June 2017
A few years ago, the economist William Lazonick was contacted by an editor at Harvard Business Review and asked if he’d be interested in writing about his latest research on stock buybacks. Lazonick was surprised.
For nearly three decades, Lazonick, an economics professor at the University of Massachusetts Lowell who holds a PhD in economics from Harvard, has been investigating the use of stock buybacks. Specifically, his focus is on how corporate executives use buybacks to manipulate stock prices and boost their own pay. It’s been Lazonick’s long-standing contention that corporate profits spent on buybacks—instead of R&D and employee pay—slows innovation and weakens economic growth.
But up until that point a few years back, the issue had not received much interest or attention, either from academics or Wall Street executives. It wasn’t really a popular, trendy issue—and most people seemed to hold the belief that buybacks were a good thing for shareholders. Nonetheless, Lazonick agreed to write the piece.
The resulting article, Profits Without Prosperity, was an astounding success. It’s not hard to see why: The piece exposed, in vivid detail, how trillions of dollars of stock buybacks were being used by CEOs to enrich themselves, leading to unprecedented levels of income inequality and stagnant wages for the middle class. Ted Kaufman, a former U.S. senator, called it “mind-boggling.” Lazonick agrees.
“The main reaction,” Lazonick tells me, “was that this was an eye-opener.”
The piece went on to win the 2014 HBR McKinsey Award, and has been cited directly by former VP Joe Biden, Senator Elizabeth Warren, Senator Tammy Baldwin—and even used as the basis to form coalitions among fast-food worker unions, urging corporate CEOs to sending company cash into the stock market.
Readers of my blog will know that excessive stock buybacks are a core focus of mine as well—I write about the issue frequently—but in my opinion, Lazonick is by far the nation’s foremost expert on the issue. We got the chance to speak with him recently. Below is an edited transcript of our conversation.
Arne Alsin: Can you tell me a little about your background and how you came to be interested in this subject?
William Lazonick: I got a PhD from Harvard and taught there for about a decade. In the mid-80s I was at Harvard Business School on the faculty with a research position. At that time I was starting to see signs of what I would now call the “financialization of the corporation.” People who only have an interest in taking money out of a corporation, and often are not ones who put money in—or even time and effort to create the products. My area of research was on the theory of the firm, and the theory of the capitalist enterprise and its role in economic development.
At that point, I started looking at some of the evolving practices of business corporations in more detail. Coming in the 70s and early 80s, buybacks did not exist as a phenomenon, it was a relatively minor thing. The issue was, “Are companies paying too much in dividends?” That was the issue. [But with buybacks], of a sudden you have this new form of distribution that I saw were becoming more and more important after the 80s.
As far as I’m concerned, then and now, if you buy a share of a company that’s not a preferred share, a common share, then you should expect a dividend after everything else has been taken care of, including training and retaining employees, i.e. the people who helped you create value, paying the government taxes that are needed to support the infrastructure and knowledge that are used, and then there’s dividends left over—maybe—if the company is profitable enough. The company has to retain enough to reinvest in the future.
But with the rise of the ideology that companies should maximize shareholder value, it was all about “disgorge.” It was the notion that the money in the corporation shouldn’t be there, it should be reallocated in the market. So there were a bunch of people who had an ideology about value extraction and no theory at all about value creation, who were coming in and saying here’s how we should run the economy.
It helped that I had an undergraduate degree in accounting, so I was never afraid to look at balance sheets and profit and loss statements. I saw this stuff happening and became a critic of it. That was three decades ago, and I’ve seen how it’s evolved.
Alsin: In Profits Without Prosperity, you write: “Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market.” Do you think average investor understands the scope of this issue?
Lazonick: No. When I published Profits Without Prosperity, the main reaction was that this was an eye-opener. Recently, I was talking to someone at one of the largest sovereign wealth funds that was critical of US-style executive pay, and what to do about it. And this person, who had written a critical document on executive pay, didn’t even know about the buyback issue. And he asked,
“Well, who is doing research on this?” And I said, “Well, I am.” At least the only one doing critical research.
In academia and in business school you have have people cranking out regressions of buybacks versus dividends, but it’s all just another exercise in cranking out data. It’s not critical from the point of view of the companies and the economy.
