UTSpeaks: Endless Prosperity? Professor Thomas Clarke, Professor William Lazononick – 12 July 2012

A BUSINESS MODEL FOR A SUSTAINABLE FUTURE ?

Thomas ClarkeCentre for Corporate Governance

UTS Sydney

• A business model conceptualises the explanation of how an organisation creates and delivers value (economic, social or other forms of value).

• The viability of business models in the contemporary economy and society is determined by their capacity to continuously innovate.

• Increasingly business models will be tested also by their sustainability not simply in economic, but in social and environmental terms also.

Business Models

• Innovation is the implementation of a new or significantly improved product (good or service), process, new marketing method or a new organisational method in business practices, workplace organisation or external relations.

Australian Innovation System Report (2011)

“The design, invention, development and/or implementation of new or altered products, services, processes, systems, organizational

structures, or business models for the purpose of creating new value for customers and

financial returns for the firm.”

Innovation (US Dept Commerce 2012)

Accelerating Life Cycles

National Innovation SystemsKey components include:

• Firms

• education and training systems

• knowledge infrastructures (universities, R&D institutes, standards agencies, regulation systems)

• physical infrastructure

• public macro-micro policy systems

Roos et al, National Innovation Systems, ABF, 2005

Dodgson et al, Systems thinking, market failure, and the development of innovation policy, UQ/CBR Cambridge, 2010

• Countries have a choice. They can focus on development based on either:

• Competition via investment in technology and innovation - which is important in high knowledge industries and high innovation economies, or

• Competition via exchange rates and wages - which is important in industries producing standardised, lower-tech goods and services.

OECD (1997) National Innovation Systems

• The first route will maximise higher-skilled, higher-paid employment growth and living standards.

• Given the lack of control over the exchange rate, the second route requires competition based on wages. It is essential to understand that markets themselves won’t shift a country from one path to the other.

• These conclusions arise from the OECD’s recognition that technical progress - the creation of new products or the adoption of more efficient methods of production - is the main source of economic growth and enhanced quality of life.

OECD (1997) National Innovation Systems

Choice

knowledge industries

standardised, lower-tech goods and services

• Australia's manufacturing sector has contracted in relative terms at the fastest rate across the OECD economies and it seems Australian manufacturing is in general not gaining employment in industries with higher R&D intensities, contrary to OECD trends.

• There appears to have been little net increase in value-adding to our natural resources since the mid 1970s.

• Many of Australia's industries are increasingly concentrated, with already 0.4% of businesses employing nearly 40% of all workers. The position of SME's versus large firms is likely to deteriorate

THE HIGH ROAD OR THE LOW ROAD? (1997)

• Australia's overall internationally poor R&D performance is largely the result of our industrial structure which is concentrated in low-tech industries.

• Manufacturing has been measured as one of the most innovative sectors of the economy. Innovative firms tend to show better performance in sales and export growth.

• Australia's trade structure has serious built-in negative biases, like our poor and deteriorating terms of trade, costs of investment in productive equipment imports.

THE HIGH ROAD OR THE LOW ROAD?

• Integrate trade and industry policies. • Shift the economy towards greater knowledge and innovation

intensity. • Improve cooperation and linkages. • Target key productivity drivers. • Build global distribution channels and capability. • Invest in education and research infrastructure and training. • Focus public policy and private sector attention on innovation

and knowledge as the bases of competition.

REACHING FOR THE HIGH ROAD

• The stimulus from the resources boom means that mining states will tend to grow faster than the non-mining states while the mining industry is expanding.

• Further, faster expansion of mining-related sectors and regions will attract labour and capital away from the rest of the economy.

• In a fully-employed economy, this may imply slower growth in non-mining sectors and regions (Henry 2006). (The resource curse/ Dutch disease?)

The resources boom and the two-speed economy

• The resource curse (Paradox of Plenty) refers to the paradox that countries and regions with an abundance of natural resources, specifically point-source non-renewable resources like minerals and fuels, tend to have less economic growth and worse development outcomes than countries with fewer natural resources.

• This is hypothesized to happen for many different reasons: including a decline in the competitiveness of other economic sectors (caused by

appreciation of the real exchange rate as resource revenues enter an economy), volatility of revenues from the natural resource sector due to exposure to global

commodity market swings, government mismanagement of resources, or weak, ineffectual, unstable or corrupt institutions (possibly due to the easily

diverted actual or anticipated revenue stream from extractive activities).

