The Slow Collapse of Long Term Planning

A Look at Business Debt and What’s Happening with Companies#

Okay, so you might hear a lot about the US federal debt, and yeah, it’s a big deal. But there’s this other kind of debt that’s been growing just as fast, and honestly, it might be even more of a headache. We’re talking about business debt.

Right now, in America alone, this business debt is sitting at all-time highs, getting close to $14 trillion. See, unlike the government, private companies can’t just whip out a printing press when things get tough. And with interest rates going up, they’re really starting to feel the pressure.

What makes it worse? A huge chunk of this money hasn’t been used for smart stuff like investing in the business to make it better or build new things. Nah, most of it went into something called financial engineering. Basically, doing fancy financial footwork to make investors happy right now, in the short term.

This whole trend? It’s tied to a business approach that helps explain what’s been going on with big names like Boeing, Intel, and General Electric (GE). It’s also making the stock market feel a lot shakier than it used to, and yeah, it’s making that government debt situation look even scarier.

The wild part? This isn’t new. Companies have tried this stuff many times before. People know it doesn’t last forever, but hey, that’s a problem for the next quarter, right?

You might have seen news like:

General Motors (GM) announcing a $6 billion stock buyback.
Bed Bath & Beyond filing for bankruptcy, after trying to recover from the pandemic by closing nearly half their stores, saying profits just took too big a hit.
The government administration giving Intel nearly $20 billion** in grants and loans, with the company set to receive **$ 8.5 billion in grants immediately, and potentially more. That’s from the Chips Act.

So, what’s the story behind this?

The Old Way: Pre-1980s Business Thinking#

Let’s rewind to the 1970s. Back then, company executives were, well, pretty much just regular employees. They collected a paycheck like everyone else. Sure, it was bigger than most folks’, but maybe not that much bigger.

According to data from the Economic Policy Institute:

In 1965, the average CEO of one of the largest 350 companies earned just over 20 times more than the average employee.
This was partly because average workers earned more back then, and executives earned significantly less year-to-year compared to today.

This setup encouraged executives to stick around for the long haul, keeping their jobs and comfortable salaries, without taking huge risks. The average time a top executive stayed in their job was roughly double what it is now. Also, back then, the average company spent roughly twice as long listed in the S&P 500 index.

What about profits? Most of the money these companies made was put right back into the business. This meant:

Acquiring new businesses.
Research and development (R&D) for new products.
Paying their staff.

The Shift: Shareholders Want More#

Eventually, the folks who owned the companies – the shareholders – started thinking differently. They figured it’d be better to pay executives bigger bonuses, but tie them to how well the company performed, especially if that performance meant more money for the shareholders themselves.

Now, here’s a hot take alert: On its own, this idea is totally reasonable. Shareholders own the place. They should want systems that make sure the people running the company are working towards their goals, which, let’s be real, is usually getting a good return on their investment.

Things Go “Off the Rails”: The Return of Stock Buybacks#

Where things started to get a bit wild was when a law that really limited stock buybacks was repealed in 1982. This change let executives use the company’s own money to buy back its shares right off the public market.

This did a few key things:

Increased the share price: Even if the company itself wasn’t doing any better business-wise, reducing the number of available shares made the remaining ones worth more.
Changed valuation metrics: When that law was repealed, the average company in the S&P 500 had a price-to-earnings (PE) ratio of about 6.2. This meant it would take about 6.2 years of company profits to equal the price of all the company’s shares. Today? That PE ratio is over 36. In simple terms, for the same amount of profit, shares are roughly six times more expensive than they were in 1982. Great for current shareholders, but makes you wonder about the true value of the market overall.
Improved financial metrics: Buybacks make things like earnings per share (a common way to measure profitability per share) look better. Not because the company made more money, but just because there are now fewer shares out there.

Another hot take alert: Even this, just focusing on buybacks for shareholders, was arguably good for those investors who liked seeing their stock value go up (that’s called capital appreciation) in a tax-friendly way.

The “Crack” of Corporate Finance: Buybacks Take Over#

But, as the late Charlie Munger famously said, “Show me the incentive and I will show you the outcome.”

Stock buybacks are kind of like crack for corporate finance. They are really good at getting that stock price up, even if the rest of the business is falling apart, or even if the buybacks are causing the rest of the business to fall apart.

