How the U.S. Securities and Exchange Commission Encourages Stock-Market Manipulation, and Why It Undermines the Performance of the Economy

Friday, 3 July 2015: 8:30 AM-10:00 AM
TW1.1.03 (Tower One)
William Lazonick, University of Massachusetts Lowell, Lowell, MA
Ken Jacobson, The Academic-Industry Research Network, Berkeley, CA
On November 17, 1982, the U.S. Securities and Exchange Commission (SEC) promulgated Rule 10b-18, giving a company a safe harbor against manipulation charges in doing open-market repurchases if, among other things, its repurchases on any single day total no more than 25% of the previous four weeks’ average daily trading volume (ADTV). Under Rule 10b-18, moreover, there is no presumption of manipulation should the corporation’s repurchases exceed 25% ADTV. 

With Rule 10b-18 the SEC permitted a corporation to manipulate the price of its own publicly-traded stock.  Over the past decade U.S. business corporations have done about $7 trillion in stock buybacks, with S&P 500 companies accounting for half of that amount. As Lazonick has shown in his Harvard Business Reviewarticle, “Profits Without Prosperity” (September 2014), the only sound explanation for this buyback activity is the fact that by far the largest components of top executive pay are gains from stock options and stock awards that benefit from manipulative boosts in a company’s stock price or earnings per share. Lazonick has also shown that the massive disgorging of corporate cash-flow to shareholders through stock buybacks, in addition to ample dividends, has done immense damage to industrial innovation and job creation in the United States.

A 1984 article, “Issuer Repurchases,” by SEC officials called Rule 10b-18 a “regulatory about-face” from previous SEC proposals to prevent stock-price manipulation through open-market repurchases. Our proposed article explores the character of this “regulatory about-face” and why it occurred when it did. Key was the 1980 election of Ronald Reagan as U.S. President and his appointment in 1981 of Wall Street executive John Shad to head the SEC. In short order, Chicago-School economics became embedded in the ideology and practice of the SEC.

As it happened, on November 19 and 20, 1982, just two days after the SEC adopted Rule 10b-18, an academic conference on “Corporations and Private Property” took place at the Hoover Institution at which Eugene Fama and Michael Jensen presented two joint papers, “Separation of Ownership and Control” and “Agency Problems and Residual Claims.” In both law and economics in the early 1980s, the movement to “maximize shareholder value” (MSV) was poised to transform the regulatory and academic discourse on how companies should be governed to achieve superior economic performance. Unfortunately, as Lazonick has shown, MSV ideology is fundamentally flawed in its assumptions that a) public shareholders invest in the productive assets of corporations and b) public shareholders are the only economic actors who bear the risk of investing in productive assets. By exposing these flaws, we can begin to analyze how, in fact, MSV results in inferior economic performance. The proposed paper on the adoption and implications of SEC Rule 10b-18 represents, therefore, an important demonstration of how bad economic theory can result in bad public policy.