William Lazonick, Investing in Innovation: Confronting Predatory Value Extraction in the U.S. Corporation. A Review
If you are at all concerned about the cruel, rising inequality in our society, this is one of your must reads.
Some writers, certainly not enough, have identified buybacks as the prime mechanism for the unconscionable level of the upward transfer of wealth since the 1980s. However, appeals to fairness fall on deaf ears. The top 10%, these are the professionals- lawyers, accountants, senior executives, and such — who have the best training and background to understand the issues and could influence change for fairness, but they are the ones most benefitting from buybacks. Why would they pressure politicians for effective policies to end buybacks ?
Lazonick gives an answer: buybacks are hurting America’s corporate competitiveness. American businesses were once a leader in innovation because about half of profits were set aside for research and development- which included better pay for skilled staff. But today, studies show that many of the major corporations are paying out close to 100% of profits, and sometimes more, in buybacks and dividends, no longer investing in innovation.
In enlightened self-interest, the top 10% should support reigning in buybacks for the future prosperity of the American corporation in the ever more competitive global marketplace.
Lazonick references studies that show that buybacks are done when the stock prices are high. The executives who control the process are insiders; they would know to have the corporation buy when prices were low. Except, of course, if their own personal interest conflicts with the welfare of the corporation. And that is the case. As Lazonick explains, in 1982, the SEC gave the senior executives a license to loot” (his terms) their own corporations. It’s a complicated regulation, this 10B-18; but to translate into ordinary language: it permits insider trading-the executives who control the corporation are permitted to cause the corporation to buy the executives’ shares when the executives decide.
But sometimes it’s not the executives; there can be another cause. Lazonick uses Apple as an example. Under Jobs, Apple did zero buybacks, but under Cook, it has splurged on them, spending $553 billion in buybacks between October 2012 and September 2022. Yet, in Lazonick’s opinion, Apple executives did not want this. It was to prevent the equity/hedge fund investors (Lazonick calls them predatory value extractors), who can use the proxy system to unite in cartels (his kind word for wolf packs) when it suits their purpose to replace a board of directors that refuses to do their bidding.
Lazonick skewers the ‘maximize shareholder value’ doctrine, a theory promoted by Milton Friedman and sanctioned by the New York Times in 1970. It’s the pseudo economic justification for complete corporate asset stripping in favour of shareholders by dividends and buybacks. The doctrine says that the primary purpose of a corporation is to increase the wealth of its shareholders. But as Lazonick points out, this maximum shareholder value theory assumes that the shareholders have borne all of the risk in creating the successful corporation. To the contrary, the equity/hedge fund shareholders have assumed very little risk. They don’t buy at the stage when it’s two guys working out of their garage. They wait until a corporation is on a solid basis and certain to create value. They take little risk and sell at the first opportunity for a profit. Their interest for immediate profit usually conflicts with keeping the corporation competitive in the long run. And the money they pay to buy the shares does not go into the corporate treasury, but to another investor who is reselling shares.
Biden’s proposed 4% transaction tax will, like every piece of legislation designed to reduce economic inequality before it, be totally ineffective. A 4% tax will not stop the practice; it’s not even expected to. But it will do the opposite, it will legitimize buybacks. Lazonick states, they must be banned.
And banning them alone would not be sufficient. There must be policies in place to ensure that the retained earnings can be used for innovation, shared with the workers whose effort produces these profits, and when relevant, with taxpayers whose grants and tax subsidies made the corporation’s success possible.
Much work is needed to inform the 90% of how buybacks are a major cause of the hollowing out of the middle class, and the reduction of the working class back to a serf class. Uniquely, this work contains new evidence for understanding how predatory value extraction by buybacks harms innovation.
A needed addition to the struggle against economic inequality, it is a well-researched disclosure of the harm of the combined buyback and maximize shareholder value theory, illustrated with those charts and graphs economists love. An important read for this summer, it brings understanding not just knowledge-but it’s not a book for the beach.
William Lazonick, Investing in Innovation: Confronting Predatory Value Extraction in the U.S. Corporation. To be published by Cambridge University Press this May, in Cambridge Elements: Corporate Governance Series.
Acknowledgement: Graphic by Geralt Altman pixabay https://pixabay.com/users/geralt-9301/
Jan D. Weir is a retired trial lawyer who has advised international corporations, banks, accounting firms and Lloyds of London that insured auditors. He has taught business law at the University of Toronto and is the co-author of a text on business law (available on KOBO). He discusses how the superrich have been using unrecognized methods for the upward transfer of wealth since the 1980s in the tax, corporate and banking areas on https://janweirlaw.medium.com/, and Twitter@JanWeirLaw.