Soon after economist William Lazonick became a fellow at Harvard Business School in 1984, the world he had studied for decades began to radically change. Instead of plowing their profits back into their businesses, companies were being advised to do everything they could to boost their share price to return those profits to shareholders.
The doctrine of “shareholder value,” which has become part of our lexicon, was just beginning to take hold. But Lazonick was suspicious. He had studied the role of corporations in economic development and began to witness the hollowing out of our economy—the massive buybacks, layoffs and lack of innovation that, he says, were caused by this singular focus on shareholder value.
One of the changes, he later discovered, was driven by a 1982 rule change by the Securities and Exchange Commission that allowed companies to buy back their stock without being charged with manipulating its price, as had previously been the case. (Reducing the shares outstanding not only makes them scarcer and therefore more valuable, it also automatically increases earnings per share, the metric by which companies are analyzed by Wall Street.)
Lazonick’s views on the wrongheadedness of this approach finally got attention in 2014 when he wrote a Harvard Business Review article called “Profits Without Prosperity.” In it, he argued that corporations focusing on their stock price are engaged in behavior that he calls “value extraction” instead of “value creation.”
“By favoring value extraction over value creation, this approach has contributed to employment instability and income inequality,” he wrote.
A soon-to-be published book he authored with economist Jang-Sup Shin, called Predatory Value Extraction, takes off on that theme by explaining how the ideology of “maximizing shareholder value” came to dominate business schools and corporate agendas.
Toronto-born Lazonick received an MS in economics from the London School of Economics and a PhD from Harvard University. He has worked for decades in academia, at Harvard and also Columbia University and the University of Massachusetts at Lowell. He is the cofounder and president of the Academic-Industry Research Network, which is funded by the Institute for New Economic Thinking, a Soros Foundation organization.
In recent years, Lazonick’s ideas have been picked up by several progressive Democrats, including presidential hopeful Sen. Elizabeth Warren, who addressed them in her Accountable Capitalism Act. Last year, Sen. Tammy Baldwin, a Democrat of Wisconsin, introduced specific legislation to curb buybacks by rescinding the SEC rule that allowed them to go unchecked. (Lazonick testified at a Congressional hearing on the topic.)
But perhaps the biggest signal that public opinion is shifting came this summer when the Business Roundtable, a group of America’s most influential corporate leaders, changed its mission statement. Since 1997, it had one principle: “The paramount duty of management and of boards of directors is to the corporation’s stockholders.”
In August, the group of 181 CEOs changed that definition to include other “stakeholders,” including employees and the community at large. It was a specific rebuke to the academic theories of Milton Friedman, the University of Chicago economist, and his disciple Michael Jensen, who joined Harvard Business School in the 1980s and began to promote the doctrine of shareholder value—much to the chagrin of his fellow economist, William Lazonick.
Worth recently talked with Lazonick about how ideas around value are shifting again today.
Q: The Business Roundtable recently put out a statement saying that businesses should take other stakeholders, not just shareholders, into consideration in how they run their business. What do you make of it?
A: I was somewhat surprised by it. I take it at this point as just words. We’ve been collecting data on the pay and distribution policy, buybacks and dividends of the companies that were signatories. Boeing is a signatory of this, and its obsession with keeping its stock price up contributed to its planes crashing.
How so?
They did $43 billion in buybacks in 2013, right up to the time of the second airplane crash. After they acquired McDonnell Douglas in ’97, they became a highly financialized company and had been totally focused on using whatever profits they could get, or prospective profits in this case, to prop up their stock price.
So why are corporations like Boeing suddenly changing their tune?
I think that they are afraid of the progressive agenda coming out of the Democrats—Elizabeth Warren’s Accountable Capitalism Act, which was introduced a year ago last August, and she’s cosponsored a bill by Tammy Baldwin.
The other thing is a lot of these corporate executives are afraid of shareholder activists, who have a huge amount of power. And I have a book coming out, Predatory Value Extraction, which explains how someone like Nelson Peltz could have 0.8 of 1 percent of GE shares but really call the shots by using the proxy advisory services and the proxy votes of institutional investors.
That’s interesting. Back to politics, what’s the gist of Baldwin’s legislation?
It would rescind SEC Rule 10b-18, which was adopted in November of 1982, because it’s a safe harbor against charges of manipulation by companies engaged in buybacks.
That was just before the bull market took off. What were the rules like before then?
In the past, the SEC thought that buybacks that companies were doing—which were nothing compared to what’s being done now—might be a manipulation of the market. It turned out that you can look at the data and in 1984 they all started doing buybacks in a big way, and it escalates over time. By 1997, buybacks surpassed dividends as a form of distribution to shareholders.
When did you start seeing this change?
