Companies are spending more money buying back their own stock than they ever have. These stock buybacks have come under criticism as a bad investment – the argument being that companies sitting on record amounts of cash ought to invest in innovation, salaries, or at least dividends, rather than pumping up their own stock price through buybacks.
But before we vilify stock buybacks, let’s take a closer look at the charges against them.
Critics have pointed out that companies who spend money on stock buybacks a) are wasting money they could be plowing into R&D and innovation, and b) also hypocritically lobby for federal investment in research benefits them. Intel, for one, urged for greater public funding for nanotechnology research. Other top executives at the American Energy Innovation Council are pushing for more funding for alternative energy research. The list goes on. Shouldn’t these companies be using the money they’re spending on stock buybacks to fund that research themselves?
Not so fast. For one thing, it’s not clear that the stock buyback trend is actually limiting corporate innovation spending. US business already are spending heavily on research and development – data from the National Science Foundation (NSF) even shows an uptick in US business investment in R&D.
Not only has business investment in R&D been outpacing economic growth in recent years (2012 is the most recent year available), but it’s also outpacing longer term trends.
While R&D spending is an imperfect proxy for innovation investment, this data should give us pause when we hear claims that American innovation is in crisis because corporate investors are unwilling to invest in the future, or because activist investors demand short-term results.
The case of Apple is an instructive, if extreme, example. Last year, the company spent $56 billion on share repurchases. That exceeds its operating income of $52.5 billion by more than 7%. Surely, it seems that Apple is rewarding investors at the expense of its future.
But a closer look reveals that Apple has also been expanding investment on R&D at a compound rate of 28%, while simultaneously increasing its ratio of
to sales. What’s more, the company still holds more than $170 billion in cash that it has very little idea what to do with.
We should also question the assumption that investor preference for quick returns limits managers’ ability to invest in the future. In fact, private capital investment, an even larger ticket item than R&D, has also been increasing and is at historically high levels of GDP.
And it’s not just short-term investors that like buybacks and dividends. Mark Mulholland, whose Matthew 25 Fund holds investments for an average of five years, argues that returning excess capital to investors is healthy, not just for share prices, but for the economy. He says, “a company shouldn’t sit on cash, they should put money to work. If not in their own business then back to their investors so that it can be deployed elsewhere.”
So it appears that the current surge in share buybacks may be a reasonable course of action: faced with a superabundance of capital, firms are both increasing investments and returning the excess to shareholders so that it can be invested elsewhere.
Moreover, we can’t assume that these firms are lobbying for the federal government to invest in research that they could just as easily perform themselves. Firms are in business to make money and should therefore willing to make investments to make more of it. However, not all investments are equal. Some, like the development of specific technology for 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. The former tends to be conducted by corporations to develop products they expect will be profitable, and the latter tends to be more exploratory.
Even if corporations were willing to take on exploratory research, it’s not clear the public should want them to. Because private research is proprietary, its fruits become the property of the organization. Public research, on the other hand, is published and shared widely. If we replace public sources of funding with private ones, we run two risks: first, that exploratory research would be effectively defunded, and second, that any important discoveries made will not become public property, but will remain in private, corporate hands.
The two different types of research are complementary. 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.”
Let’s return to the example of Intel, one of the companies that’s used its cash to buy back it’s own stock, even as it’s lobbied for more federal funding for research that would benefit them. In a recent HBR article by William Lazonick, 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 are four times the federal nanotechnology budget.
Fair enough, but Lazonick fails to mention 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.
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.
My point is that there is a fundamental difference between public and private investment. We don’t advocate for corporate investments in all the public goods corporations rely on—the roads their trucks drive, the schools that educate their future employees, and so on. (Although we do expect corporations to pay their taxes, which of course help to fund those things.)
The fact that private firms benefit from public investment in research is not a bug, but a feature. 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.”
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.
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. However, insisting on private accountability is no excuse for shirking public duty.
The real problem isn’t that corporations are unwilling to think long term, but the rest of us. It’s easy to point our fingers at highly paid executives and greedy investors for short-term thinking, but when it comes to our collective future, we are failing to live up to our basic responsibilities.
The American Society of Civil Engineers gives US infrastructure a grade of D+ and we hardly take notice. A bill for an infrastructure bank, written in 2007, languishes in Congress due to lack of political support. Senators gain cheap political points by attacking scientific research and we cheer them on. We make drastic cuts to funding for an Ebola vaccine and then panic when there’s an outbreak.That’s the real capitalist’s dilemma.
It’s much easier to demand lower taxes than to fix our crumbling roads, bridges and airports. It feels good to laugh at egghead scientists and their goofy research, but much harder to understand the significance of their work. I shudder to think of what political hay today’s leaders would make of Einstein’s notion of the relativity of time and space.
The truth is that you can only win the future if you invest in it. It is, in fact, America’s postwar commitment to infrastructure and science that we have to thank for our current prosperity. So if we really care about innovation, we not only need to be forward looking in our private decisions, but our public ones as well.