Alsin: What are some of the worst examples of buyback excess that you’ve found?
Lazonick: A company I use as an example is Cisco. Cisco was the fastest-growing company in the 90’s, but it’s still selling the same boxes as it was back then. [Note: We covered Cisco’s 5-year, $27 billion buyback spending spree].
And everything else it has tried to get into on the cheap was commodities. It stopped investing in the early 2000’s in sophisticated communication equipment for service providers. There’s a company that’s a worldwide leader in this, that Cisco should be, and that’s Huawei technologies. It’s now 180,000 employees, without being allowed to sell in USA. It’s an innovator in infrastructure and enterprise equipment and Cisco is not.
I also look at industries. For example, I’m doing a couple of talks in Europe right now on the pharmaceutical industry, where you have prices that are at least twice as high as anywhere else in the world for pharmaceutical drugs.
Companies claim they need to have higher prices to have higher levels of R&D spending, but all you need to do is look at Merck and Pfizer, and they’re the worst—they’re spending 100% of profits on dividends and buybacks, and increasingly buybacks, for decades. The lead critic of this was the former congressman Henry Waxman, who, even in 1985 was talking about drug companies being greedy, and it’s gotten much worse since then.
But no one in congress ever linked the issue, and asked, “Well how are they actually using those profits?” As far as I can see, I’m the first one making the argument [that the profits are being spent on buybacks]. They are missing what was going on.
Alsin: What’s been some of the more interesting reaction to your work?
Lazonick: After the HBR article came out, I was approached by the Service Workers International Union, which became the first union to try and come out against stock buybacks. They used it in their organizing efforts, and they had a big protest at McDonald’s in May 2015. McDonald’s had spent about $3 billion on buybacks per year for the last decade. They were the first union that said,
“Why are you doing this?”
It’s not just affecting lower paid workers, either. It was affecting the franchisees. In the past, when McDonald’s grew, they would share it with the franchisees by upgrading their menus, outlets, and spending more on advertising. But the corporate office stopped doing this to focus on buybacks.
Alsin: So can you talk a little bit about why buybacks hurt innovation, and how we got to this point?
Lazonick: If you look at once-highly innovative companies, like a Cisco or Intel or Microsoft, at first they don’t do buybacks. They reinvest everything, and they don’t even pay dividends. And because they are growing so fast, the people who are watching these companies say “Ok, maybe I’ll bet on that company.”
But once the companies become successful, they start just propping up their stock price with buybacks. And a big part of the reason for this is that for them, the stock price is part of their DNA. That’s what was used to attract venture capital, the ability to go public quickly on the stock market. Also, starting in the 1980’s and 1990’s, a startup couldn’t give people a career with one company, and a defined benefit/pension, so they gave them stock options which went to a broad base of employees, and that made the stock market very important to them.
Alsin: What’s the future look like with respect to buybacks?
Lazonick: So I think the problem is going to get much worse, because there’s actually no constraints on it. The power of what I call the “value extractors” has become greater and greater. That’s both the CEOs on the inside who are incentivized by stock-based pay, which I’ve written about a lot.
Now, there are some institutional investors who have stood up and said “no”—you hear noises from Larry Fink at Blackrock, but I’m not sure where that leads. If people start listening to the critique that I’m making, and some politicians have, like Joe Biden, Tammy Baldwin, and Elizabeth Warren, then maybe there will be changes. There are some who get it—but not many, however.
Alsin: Last question. If you were head of the SEC, what would you do?
Lazonick: For me, it’s actually kind of simple, once you recognize the nature of the problem. But the problem is most policy makers and most economists don’t recognize the nature of the problem.
In 1982, the SEC passed Rule 10b-18, which gave companies safe harbor to purchase back stock without fear of being accused of market manipulation. By 1983 we think the lawyers were discussing it. By 1984, the companies were doing it, and then it became more systematic over time, and it’s become a bigger and bigger amount.
If you recognize the nature of the problem as I’m describing it, you ask: What allows this to occur? You say, well, that was kind of a silly thing they did back in November 1982. It was misinformed in terms of how the stock market works. So you get rid of it, so you rescind it. You say companies cannot do these open market repurchases.
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