The Curse of Resources

Jan du Plessis, Chairman, Rio Tinto

“We are going to have to be much more responsive to how the public perceive us, more responsive to

how our shareholders perceive us, and more sensitiveto how our employees perceive us.”

Royal Institute for International Affairs, London,4 July 2012)

• Minerals Resource Rent Tax

• Fixed-price Carbon Tax commencing 1 July 2012, transitioning to a Cap-and-Trade ETS on 1 July 2015

Sharing the benefits of the resources boom

EDUCAT ION

ENHANCING

• China (37m); • India (28m); • US (20m); • Brazil (9m); • Indonesia (7.8m)• Russia (6.3m), • Japan (3.8m), • Turkey (3.8m), • Iran (3.8m), • Nigeria (3.6m)

Growth Rates:• Highest growth in tertiary enrolments expected in China –from

24% to 38%• India to reach 23% from 16%• Other emerging economies with significant growth: Brazil (+2.6m), Indonesia (+2.3m), Nigeria (+1.4m), Philippines, Bangladesh

and Turkey (+0.7m each) and Ethiopia (+0.6m)

The largest tertiary education systems in 2020

INFRASTRUCTURE

BUILDING

NEW

MANUFACTURING

REVITALISING

BUSINESS

CLUSTERS

ENGINES

OF

INNOVATION

International Focus on Innovation, Competitiveness and Jobs

2009

Australian Government (2008/2009)

Australia’s performance in innovation outcomes against other OECD countries (OECD 2009)

Australia’s performance in innovation outcomes against other OECD countries (OECD 2009)

Australia Selected Industries, contributions to GVA, employment, exports, innovation and R&D

(ABS 2011)

The Australian economy maintains a high level of dependence on natural resources and is failing to develop new areas of specialisation and growth.

Recent productivity growth the result of one-offs: micro-economic & ICT

This performance masks underlying weaknesses in new firm formation and in the growth of new internationally competitive industries.

The poor performance of Australian firms in R&D and patenting signals the weaknesses in management, scale and international positioning.

Australia’s declining position in ‘high tech’ sectors indicates the extent to which Australia is being left behind the frontier of innovation and growth in the world economy.

• One of the lowest in the OECD in BERD, investment in venture capital;and international patenting activity (per mill. Population) • 80% of the top fifteen export products are resource-based commodities

with a low level of processing;• large and growing trade deficit in ICT products and services

Australia’s WeaknessesDon Scott-Kemmis (2010)

Australia is a broadly based dynamic and flexible economy, diversified across markets, and increasingly sectors, underpinned by competitive domestic markets and flexible labour markets.

High-level human resources and strong research organisations facilitate the rapid uptake of new knowledge produced anywhere.

Imported knowledge and equipment combined with local knowledge and capability supports active problem solving and systems integration in a range of sectors generating relatively high levels of productivity.

A ‘fast-user’ strategy combined with natural and human resources is a sound basis for future prosperity.

• High and increasing productivity;• Relatively high level of public sector R&D [R&D intensity in some sectors > the OECD av.];• Substantial growth in niches markets in key manufacturing sectors: telecom equipment, wine, boats,

automobiles and components;• Maintaining strong competitiveness in resources sectors through the effective application of new technology,

including IT;• A strong ICT services sector and high growth in ‘knowledge based services’;• Rapid and broadly-based uptake of new ICT.

Australia’s StrengthsDon Scott-Kemmis (2010)

• In June 2009, all OECD member countries signed a Declaration on Green Growth, recognising their ability to drive economic development while ‘addressing urgent challenges’ including climate change, environmental degradation and energy security. The Declaration tasked the OECD with developing a Green Growth Strategy, which was released at the OECD Ministerial Council Meeting on 25–26 May 2011.

• Green growth means: ‘fostering economic growth and development while ensuring that natural assets continue to provide the resources and environmental services on which our well-being relies. It is also about fostering investment and innovation which will underpin sustained growth and give rise to new economic opportunities.’

• It has the potential to secure future growth and build prosperity by promoting new markets and economic opportunities that also help us to manage ‘wicked problems’, such as climate change and unsustainable natural resource depletion.

OECD Green Growth Strategy: A new driver of innovation

Sustainable Prosperity in the New Economy?