I did a PhD at Harvard in the early ’70s and I had become an assistant professor at Harvard, but I was focused in on this issue of large corporations driving the economy.
Nobody was talking about shareholder value in 1984. It really took off in 1985, and I see it very much related to Harvard hiring Michael Jensen, who had been at the University of Chicago and then was the guru of maximizing shareholder value. And so, in 1986, everybody was talking about shareholder value.
I believe that idea is also attributed to Milton Friedman, right?
Yes, he was saying that the responsibility of the corporation is to increase the profits for the benefit of shareholders. It was called the Friedman Doctrine.
What was the impetus for this?
There had been something called Campaign GM, which was inspired by Ralph Nader, that sought to put three public interest people on the board of directors of General Motors to deal with car safety and fuel efficiency pollution issues. Friedman called Campaign GM pure and unadulterated socialism. We know what happened in the auto industry. They should have put those people on the board.
Why have you been so critical of buybacks?
I think they’re just a manipulation in the market, and I see what damage they do.
What do you mean?
It is absolutely clear to me that the foundation for capital formation is companies retaining their profit through investing in the capabilities they have. In the late ’70s and early ’80s when you had the Japanese challenge, people were saying, “American companies are paying out too much dividends. They need to invest more.” But now on top of dividends, you have buybacks, and it took me a lot of time to really understand it. It wasn’t until much, much later that I understood its origins with this SEC rule.
How have increased buybacks affected the health of corporations?
A lot of the companies that are doing the largest purchases are now collapsing, like General Electric. It has now kind of gone totally towards financialization, or what I call value extraction. Or Cisco. It was the fastest-growing company in the world in the 1990s. It’s now about twice the size as it was in 2000 but totally not innovative. It had been the highest market capitalization in the world in 2000, and the stock came down and all the profits went into propping up the stock price. As a result, it’s not simply that the money disappears, it’s that the leadership of the company is not focused on the next round of innovation. That’s precisely what’s going on with Apple, which has done $270 billion in buybacks.
What other problems did you see this causing?
Blue collar workers getting laid off, not being retrained, downward mobility of the labor force. In the 1980s it was blacks, now it’s whites who are following the same route—shortened life expectancy. For blacks, it was crack cocaine, which threw them in jail. Now it’s opioids.
Do you think stock buybacks are to blame?
Focusing on shareholder value is not simply about increasing buybacks. That’s the most egregious manifestation of it because it’s totally unnecessary; it’s just manipulating stock prices. What we find is that it goes along with other behaviors like the willingness of companies—which was not the norm before the 1980s—of just being willing to get rid of 10,000 people all at once.
How does that affect the larger economy?
The way you get sustainable rising wages—standards of living—that affect a lot of people in the economy is when companies employ people, those people learn how to develop the products, utilize the products, transform the technologies, access the markets, for very complex social organizations. They become more productive collectively in the process, and they share in the gains of that productivity. You want to retain them. So you give them employment security, you give them higher wages, you give them promotion possibilities.
A lot of the focus on the buybacks has to do with stock-based compensation, which leads executives to want to boost their stock prices. Should companies reward their employees or their executives this way?
The way stock options work, have worked, in the United States—and still do by and large—is there’s no performance criteria. And if the stock price comes down because the market tanks, then they give you lots more options at low prices and tell you to get the price up. Buybacks are a way to do this.
What does this corporate mindset mean for the rest of us?
These companies are going to be looking to not to pay taxes. They’re going to be lobbying Congress as they did with the tax cuts of 2017, which were all going to buybacks and propping up stock prices. In the pharmaceutical industry, the companies are going to price gouge and say that it’s for the sake of innovation. So there are all kinds of other behaviors that go along with this.
How much money are we talking about?
The S&P 500 for the last decade, it’s over $4 trillion for the buybacks, another $3 trillion in dividends. If we go back to 2014, collectively about 106 percent of the profits were spent on buybacks and dividends, and about 60 percent of that was on buybacks.
So you are saying basically that when you’re not reinvesting in the workers, and in the human capital in the organization, that is bad for not only the business but for the economy as a whole. What’s the solution?
We’d all be better off if these companies remain competitive on global markets, pay their workers more, which would be out of their higher productivity, and pay shareholders reasonable dividends. The money that was reinvested would produce the next generation of great products run by people who knew how to manage innovation.
What message can you give to entrepreneurs about stock buybacks and why they should be thinking cautiously about them?
Any entrepreneur will know when they’re building a company that if they really want to be competitive, they should control as much of the cash they have as they can and not give it away.
Would this hurt the stock market?
Everything is geared to keeping the market up but keeping it up is making everything more fragile, including the Fed. Why are the best stocks in the stock market called blue chip stocks? That’s the most valuable chip in the gambling casino.