Here’s how it evolved:

Buybacks started as an alternative to dividends (paying out profits directly to shareholders) when executives thought the company’s stock was undervalued.
Eventually, companies started spending more money on buybacks than on dividends.
Then, they spent more money on buybacks than on reinvestment back into the business itself, like funding R&D or training their workers (workforce development).
Lots of companies took it even further: they spent more on stock buybacks than the company was even making in profit. How? By borrowing money just to buy their own shares back! This is a huge reason why corporate debt is at all-time highs right now.

Look, for most businesses, borrowing money just to buy your own stock back is clearly pretty dumb from a long-term perspective. But it does one thing really well: it pumps up stock prices enough for CEOs to rake in absolutely enormous bonuses. The average CEO now earns more than 340 times more than their average employee. When you can make that kind of money that fast, it’s incredibly tempting to play that game.

Is it sustainable? Nope. But again, that’s a problem for next quarter.

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(Okay, back to the main topic.)

Why This Continues: Profits Without Prosperity#

So, if corporate buybacks have been bad for workers, bad for the economy overall, and maybe even bad for investors in the long run, and if people already know this… why is it still happening? There’s a reason people just don’t seem to care enough to stop it.

Over a decade ago, one CEO actually broke ranks and wrote publicly that too many companies were cutting back on things like capital expenditures (investing in physical assets) and even adding to their debt just to boost dividends and increase buybacks. That was back in 2014, and people thought that was the peak of this buyback craze.

Guess what? Since then, quarterly buybacks have roughly doubled. This is happening even though interest rates are much higher, which in theory should make businesses want to hang onto cash instead of borrowing to buy shares. But hey, that’s a problem for next quarter.

By the way, the CEO who sounded the alarm, who “betrayed his executive comrades” about how buybacks were messing up the market? None other than Larry Fink, the head of BlackRock, which is the largest asset manager in the world.

It’s easy to point fingers at corporate executives using tricky financial plays to get super rich and say they caused all this short-term thinking. But really, they’re more of a symptom of a much bigger issue that goes way beyond just corporate America.

There are a few reasons this is happening:

1. Value Extraction Over Value Creation#

Today, there’s simply more money to be made by extracting value (like financial maneuvering) than by creating value (building better products or services).

William Lazonic, an economics professor at the University of Massachusetts, wrote a pretty well-known paper about this called “Profits without Prosperity.” He noted that from the end of World War II until the early 1970s, most successful businesses got that way by genuinely creating value for customers or other businesses.

Now, that’s much harder. Companies are focused on keeping up with the financial promises they’ve made to shareholders. Over time, more money for research and development (R&D) has actually come from the government instead of from the companies themselves, because companies have spent what they used to put into R&D on propping up their own stock prices.

2. The Paradox of High Profits and Failing Companies#

Today, corporate profits are at all-time highs, but at the same time, a record number of companies are actually losing money. This, again, is largely a result of prioritizing short-term plans.

As companies’ price-to-earnings (PE) ratios have gotten bigger, the best way for innovators to make money from their ideas isn’t necessarily to build a long-term, profitable business. It’s to scale a business quickly and then sell it.

When average company PE ratios were low (like 5 to 6), a founder could stick with their business and potentially make its value back in profits fairly quickly (5 to 6 years). Good founders often preferred this.
Today, some company valuations are incredibly high, easily 100 times earnings. For founders and early investors, they might be long gone before the company could ever make enough profit to match what they could just get by selling it now.

Many of these companies that sell don’t actually make a profit, and a lot of them fail. But the founders can still get very wealthy from the sale. Big existing companies like this because they can simply buy the best ideas before those new companies become competitors. They don’t have to take the risks of funding their own technical development.

Even with all this, the net earnings of the largest listed companies in America are claiming the highest share of GDP (the total value of goods and services produced in the country) in history. In simple English, corporate profits make up more of our economy than ever before, except maybe during the early days of the pandemic stimulus.

So, Where Does the Money Come From? The Two Big Spenders#

If companies aren’t relying as much on building value for average customers or reinvesting in their own R&D, and yet profits are high… who is funding these profits? There are really only two customers left who still have the big money:

1. Very Wealthy People#

These are the folks who have benefited from asset values being stretched high. We talked about them before. The risk is, if there’s some kind of financial shakeup that hits the asset markets (stocks, real estate, etc.), these wealthy people might cut back on their spending. This could create a nasty cycle:

Less spending by the only people who can afford to spend big.
Leading to lower company earnings.
Leading to market drops.
Leading to even further reduced spending.