William LazonickUniversity of Massachusetts Lowell

The Academic-Industry Research Network

Presentation to UTSpeaks

“Endless Prosperity? Can Australia Find a Business Model to Keep the Good Times Going?

University of Technology Sydney

July 12, 2012

Sustainable prosperity

Macroeconomic Objectives:

Equitable and stable economic growth

• Growth: real per capita productivity gains that can raise standards of living

• Equity: gains from growth shared fairly among those who contribute to it

• Stability: employment and income that is not subject to boom and bust

United States, real GDP per capita, 2009$, 1960-1969

000

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20,000

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30,000

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Real GDP per capita, 2009$

United States: Economic growthReal GDP per capita, 1960-2009

United States, annual growth rate, real GDP per capita, 1960-2009

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Annual growth rate, real GDP per capita

United States: unstable growth, 1960-2009

Instability and structural changes in corporate employment

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12.01

94

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81

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97

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20

05

20

09

percen

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percent unemployed

US unemployment rate, 1945-2010

1970s stagflation, financial deregulation

1980-82 recession, rationalization

1990-91 recession, marketization

2001 recession, globalization

2008-09 recession, financialization

Current unemployment rate, June 2012: 8.3%

http://www.motherjones.com/politics/2011/06/speedup-americans-working-harder-charts

Inequitable growth, 1979-2009

The Great U-TurnGini coefficient for all US families, 1947-2009

0.340

0.360

0.380

0.400

0.420

0.440

0.460

Gin

i co

effi

cien

t Gini coefficient

more equalitygrowing inequality

Shares of total US income of highest income households, 1913-2010Concentration of income at the top

Old Economy Business Model (OEBM)

OEBM: foundation for somewhat equitable and reasonably stable growth

• Career employment with one company• Limited role of the stock market in the operation of the corporation:

separation of ownership and control• Creation of high quality jobs in the United States• A progressive income tax structure: 91% marginal tax rate on highest

incomes in the 1950s; 70% in 1980• Government investment in physical infrastructure and the knowledge base (US: the most formidable developmental state in

history)

New Economy Business Model (NEBM)

NEBM: high-tech innovation based on technologies developed with massive government support, often in OEBM research labs, but with the stock market playing major functions in the allocation of capital and labor

• NASDAQ as an inducement for venture-capital investment: exit investments via a speculative market

• Interfirm mobility of labor over the course of a career, with stock options as prime inducement to change jobs

• Top executives especially highly paid via stock options

• In name of innovation, High-tech “NEBM” lobby seeks and gets low taxes

• Outsourcing of manufacturing and globalization of the value chain

The shift from the Old Economy business model (OEBM) to the New

Economy business model (NEBM) has resulted in a highly financialized US

corporate economy that contributes to inequity and instability, and threatens

economic growth

Published in September 2009 by the Upjohn Institute for Employment

Research1. What is New, and Permanent, about the “New

Economy”?2. The Rise of the New Economy Business Model3. The Demise of the Old Economy Business

Model4. Pensions and Unions in the New Economy5. Globalization of the High-Tech Labor Force6. The Quest for Shareholder Value7. Prospects for Sustainable Prosperity

WINNER OF THE 2010 SCHUMPETER PRIZE COMPETITION

A business model transforms productive resources into goods and services that can be sold to generate revenues

A business enterprise engages in three generic activities:• strategy: allocates resources to investments in human and physical resources• organization: develops the productive capabilities of these resources• finance: seeks to generate returns on the resources that it has developed through sale of goods and services

Innovation: generation of higher quality products at low unit costs

What do business models do?

• Uncertainty: Innovation is not “optimal”Investments in innovation are made in the face of technological, market, and competitive uncertainty, with the expectation, but no guarantee, of future returns – need for “strategic control”

• Collectivity: Innovation cannot be done “all alone”Workers with different hierarchical responsibilities and functional specialties contribute to organizational learning – need for “organizational integration”

• Cumulativity: Innovation cannot be done “all at once”Finance required to sustain the innovation process from the time investments are made until the time that these investment generate financial returns – need for “financial commitment”

Innovation is uncertain, collective, and cumulative

Social conditions of innovative enterprise

• Strategic control: a set of relations that gives decision-makers the power to allocate the firm’s resources to confront uncertainty by transforming technologies and markets to generate higher quality, lower cost products

