousand engineers and technical workers went on strike for far more modest benefits than were granted top management.

During the three years 1999-2001, Boeing paid its top five executives an average annual amount of six million dollars – almost fifty times the remuneration of the typical engineer and ‘rocket-scientist’ that actually produced the hi-tech marvels for which the company was renowned.

However, the top executives did not have to strike to convince a submissive board to provide them with a generous pay package.

In the previous twelve months, Boeing had laid off thirty-four thousand workers – fifteen percent of the workforce.

Striking SPEEA engineers were needed to certify the commercial planes before they could be delivered to clients.

The company admitted that earnings depended on how long the members of the Society of Professional Engineering Employees stayed off the job.

Under-funded Pension Plans

Boeing had massive liabilities with defined-benefit pension plans that covered over five hundred thousand active and former employees. Each year, the company distributed over two billion dollars to retired employees and their beneficiaries.

Under federal law these pension liabilities had to be funded, and any shortfalls had to be made up by the company.

In December 2000, Boeing’s pension liabilities were $29.1 billion. By December 2002, this liability had increased 23.3% to $35.9 billion. Over the same period, the fair market value of Boeing pension fund assets had fallen by 32.7%, from $42.8 billion to $28.8 billion.

The pension plan was now under-funded by $7.1 billion. In addition, the company had $8.2 billion dollars in unfunded post-retirement employee benefits, mostly health plans promised under union contracts.

Nine billion dollars were frittered away in stock buybacks, while employee pensions went unfunded.

Considering that, even in 2002, the stocks that made up the Boeing pension portfolio were still over-priced as a result of the Great Bubble, and considering the acceleration in health care costs, the decision to borrow funds so that the company could disburse nine billion dollars to a relatively small group of exiting shareholders seems imprudent, at best.

Commonsense would suggest that such actions would be to the detriment of long-term shareholders and contrary to the interests of the half-million current and future beneficiaries of company retirement plans.

It is interesting to note that as part of the board’s modernization efforts during this period, Boeing moved its head office from Seattle to Chicago.

This brought top management closer to financial markets and investment bankers and less likely to be required to meet the eyes of workers and engineers in the streets of Seattle, Boeing’s traditional hometown.

After Profligate Buybacks, Boeing Asks For A Handout

The actions of Boeing management during this period suggest that the board placed greater priority on the interests of short-term stock speculators and executive pay than on the welfare of hundreds of thousands of technical workers and long-term shareholders that had invested their lives and fortunes in the company.

On June 20, 2020, less than two years after Boeing completed its program for the repurchase of twenty-five percent of equity, a headline in the Wall Street Journal announced, “Boeing to Seek Financial Aid – Commercial-Space Woes Leads to Talks with Pentagon”.

Company executives were characterized as issuing “pessimistic public assessments” about the future of their business. The article said that the company was hoping that the U.S. government could help with financial assistance.

Curiously, although the company was now proposing to go on public welfare, there was no mention of the distribution of nine billion dollars of Boeing money to exiting shareholders and speculators, through buybacks, only a few years earlier.

The Blind Side of Asset-lite

It is reasonable to reduce capital when a company is in a declining line of business and lacks ideas as how to use its money, such as a manufacturer of buggy whips facing a newly expanding market in automobiles.

However, Boeing was supposedly at the forefront of American technology – satellite communications, rocketry, and ultra-advanced defense systems.

It was a world leader in the manufacture of commercial airplanes. For the directors to think that Boeing stock was ‘cheap’ at thirty times earnings implied an expanding market for the development, manufacture, and financing of these sophisticated products.

Such a favorable outlook would seem to call for additional reserves of capital – not less. Nevertheless, the directors not only dismissed any need for a financial cushion against bad times, but also appeared to be short on ideas regarding productive uses of company funds.

A majority of the board was dominated by people who had spent their lives as corporate bureaucrats or on government payrolls. One would be hard-pressed to find a board member who had a life experience that truly represented the entrepreneurial spirit of American capitalism.

Are executives of big corporations like Boeing really capitalists?

A young entrepreneur in a capitalist society finds it extremely difficult to amass the large amounts of money it takes to do something of importance for mankind.

By dispersing nine billion dollars of accumulated capital, Boeing directors gave up any ability they might have had to apply these funds in a way that would be useful for their shareholders, employees, clients, or nation.

It is understandable why someone who has never faced the world without connections and with empty pockets, when trying to raise funds for a new idea, would not see the foolishness, if not immorality, in frittering away nine billion dollars of accumulated wealth that could be used for productive purposes, creating jobs, and contributing to human progress.

This is the blind spot in asset-lite thinking – the triumph of abstract, empty numbers over rational and moral behavior.

Again we are reminded of Robert McNamara, a graduate of the Harvard Business School, and the tragic ‘scientific management’ that led America to its great defeat in the War in Vietnam.

Nine Billion Dollars Is Mucho Dinero!

It is easy to gloss over the significance of the wasted nine billion dollars, because the number is so big that it escapes easy comprehension.

Nine billion dollars is equivalent to sixty-thousand engineering man-years – enough cash to pay two thousand aeronautical and space engineers for a lifetime of research and development.

If Boeing had put this money into, say, an institute for satellite and space research, staffed by two thousand scientists, it is almost certain that something useful would have been discovered.

This would certainly have been more productive than throwing the money away to Wall Street speculators, while reducing benefits to long-term shareholders and company employees.

Chairman Condit, in the Schwab interview, said that the company was “in a mode of value creation” and that “where we find … opportunities to expand our business … we will.”

However, the executives of Boeing apparently could not find productive uses for this money and decided instead to temporarily pump-up stock prices.

The barriers to productive use of these nine billion dollars were the irrationality of accounting rules and the foolishness of asset-lite thinking.

If the money had been used for any productive or charitable purpose, the amount would have to be classified either as an expense or an asset.

In the first instance, reported profits would decline; in the second, short-term ROE would not improve. Both of these outcomes were unacceptable to Wall Street.

Tax Law Plus Accounting Rules Lead to Bad Policy

Only by using the money to repurchase stock could nine billion dollars escape classification as an asset or expense, although the purpose might really be to jack-up stock prices and make management temporarily look good.

If the money had been spent on an advertising campaign to polish the reputation of company executives, the amount would have to be classified as an expense.

However, using the same money to manipulate stock prices for the same reason would be excused by accounting rules from rational classification. Form triumphs over substance.

This examination of the Boeing case is meant only to indicate typical behavior of large American corporations during the Great Bubble. Compared of their colleagues in other listed companies, Boeing executives were modest in their take-home pay, conservative in their accounting methods, and less destructive of the interests of their long-term shareholders and employees.

Furthermore, their actions were consistent with the best corporate behavior, as taught at leading business schools, backed by the received wisdom of Nobel laureates in ‘economic science’.

Nevertheless, this was the same brand of asset-lite thinking that, in the extreme, led to the downfall of Enron, WorldCom, and Long Term Capital Management.

The link between asset-lite thinking and buybacks contributed to the shortage of equities that drove the Great Bubble.

July 25, 2020

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