Why Stock Buybacks Are Good For The Economy And Country
Self-interest has always been a primary tenet of capitalism. As Adam Smith famously wrote, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” Private interest, in the aggregate, is often a public good.
Yet in an article in Harvard Business Review, William Lazonick argued just the opposite. In particular, he accused greedy CEO’s of advocating for public research, while at the same time pumping money into share buybacks in order to gin up their stock based compensation, enriching themselves while impoverishing the rest of us.
His argument, while sensational and superficially persuasive, is ultimately flawed. First, he cynically selects his facts to suit his argument (more on that below). Second, he seems to fundamentally misunderstand the relationship between public and private investment. The reality is that stock buybacks are often positive and healthy for the economy and the country.
Feeding At The Public Trough?
In the article, Lazonick points to several examples of industry groups lobbying for federal investment in research for their own benefit. Intel, for one, urged for greater public research into nanotechnology. Other top executives at the American Energy Innovation Council push for more funding for alternative energy research. The list goes on.
Yet for Lazonick’s argument to be valid, you would have to assume that these firms were lobbying for the federal government to invest in research that they are just as capable of performing themselves and that private investment could replace public investment without diminishing the public benefit. He’s wrong on both counts.
Private research is proprietary. Its fruits are the property of the organization that invests in it. Public research, in most cases—and certainly the ones that Lazonick describes—is published and shared widely. If, as Lazonick contends, private corporations know a particular line of inquiry is potentially valuable, why wouldn’t the keep it for themselves?
Lazonick implies that they are getting the government to do it for them and then squandering the money they save on stock buybacks. However, as I pointed out in a previous article, US businesses are currently investing in both capital goods and research and development at historically high levels, so that argument doesn’t hold water.
There is, in fact a much better explanation for the research lobbying that Lazonick highlights in his article, that of appropriability.
The Appropriability Principle
Firms are in business to make money and are generally willing to make investments that will increase their profits. However, not all investments are equal. Some, like the development of a new product, largely benefit one firm. Others, such as the discovery of DNA, the human genome project and clean energy, benefit society more broadly.
Economist’s call this the appropriability principle and it explains a lot about how long term investment works. Many of the corporations that Lazonick berates for advocating larger public research budgets, such as Microsoft, Intel and the pharmaceutical industry, have extensive research and development efforts of their own.
However, when it comes to basic research, government is often better suited to the task. As Ed Lazowska, who co-chaired President Bush’s Information Technology Advisory Committee, says “In it’s essence, innovation is combination. A private company is unlikely to come up with more than a few pieces of the puzzle. If the government doesn’t invest, there will be nothing for these companies to engineer into products.”
One might argue that that industries could establish consortia to undergo basic research and therefore spread benefits more broadly. Yet that type of collusion, even if legal, would be undesirable. We want knowledge to be spread widely so that it can benefit all of society, not just a handful of wealthy corporations.
Appropriability At Work
To understand how appropriability works, let’s use one of Lazonick’s own examples. He writes that “Intel executives have long lobbied the U.S. government to increase spending on nanotechnology research” and then points out that Intel’s share repurchases amount to four times the federal nanotechnology budget.
Fair enough, but he fails to note that according to Intel’s most recent 10-K filing, the company’s annual research budget of $11.5 billion is more than six times that of the National Nanotechnology Initiative (NNI) budget of $1.5 billion. So clearly Intel’s advocacy of broad based nanotechnology should not be considered a reticence to invest in the future.
Other examples are equally puzzling. He points out that “top executives of Microsoft, GE, and other companies have lobbied the U.S. government to triple its investment in alternative energy research and subsidies.” Yet he neglects to note that those companies are not in the energy exploration business and are not well placed to make investments in energy research.
He should also have mentioned that the unnamed “Microsoft executive” is, in fact, not an executive at all, but the company founder, Bill Gates. Gates, as most people are aware, has not had an active role at the company for over a decade, having left to devote the rest of his life, and most of his fortune, to good works at the Gates Foundation.
While Lazonick cites the examples above as corruption and “hypocrisy,” what we really see is appropriability at work—firms lobbying for broad based research that do not apply to their companies directly, but benefit society as a whole. Surely, they are not doing so out of pure altruism, but there is no evidence, at least in these examples, of cynical self-dealing either.
Hypocrisy Cuts Both Ways
In essence, to buy Lazonick’s argument, you would essentially have to advocate for corporate investments in all public goods—the roads they drive trucks on, the schools where their future employees are educated in, etc.—and that is patently ridiculous. There is a fundamental difference between public and private investment.
I’m not arguing that hypocrisy and rent seeking in corporate lobbying doesn’t exist and, in fact, Lazonick cites some other examples where it does seem to be taking place. However, his failure to distinguish between self dealing and legitimate advocacy is both instructive and disheartening.
The fact that he castigates firms that, by all appearances, seem to be responsible corporate citizens represents a hypocrisy all its own. Even worse, his misapprehension of the complementary roles of public and private research, not to mention his unfounded allegations, amounts to either sloppy negligence or troubling intellectual dishonesty.
Yet the point here is not merely to castigate Mr. Lazonick, there is much more at stake here than the diligence of an obscure academic. The idea that public investment should benefit private enterprise has been critical to America’s unique record of prosperity and innovation.
The Role And Value Of Public Investment
The fact that private firms benefit from public investment in research is not a bug, but a feature of its design. Vannevar Bush, who was the chief architect of today’s federal research programs wrote that “there must be a stream of new scientific knowledge to turn the wheels of private and public enterprise”
Moreover, he did not write these words offhand or as an aside, but in the founding document of our public research efforts, in which he argued strenuously that public support of basic research was essential to our national well being and prosperity. He did so not to augment corporate programs, but to undertake efforts that they cannot.
And Bush’s model clearly works. In fact, it is the envy of the world. It is not an accident that the iPhone was invented by a US company, virtually all of its basic technology has its roots in some federal program. Moreover, as Gary Pisano and Willy Shih point out in another HBR article, although data from the US funded Human Genome Project is available across the world, it is US companies that are reaping the benefits.
So, contrary to Lazonick’s central narrative, public and private research are not substitutes, but complementary and synergistic.
The Importance Of Returning Capital To Shareholders
There is a lot to find fault with in corporate America today. Lobbying and rent seeking, elaborate tax dodging on a massive scale, outright fraud and other crimes are very real. We should take them seriously. However, taking them seriously means uncovering true acts of malfeasance, not imagining them where they don’t exist.
Let’s return to the issue of buybacks. A recent Bain report shows that the world is currently awash in capital and many corporations have more than they can invest productively. What would Mr. Lazonick suggest that they do with it? They are already investing at near record rates.
When firms have excess capital the best thing they can do is return it to investors so that it can be deployed elsewhere and stock buybacks, unlike dividends, allow investors to defer taxes. One could argue that’s a flaw in our tax system, but clearly that’s not the fault of corporate executives. They are merely making prudent choices in light of available incentives.
And evidence suggests that the money returned to investors is being deployed to create new value. The venture capital market has reached levels not seen since the dot com era and has produced an unprecedented number of billion dollar startups. Some of these, such as Space X, Theranos and Cloudera, are helping to create entirely new industries.
By all means, we should endeavor to highlight corporate malfeasance wherever it exists. However, by making unfounded accusations, Lazonick does us all a disservice.