• Organizational integration: a set of relations that create incentives for people to apply their skills and efforts to engage in collective learning

• Financial commitment: a set of relations that secure the allocation of money to sustain the cumulative innovation process until it generates financial returns

By creating new sources of value (embodied in higher quality, lower cost products), the innovative enterprise makes it possible (but by no means inevitable) that, simultaneously, all participants in the economy can gain:

• Employees: Higher pay, better work conditions• Creditors: More secure paper• Shareholders: Higher dividends or share prices• Government: Higher taxes• The Firm: Stronger balance sheet

AND• Consumers: Higher quality, lower cost products

Innovation: potential for sustainable prosperity

• In the 1980s and 1990s, integral to the microelectronics revolution that brought us the PC and the Internet was a dramatic change in the dominant business model – the “New Economy Business Model” (NEBM) replaced the “Old Economy Business Model” (OEBM)

• Coming primarily out of Silicon Valley, NEBM has been a potent force in commercializing the technological potential of the microelectronics revolution.

• It did so, however, by making the stock market far more important in the operation of the US corporate economy than it had been under OEBM

• The result has been economic performance that is highly inequitable and unstable – that is, the antithesis to what I call “sustainable prosperity”

The rise of the “New Economy Business Model”

OEBM NEBM

Strategy, product

Growth by building on internal capabilities; business expansion into new product markets based on related technologies; geographic expansion to access national product markets.

New firm entry into specialized markets; sale of branded components to system integrators; accumulation of new capabilities by acquiring young technology firms.

Strategy, process

Corporate R&D labs; development and patenting of proprietary technologies; vertical integration of the value chain, at home and abroad.

Cross-licensing of technology based on open systems; vertical specialization of the value chain; outsourcing and off-shoring.

Finance Venture finance from personal savings, family, and business associates; NYSE listing; payment of steady dividends; growth finance from retentions leveraged with bond issues.

Organized venture capital; NASDAQ listing; low or no dividends; growth finance from retentions plus stock as acquisition currency; stock buybacks to support stock price.

Organ-ization

Secure employment: career with one company; salaried/hourly employees; unions; defined-benefit pensions; employer-funded medical insurance in employment and retirement.

Insecure employment: interfirm mobility of labor; broad-based stock options; non-union; defined-contribution pensions; employee bears greater burden of medical insurance.

A greatly increased role of the stock market in allocating capital and labor in NEBM compared with OEBM

NEBM: F

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The long stock-market boom of the 1980s and 1990s – and the illusion of sustainable prosperity

Source: Yahoo! Finance

Stock-price movements September 1982-October 2009

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S&P 500 NASDAQ

Stock market gains in the 1980s and 1990s

1960-1969

1970-1979

1980-1989

1990-1999

2000-2009

REAL STOCK YIELD 6.63 -1.66 11.67 15.01 -3.08

PRICE YIELD 5.80 1.35 12.91 15.54 -2.30

Dividend yield 3.19 4.08 4.32 2.47 1.79

Change in CPI 2.36 7.09 5.55 3.00 2.57

REAL BOND YIELD 2.65 1.14 5.79 4.72 3.41

Ave. annual US corporate stock and bond yields (%), 1960-2009 Source: Economic Report of the President 2010

The long boom in the stock market in the 1980s and 1990s, culminating in the Internet revolution, led Americans to view the stock market as both the cause and effect of a prosperous economy.

In the process, Americans imbibed the ideology that a business model that seeks to “maximize shareholder value” (MSV) results in superior economic performance.

Manipulating the stock market in the 2000s: buybacks push S&P 500 Index to new peak in 2007

Drivers of stock prices:Innovation, speculation, manipulation

Source: Yahoo! Finance

Stock-price movements September 1982-October 2009

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S&P 500 NASDAQ

SPECULATION

MANIPULATION

INNOVATION (NEBM)MANIPULATION (OEBM)

What drove stock prices over 1980s, 1990s, 2000s?

