Why a focus on shareholders may be causing supply chain backups

The Dutch East India Company was probably the biggest corporation in history and frequently paid dividends to shareholders – sometimes in the form of cloves. That enduring largesse, even at the expense of investing in its sprawling trading business, is one reason cited for the company’s demise in the late 1700s.

Fast forward a bit more than a couple of centuries. The tendency of companies to put shareholders first with dividends and stock buybacks, rather than investing that money in additional storage or truck drivers to ease the flow of commerce, is now being blamed for contributing to supply chain misery.

Supply chain backups around the world have led to empty grocery store shelves in the US, blood test shortages in Britain and a looming lack of Christmas gifts in Australia. Experts say things are unlikely to get better anytime soon.

Prioritizing the needs of shareholders above those of customers, employees, or society as a whole runs counter to the increasingly-adopted tenets of stakeholder capitalism. It may also be hindering the global economy’s return to “normal," even as COVID-19 becomes endemic.

In the US, spending by companies on stock buybacks relative to earnings jumped to 50% by 1998 from 5% in 1980 – the eve of a Ronald Reagan-era regulatory change that opened the buyback floodgates.

The practice has accelerated this year; buybacks among companies in the S&P 500 Index neared $199 billion in the second quarter, a nearly 12% increase from the previous period.

Europe, too, has seen a surge recently. In Japan, which started permitting the practice in 1994, Sony announced its first-ever major buyback in 2019. Its shares immediately gained 5% in value.

This penchant for buybacks is one of many suspects now being fingered for lingering shortages, and longstanding calls to restrict or tax them have become louder.

Buybacks long ago matched and even surpassed dividends as a primary means to reward shareholders. Companies simply buy up their own shares on the open market, reduce the supply and boost the value of what remains for investors. The practice has many admirers.

After all, shareholders, including those with stock underpinning their retirement accounts, have real skin in the game. Rewarding their confidence seems logical.

US investor Warren Buffett has long touted buybacks, and their use in combination with dividends can be interpreted as optimism about an economy’s prospects. One study found that they correlate with higher long-term returns, despite frequent criticism that they're an example of short-termism.

Even if companies did want to use funds otherwise earmarked for buybacks to invest in their businesses, they might find that difficult at the moment – due to the same supply chain issues affecting everyone else.

There’s also a general mistrust of corporate decision-making, dating back at least hundreds of years, that’s informed some of the logic behind buybacks. Better to spend surpluses on shareholders, the thinking goes, than see them squandered through bad behaviour and poor strategy.

Risk, too, is a factor – if a company genuinely believes money it invests in a new warehouse in an uncertain economy may be wasted, does it have an obligation to do it anyway?

Still, as long as ships unable to unload cargo continue to accumulate outside of ports, questions about how the companies responsible for getting goods from one place to another use their cash are probably inevitable.

For more context, here are links to further reading from the World Economic Forum's Strategic Intelligence platform:

On the Strategic Intelligence platform, you can find feeds of expert analysis related to Supply Chains, Corporate Governance and hundreds of additional topics. You’ll need to register to view.