Creating value or extracting it An existential question.

CREATING VALUE OR EXTRACTING IT? AN EXISTENTIAL QUESTION.

A board and governance level issue that doesn’t get nearly enough attention is whether firms are being run as value creators or value extractors. As economist William Lazonick points out, absent real pushback, it is all too easy for management to simply extract value from companies – value that was built up patiently, sometimes over years, by innovators. This is very bad news for our society as we shall see.

FINANCIALIZATION AND VALUE EXTRACTION IN CAPITALIST ECONOMIES

The economist William Baumol attributed the spectacular growth of human flourishing in late-stage capitalism to what he calls the ‘free market innovation machine’ in which firms engage in an “arms race” to create the next innovation and stay ahead of others. This pushes everybody to do the very uncomfortable act of retiring the old and investing in the new.

THE THEORY OF THE GROWTH OF THE FIRM A WARNING

As she says, (From the Theory of the Growth of the Firm Penrose p. xii) “Profits were treated as a necessary condition of expansion – or growth – and growth, therefore, was a chief reason for the interest of managers in profits. Moreover, the more profits that could be retained in the firm the better, for retained earnings are a relatively cheap source of finance; management had no desire to pay out to shareholders more dividends than were necessary to keep the capital market happy.”

HOW MUCH VALUE EXTRACTION IS TOO MUCH

The numbers are pretty staggering. Citing Lazonick again, “The main instrument of predatory value extraction is the open-market repurchase of the corporation’s own outstanding shares aka stock buybacks the overwhelming purpose of which is to manipulate the corporation’s stock price. In 2012-2021, the 474 corporations included in the S&P 500 Index in January 2022 that were listed throughout the decade funneled $5.7 trillion into the stock market as buybacks, equal to 55% of their combined net income, and paid $4.2 trillion to shareholders as dividends, another 41% of net income.”

REIMAGINING BALANCED CAPITALISM THAT WORKS FOR THE MAJORITY OF PEOPLE ENDING THE ‘WEALTH PUMP’

Harvard’s Rebecca Henderson has argued that we desperately need to reimagine capitalism, and suggests that the statistics on really long run shareholder return show that there is a strong relationship between running a firm with a balanced focus on operations and innovation and eventual total shareholder returns. Her book

Reimagining Capitalism in a World on Fire is full of great suggestions. You can watch our Fireside conversation here, in which she pulls no punches. Capitalism is “committing slow suicide.”

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