1. INNOVATION: in 1980s and 1990s rise in stock prices is a result of innovative enterprise; “retain-and-reinvest”, especially by New Economy firms that pay no dividends

2. SPECULATION: an acute case of so-called “irrational exuberance”, which, as it turns out, was not at all irrational for insiders to the system

3. MANIPULATION: in 1980s established (“Old Economy”) companies downsize corporate labor forces and distribute corporate revenues to shareholders – by the 2000s, transition to “New Economy business model”, but companies doing massive stock buybacks

How the stock market undermines innovative enterprise

• Strategic control: unindexed stock options enable top executives to gain from speculation in and manipulation of their companies’ stock prices – they can enrich themselves by not investing in innovation

• Organizational integration: interfirm labor mobility, induced stock-based compensation, can undermine engagement in organizational learning

• Financial commitment: to boost stock prices, companies do massive buybacks, thus draining the enterprise of financial resources under its control

The macroeconomic perspective

The last three decades have seen a dramatic increase in US income inequality, characterized by

concentration of income at the top, erosion of “middle class” employment increasingly severe “jobless recoveries” from economic

downturns

• Income inequity and employment instability are results of the financialization of the US economy, including not only an increase in financial over productive sector activity but also, more fundamentally, financialization of corporate resource allocation, the most important manifestations of which are stock buybacks and the explosion of executive pay

Shares of total US income of highest income households, 1913-2010

Concentration of income at the top

Recessions initiate structural changes in corporate employment followed by jobless recoveries

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94

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81

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percent unemployed

US unemployment rate, 1945-2010

1970s stagflation, financial deregulation

1980-82 recession, rationalization

1990-91 recession, marketization

2001 recession, globalization

2008-09 recession, financialization

Current unemployment Rate June 2012: 8.2%

The 2008 financial crisis as an employment crisisHistorical process that created a growing “sub-prime” population:

Financialization from the 1970s: the transformation of Wall Street in search of high financial returns creates the conditions in the1980s for the ideology that companies should be run to “maximize shareholder value”

Rationalization from the early 1980s: results in a large part of the high-school educated labor force with upwardly mobile aspirations, including the ability to obtain a home mortgage, but with downwardly mobile income-earning power

Marketization from the early 1990s: results in insecure employment for both high-school and college-educated white-collar workers

Globalization from the early 2000s: results in the ability of US corporations to make profits even without employing US workers

The subprime mortgage crisis reflected the focus of major US corporations, both financial and industrial, on generating high financial returns, in this case by exploiting the vulnerability of a working population that had for a quarter of a century seen the erosion of middle-class employment opportunities.

1980s: Rationalization: permanent layoffs of blue-collar workers

1990s: Marketization: the end of the norm of a career with one company

2000s: Globalization: the emergence of supplies of highly capable, labor in lower wage areas of the world

All three transformations in employment resulted in the erosion of “middle-class” jobs in the United States

But the corporations that had employed these people did not disappear; most remained highly profitable – Why didn’t US corporations invest the gains from rationalization, marketization, and globalization in the next generation of higher quality jobs? (Answer: Financialization)

Three sources of structural change in corporate employment in the United States since the beginning of the 1980s

“Financialization”

• “Financialization” generally refers to the growing role of the financial sector in the economy, and the casino-like activities of Wall street banks and hedge funds

• My concern, however, is with the financialization of the business corporation, and particularly the industrial corporation on which we rely to produce capital goods and consumer goods

• In 2011 the US Fortune 500 had $10.8 trillion in sales, $708 billion in profits, and 25.1 million employees

• Mean per company: $21.6 billion in sales, $1.4 billion in profits, and 50,226 employees.

Financialization and shareholder valueFinancialization of the corporation: the evaluation of the performance of a company by a financial

measure such as earnings per share rather than by the goods and services that it produces, the customers it serves, and the people whom it employs.

Ideology that legitimizes financialization: “maximize shareholder value” (MSV)

• MSV emerged in the US in the early 1980s as a corporate response to the failure of conglomeration, Japanese competition, and the erosion of savings by inflation

• by the end of the 1980s MSV was the dominant ideology in business schools and corporate boards in the US

A Johnny-come-lately critic of MSV

John F. Welch became CEO of GE in 1981

Mr. Welch published his memoirs in 2001

But it took Jack some eight years, and a massive financial

meltdown, to get his most critical thoughts on corporate

management out of his gut.

“It is a dumb idea”In March 2009, John F. Welch, Jr., ex-CEO of GE told a Financial Times reporter:

“On the face of it, shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy…your main constituencies are your employees, your customers and your products.”

The reporter probably had a look of shock on his facem because Welch saw fit to reiterate: “It is a dumb idea. The idea that shareholder value is a strategy is insane. It is the product of your combined efforts – from the management to the employees.”

