Kevin Drum wants to see a deep dive on “dividend recaps,” the process through which a private equity company loads a firm it owns up with debt and then pays itself out with the funds thereby raised.
A shallow dive is the best I can do, but I think we should see the dividend recap move as a solution to a broader issue that arises in the economy. Say you own a home outright and the home is pretty valuable. But what you really want is some money in your pocket to pay for some medical expenses or to buy a new car. One option is to sell the house. But moving is inconvenient and you’d have to go find someplace else to live. Another option—very frequently seen during the house price boom of the 90s and early aughts—is to do a home equity loan. You still own your house, but a bank lends you money and since the loan is backed by the value of the house it’s available on generous terms. And if the value of your house goes up, you’re in great shape. Of course if the value of the house declines, you have a problem.
The “dividend recap” move is basically like a home equity loan for a company you own rather than a house. A win-win for you and the bank if the firm’s value increases and a mess otherwise.
In a lot of ways, this is just an extreme version of the basic functioning of financial markets as a whole. The stock market, per Doug Henwood’s Wall Street, is about findings ways to take money out of the corporate sector not finding ways to raise capital to finance expansions. There was a big multi-pronged assault in the 1980s on managers’ tendency to horde capital inside firms they control. The rise of the leveraged buyout industry was part of that campaign and the specific tactic of the dividend recap was one tool in the arsenal.
But the general phenomenon was much broader. Up until the early eighties corporate profits far exceeded dividends plus net share repurchases. Value was stockpiling inside firms, in other words. Over the past thirty years, that generally hasn’t been the case. Cash has flowed through firms back out to their owners.