Sure, the market can stay irrational for a long time, but relying so much of the economy on a small group of people is risky.

2. The Government#

Luckily for businesses, there’s a backup spender: the government. Either directly through things like contracts and grants, or indirectly through other spending, the government has become such a huge driver of corporate profits that you might not even realize how dependent companies are on it. (They even used the same picture for two different charts to show how similar the profit sources look!).

Businesses make money off government spending through countless ways:

Contracts
Schemes
Deferments
Subsidies
Incentives
Co-investments
Bailouts
Financial protection programs
Offsets
Bonuses
Grants
Public-private partnerships
Guaranteed… (implied programs or loans)
Intellectual property awards

And that’s not even getting into new ideas like a potential cryptocurrency reserve, which would mostly benefit big financial players. That’s a whole other chat.

To be fair, no matter which political party is in charge, the government has become an incredibly profitable customer over the last 50 years. Just the federal government expenditure now accounts for more than a third of our GDP. That’s even higher than the total spending during the war economy of 1944! Other countries, like the UK, have even higher numbers, but here in America, state governments also spend a lot, so it’s a bit different comparison.

The Political Short-Term Game#

Business executives aren’t the only ones looking out for their own short-term gain, even if it hurts things long-term. Politicians do it too.

Government programs that:

Put money directly into people’s pockets.
Create jobs.
Promise to fix big problems.

…are super easy to announce and get support for. But once they’re up and running, they are really hard to roll back. No politician wants to be the one blamed for cutting jobs or programs right before an election.

As mentioned in the article by William Lazonic, over time this has created a system of “profits without prosperity.” And now, even those profits are balanced precariously on a system of speculative wealth (like inflated asset values) and unsustainable government spending.

So yeah, I guess we have to talk about it. It’s the Doge in the room.

The Challenge of Fixing It#

The frustrating part is, most people agree that cutting back on government spending that businesses rely on heavily is a good idea. It should make businesses less dependent on taxpayer money and make the economy more financially stable overall.

BUT… we’ve built such a huge, debt-filled House of Cards on this shaky system. Trying to pull back these programs now would need incredibly careful planning over years, maybe even decades, to avoid everything collapsing economically.

Trying to make big, sudden changes in just a few weeks, maybe just to get headlines, is the exact same kind of short-term thinking that got us into this mess in the first place.

Realistically, the biggest area to cut spending is probably the various Cost Plus contracts (where the government pays companies whatever the costs are, plus a profit margin) that are often given out because of immense lobbying pressure. Even these cuts need to be slow and careful, and probably shouldn’t be managed by someone who benefits a lot from government funding themselves.

We’re in a situation with:

Asset markets reaching record, stretched valuations.
Held up by record corporate and government debt.
Which can’t rely on genuine household spending anymore because household savings are at record lows, and their debt is also at record highs.

What Can We Do About It?#

This kind of short-term planning isn’t new. People haven’t changed since the 1970s. Before this turns into another episode of Angry Stickman points at historic financial data, the more important question is: what can actually be done?

You should probably admit that if you ever found yourself as the CEO of a major public company and had the chance to get a massive options package (a form of bonus tied to stock price) by doing a share buyback, you’d probably do it. I mean, I know I certainly would.

Executive compensation is so huge now that just a year or two of these bonuses can set your family up for generations. If the company goes bust after that? Doesn’t really matter for you personally. Kind of rough for the employees, though.

The same basic idea applies to starting a company today. It doesn’t necessarily have to be a business that makes steady profits long-term. It just needs to shake things up enough to get acquired. There are acquisitions happening every single day (buyouts) that would also comfortably set people up for life.

The solutions to these problems are the same old, maybe boring, solutions to most issues in corporate America:

Regulate the financial sh*t that CEOs are allowed to do with their own company’s stock.
Control corporate consolidation (companies buying up other companies).

If people can only get super rich by building something sustainable over time, then the next quarter becomes their problem again, in a good way.

There’s one last big problem: a lot of people in leadership positions, both in businesses and the government, are just really old. There’s less incentive to worry about next quarter if you don’t expect to be around for it.

So, go watch that other video they mention next to find out how we ended up here, and make sure to like and subscribe if you want to keep learning how money works.