Francesco Guerrera, “Welch rues short-term profit ‘obsession’,” Financial Times, March 12, 2009.

The “dumb idea” is the dominant US managerial ideology

• As put forward by agency theorists, MSV is ostensibly a theory that supports the interests of shareholders

• But MSV was embraced as an ideology of top corporate executives – legitimizes corporate resource allocation that ignores the interests of taxpayers and employees in the name of superior economic performance

• Yet both taxpayers and employees contribute to the innovation process and have a claim to returns if and when they occur

• Public shareholders do not generally invest in the innovation process – they invest in shares that are already on the market

The developmental/entrepreneurial state

• The government often makes investments in physical and human infrasructures (including S&T knowledge bases) at stages at which these investments are far too early, too big, and too uncertain for businesses to undertake

• Lazonick: “Nine government investments that made the United States an industrial leader”: e.g., railroads, land-grant college system, agricultural experiment stations, aeronautics (modern airliner, jet engines), computers, the Internet, life scieneces, nanotechnology, clean technology

• Mazzucato: The Entrepreneurial State makes this argument more generally, building on the theory of innovative enterprise

National Institutes of Health budgets 1938-2011

Total NIH spending, 1936-2011 in 2011 dollars=$792 billion

NIH budget for 2012=$30.9 billion

Source: http://officeofbudget.od.nih.gov/approp_hist.html

Taxpayers invest without a guaranteed return

Employees invest without a guaranteed return

• as recognized by executives who declare that “our most important assets are our human assets”, the key to successful innovation is the extra time and effort that employees expend interacting with others to confront and solve problems in transforming technologies and accessing markets, above and beyond the strict requirements of their jobs.

• Anyone who has spent time in a workplace knows the difference between workers who just punch the clock to collect their pay from day to day and workers who use their paid employment as a platform for the expenditure of creative and collective effort as part of a process of building their careers.

• the productivity differences between the two types of workers can be enormous – it will only be firms within which employees invest extra time and effort without a guaranteed return that will have a chance of innovative success.

So why does the “dumb idea” matter?

• Economic activity and performance depend on resource allocation

decisions

• We rely on corporate executives to make resource allocation decisions

• Stock-based compensation enriches top corporate executives in the name of MSV, and gives them incentives to encourage speculation in and engage in manipulation of the price of their company’s stock

• Prime mode of corporate resource allocation for the purpose of manipulating stock prices is buybacks

-1000

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0

200

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Net equity issues, U.S. nonfinancial corporations and U.S. banks and insurance companies,

1980-2011

Nonfinancial business corporations

Banks and insurance companies

$m

illio

ns

Source:Flow of Funds Accounts of the United States, Table F213Board of Governors of the Federal Reserve System, Washington DC, March 8, 2012

Federal Reserve Flow of Funds

US corporations finance the stock market (not vice versa)

Federal Reserve Flow of Funds data show that net equity issues of US industrial corporations have been negative since the early 1980s, and especially in the 2000s

Financialization of corporate resource allocation: Increasing use of stock buybacks to manipulate the stock market

Buybacks of 419 S&P 500 companies, 1997-2010

2001-2010: 459 companies did $2.7 trillion in buybacks + $1.9 trillion in dividends = 94% of net income

2011: The new run-up in stock buybacks

S&P Indices: S&P 500 Stock Buybacks Decrease for First Time Since Q2 2009: Third Quarter Success May Have Led to Fourth Quarter Pull Back PRNewswire, March 28, 2012

NEW YORK, March 28, 2012 /PRNewswire via COMTEX/ -- S&P Indices announced today that preliminary results show that S&P 500 stock buybacks decreased 22.8% to $91.5 billion during the fourth quarter of 2011, the first quarterly decline since the second quarter of 2009. For calendar year 2011, S&P 500 issues increased their buyback expenditures by 36.9% to $409.0 billion from the $298.8 billion posted in 2010….Exxon Mobil continues to be the poster child for share repurchases spending $5.4 billion on buybacks during the fourth quarter, slightly down from its $5.5 billion share repurchase level for the third quarter. Trailing Exxon during the fourth quarter was Amgen with $5.3 billion in buybacks, Intel with $4.2 billion, International Business Machines with $3.6 billion, and Pfizer with $3.2 billion.

