The COVID-19 Crisis Reveals How Short-Term, Shareholder-First Thinking Still Rules the Day
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Finance & Accounting Leadership Apr 17, 2020

The COVID-19 Crisis Reveals How Short-Term, Shareholder-First Thinking Still Rules the Day

From questionable buybacks to overly restrictive M&A clauses, a recent pledge to consider other stakeholders is ringing hollow.

Stock trader choosing route

Yevgenia Nayberg

Based on insights from

José Maria Liberti

One of the few bright spots in the COVID-19 pandemic has been seeing the many ways that businesses are stepping up and chipping in to help support their communities.

For José Liberti, a clinical professor of finance at the Kellogg School, stories about clothing manufacturers making masks or distilleries making hand sanitizer are absolutely heartening. But are they evidence of a kinder, gentler capitalism at work? Liberti doesn’t think so.

Eight months ago, the influential Business Roundtable, which includes the heads of some of the largest global corporations, pledged to redefine the purpose of a corporation away from principally serving shareholders and toward serving all stakeholders, including customers, employees, suppliers, and communities.

In Liberti’s view, this wasn’t so much a pivot as an acknowledgement that, ultimately, shareholders will benefit when other stakeholders are also served. The idea being that those other stakeholders will continue to maintain society’s support of capitalism if they see the benefit of it.

“Many social issues such as income inequality, the cost of medical care, and gun violence erode confidence in the economic and political system,” he says. By addressing these issues, and reducing the risk of systemic changes that would negatively impact a firm’s value, corporations were committing to taking a long-term view.

“People are selfish,” he says. “If you care about all stakeholders, why would you exclude a pandemic from your MAE?”

But as the pandemic pushes even the largest, wealthiest firms to the breaking point, he continues, “some of their behavior makes me question whether they truly had a long-term view in the first place.”

Questionable Share Buybacks

One such behavior, which has gotten some attention in the media in recent weeks, is share buybacks: when companies buy back their own stock with accumulated cash in order to return money to shareholders by lifting stock prices.

Liberti is quick to clarify that there’s nothing inherently wrong with this. “The issue is when and how you conduct a buyback of shares,” he says. “Are companies using excess cash above what they need to operate or are they using operating cash?”

Buying back shares, he explains, can be a sensible way for companies to return excess cash to shareholders when there are no other (potentially more profitable) projects to pursue, or when a firm has reason to want to play it safe and avoid risky R&D expenditures.

But it is “very clear that some of these companies are using any cash flow available to buy back shares instead of saving it for a downturn or negative shock,” he says. Some companies were even issuing cheap debt in order to buy back shares. Liberti adds that many of these buybacks are primarily done to prop up share prices, increase earnings-per-share measures, or otherwise benefit executives and shareholders.

“The best example is American Airlines,” says Liberti. The company filed for bankruptcy in 2011 and within a few years was profitable again. Very profitable. But despite the airline industry being notoriously boom-and-bust, the firm didn’t put away nearly enough money in its rainy day fund to weather today’s crisis. Instead, “American spent their positive cash flows on buybacks,” says Liberti—to the tune of $12.4 billion dollars since 2014.

And American is not alone. Together, major airlines have spent 96% of free cash flows on buybacks during the past decade.

Now, they want a bailout.

It isn’t entirely clear yet whether they will get one: at least some of the $25 billion dollars in payroll assistance that has been allocated to the airlines in the CARES Act may come in the form of low-interest loans rather than grants. But if they do, Liberti says, it will represent a transfer of wealth to investors from taxpayers. And if they don’t, employee layoffs will be massive.

Either way, Liberti points out, the industry’s reckless eagerness to prop up share prices over the years is hardly consistent with the stakeholder view that its CEOs have pledged to uphold.

Meaningless “Material Adverse Effect” Clauses

A less discussed but equally telling drama is currently unfolding in the mergers-and-acquisitions market.

Most purchase agreements include material adverse effect (MAE) clauses—clauses that offer buyers an “escape hatch” from a deal should the transaction be affected by an event outside of their control. And on the surface, it would seem as though a global pandemic would certainly fit the bill, offering a solid excuse for sidestepping a deal that no longer makes economic or strategic sense.

But surprisingly, that’s not the case, says Liberti. The way these clauses are written, negative effects from an event can only scuttle a deal if the acquisition or newly merged company would be disproportionately affected in relation to other companies in the industry. And, of course, this is exceedingly difficult to argue today, when whole industries are getting walloped, and it is not yet clear what the long-term financial impact on any given company will be.

For example, 1-800-Flowers, which had agreed to purchase a division from Bed Bath & Beyond, stated that COVID-19 left the company without the resources to close the deal and integrate the business by the agreed-upon date. Bed Bath & Beyond responded with a lawsuit, arguing that because the global pandemic affected everyone, it wasn’t an adverse effect. And given the difficulty of proving disproportionate impact, Bed Bath & Beyond will likely win its case. “Courts have been reluctant to accept the claim of an MAE to terminate an agreement,” Liberti says.

So what does this rather obscure clause have to do with corporations taking a stakeholder view?

The whole point of an MAE is to ensure the long-term financial performance of the newly merged company, Liberti explains. If a buyer can no longer capitalize on the transaction and put the new company on firm footing, its suppliers, customers, and employees—old and new—will suffer the consequences. So when one party in the deal is still aggressively pushing forward, that signals that it might be putting the financial interests of a select group of executives and shareholders above everyone else’s.

The current insistence on proving disproportionate impact, he says, “makes me question, ‘What do you care about?’” He would like to see less restrictive MAEs, which would allow firms more wiggle room to ensure that transactions truly create long-term value for all parties.

But if anything, the trend is moving in the opposite direction, with MAEs getting more stringent over time, explicitly excluding a wide range of events from weather conditions to acts of war. The latest batch of MAE clauses now exclude COVID-19 by name.

“People are selfish,” he says. “If you care about all stakeholders, why would you exclude a pandemic from your MAE?”

In his view, these MAEs point to the short-term thinking that remains pervasive in some global corporations. “Short-termism is one of the main issues in stock markets,” he says. “If managers were properly incentivized to take a long-term view, they should have no interest in making decisions that are harmful to employees, consumers, and society.”

Featured Faculty

Joseph Jr. and Carole Levy Chair in Entrepreneurship; Clinical Professor of Finance

About the Writer
Jessica Love is the editor in chief of Kellogg Insight.
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