Top corporate repurchasers, #1-25, 2001-2010

Top corporate repurchasers, #26-50, 2001-2010

Value extraction trumps value creation

Top 50 companies expended $1.59 trillion on buybacks, 2001-2010

Proportion of profits expended on buybacks by top 50, 2001-2010: 100%+: 11 50%+: 32 30%+: 43

Proportion of profits expended on buybacks plus dividends, top 50, 2001-2010: 100%+: 24 80%+: 38 67%+: 48

S&P 500 companies expended almost $3 trillion on buybacks, 2001-2010

Stock buybacks, top 25, 2011

Note: Oracle’s fiscal year recorded as 2011 ends May 31, 2012

This list includes some of the most successful high-

tech startups of the 1960s, 1970s, and 1980s:

IntelMicrosoft

AmgenCisco

Oracle

The explosion in executive pay %SO=% of total exec comp from actual gains from exercising stock options

Source: Execucomp

Exec pay 3X higher in 2010$ in 2004-2007 than in 1992-1995

gains from sp

eculation

gains from manipulation

Speculative gains in the 1980s and 1990s

1960-1969

1970-1979

1980-1989

1990-1999

2000-2009

REAL STOCK YIELD 6.63 -1.66 11.67 15.01 -3.08

PRICE YIELD 5.80 1.35 12.91 15.54 -2.30

Dividend yield 3.19 4.08 4.32 2.47 1.79

Change in CPI 2.36 7.09 5.55 3.00 2.57

REAL BOND YIELD 2.65 1.14 5.79 4.72 3.41

Ave. annual US corporate stock and bond yields (%), 1960-2009 Source: Economic Report of the President 2010

With unindexed stock options and double-digit annual stock price yields in the longest bull-run in US stock market history, the explosion of executive pay was automatic in the 1980s and 1990s.

Manipulating the stock market in the 2000s: buybacks push S&P 500 Index to new peak in 2007

With unindexed stock options and stagnant, but volatile, stock price yields in the 2000s, US corporate executives boosted their own pay by allocating resources to legally manipulate the stock market.

Components of the incomes of the top 0.1%, 1916-2010

“Salaries” include gains from exercising stock options

• Executives say that they are showing confidence in their company’s future performance – but their companies only sell stock to the public when compelled to do when so in financial distress

• If the company were to sell its stock when its price was high, its executives would be announcing to the financial world that they no longer have confidence in the company’s stock! So they almost never do it.

• At the same time, these very same executives have no problem selling their own stock (much of it acquired by exercising stock options) when the price is high – resulting in the explosion in executive pay

Why do companies repurchase stock?

• Stock-based compensation gives top executives a powerful personal incentive to manage – i.e., manipulate – their company’s stock price

• Top executive pay has been increasing dramatically since the 1970s

• Most of top executive pay comes from the gains from exercising employee stock options

• In the era of “maximizing shareholder value”, stock-market performance has become the most important, if not only, indicator of corporate performance

• Stock buybacks are a great way to manipulate earnings per share and hence stock price – in the name of MSV

A powerful personal incentive to do buybacks

• Health care insurers and providers do huge buybacks even as the nation’s health care system is in crisis – buybacks/net income, 2001-2010: United Health 88%, Wellpoint 101%, Aetna 102%, Cigna 111%

• WalMart does multi-billion dollar buybacks while the wages of 2 million+ “associates” yield a low standard of living

• If General Motors had banked (with a 2.5% after-tax annual return) the $20.4b. distributed to shareholders as buybacks from 1986 through 2002 it would have had $29.4b. of its own cash to help keep it afloat and respond to global competition when it went bankrupt

Why do buybacks matter?: health insurers, Walmart, General Motors

• Oil companies do massive buybacks, while Americans pay high fuel prices and lack adequate investment in alternative energy – from 2001-2010 Exxon Mobil repurchased $174.5b., including $31.8b. in 2007, $35.7b. in 2008, $19.7b. in 2009, and $13.1b. in 2010

• Leading pharmaceutical companies keep US drug prices at least double the prices in other advanced countries – they argue in Congress that high US drug prices are needed to fund drug research – yet many such as Merck, Pfizer, J&J, and Amgen did buybacks equal to 28-105% of R&D expenditures, 2001-2010

Why do buybacks matter?petroleum refining, pharmaceuticals

Why do buybacks matter?: Wall Street banks, ICT

• Wall Street banks did buybacks even as they were betting the company (and the economy) on derivative speculation, and ended up going to foreigners and the US government to bail them out

Eight of the biggest bailed-out banks spent a total of $182 billion on buybacks from 2000 to 2007

• Leading ICT companies do huge buybacks with the profits from offshoring even as they lay off US workers, and even as they demand that the government invest more in the high-tech knowledge base to make “America” competitive – 2001-2010: Intel spent $48.3b. on buybacks, more than 4 times the total budget of the National Nanotechnology Initiative for 2001-2010

• Forthcoming: Bell, Carpenter, Glimstedt, and Lazonick, “From Innovation to Financialization: How Cisco Focused on Its Stock price and Lost Its Way,” work-in-progress, 2012

Financialization in the destruction of Lucent and Nortel

• In the Internet boom of 1998-2000, Lucent Technologies and Nortel Network tried to adopt the Cisco model of growth through acquisition, using their stock as a combination currency, and destroyed themselves (see papers by Lazonick, with Edward March, a former engineering executive at Lucent)

• Lucent: world’s largest comtech company in 2000 – home of Bell Labs – in 2001 threw out its CEO Rich McGinn, wrote off billions of recent acquisitions, and to keep from going bankrupt sold its stock at 1% or 2% of its peak price in late 1999 – a shell of itself by the mid-2000s, Lucent taken over by Alcatel

• Nortel: world’s most technologically advanced optical networking company in 2000 – in 2001 threw out its CEO, John Roth (who had made $90m. from exercising stock options in 2000), wrote off billions of recent acquisitions, and went bankrupt in 2009, selling itself off in pieces

Buybacks and performance in communication technology

• Motorola: In 2005-2007, following the success of its 2G Razr cellphone, did $8.0b. in buybacks, 100% of NI, and then failed to compete in 3G phones. After losing $4.3b., 2007-2009, Motorola spun off Motorola Mobility in 2010, sold to Google in 2012.

• Qualcomm: makes high-end chipsets for smartphones and reaps billions from IP in CDMA, but, while buying back $9.0b. since 2005, has not been an active participant in setting the global 3G and 4G standards that derive from its CDMA technology.

• RIM (Blackberry): World leader in smartphones, but faltered after spending $3.0b. on buybacks in 2009-2010 (1.3 times R&D)

• Microsoft: In the 2000s a belated imitator of other more successful companies; 2000-2011 spent $126.5b. repurchasing stock, 81% of earnings and 1.6 times R&D expenditures.

• Nokia: a longstanding stock-option culture and Europe’s 7th largest repurchaser, €18.6b. for 2001-2010, has been in sharp decline.

And those that do no buybacks in comtech do wellApple: buybacks and dividends in decade from 1986 with Steve Jobs gone – then retaining all its earnings, transformed itself from a troubled niche player at the beginning of the 2000s into the world’s most profitable company by the end of the decade.

Google: has mobilized its financial resources to build on its competitive success in one line of business to innovate in other lines, including, with its Android operating system, smartphones.

Ericsson: the world’s leading communication equipment company – got rid of stock options in 2003 after adapting their use to the Swedish business model -- does virtually no stock buybacks

Huawei Technologies: a nonpublic employee-owned company that, through investment in R&D, is now the no. 2 global communication equipment company, despite being shut out of the US market

• Regulation of the employment contract to ensure that workers who contribute to the innovation process share in the gains to innovation.

• Creation of work programs that make productive use of and enhance the productive capabilities of educated and experienced workers whose human capital would otherwise deteriorate through lack of other relevant employment.

• Implementation of taxes on the gains from innovation to fund those government agencies that need to invest in the public knowledge base required for the next round of innovation.

What is to be done about employment?

• Put strict performance criteria, independent of stock price, on exercising stock options – e.g., job creation (so who needs stock options?) More generally, base executive pay on contributions to equitable and stable growth of the companies that they control

• Ban stock buybacks: force corporate executives to find productive uses for profits in the United States

• Transform boards of directors to include social representatives who seek equitable and stable growth

• Reject the ideology of “maximizing shareholder value”: invoke innovation theory rather than agency theory as an intellectual foundation for governing the corporation

• It will require a revolution in social norms.

What is to be done about corporate resource allocation?