In her recent book Makers and Takers, Time’s assistant managing editor and economics columnist Rana Foroohar powerfully explains and criticizes the pervasive nature of financialization in our society. She comes up with a set of broad prescriptions to deal with it in order to “save capitalism.” While the book is very well researched and written, I disagree with many of Ms. Foroohar’s key conclusions.
For starters, I think that she misdiagnoses the problem, considering it to be financialization itself. I believe pervasive short-termism is really the root cause, and financialization merely a large symptom of it. As I have extensively written in the past, I think that a balanced approach towards research and development (R&D), capital expenditures, dividends and stock buybacks is the ideal.
Corporate boards and managements should never yield to short-term pressures (from Wall Street or anybody else). Their focus and their obligation are towards the long-term success of their corporations. This entails balancing the needs and demands of all stakeholders, but again, with a focus always on the long run, where (as I will explain in my own upcoming book), the interests of all stakeholders tend to converge.
Ms. Foroohar takes on Apple Inc. (NASDAQ:AAPL) as a key example of financialization and financial engineering at work. She criticizes this great company for no longer investing sufficiently in innovation. I believe nothing could be further from the truth. While Apple’s R&D as a percent of revenues have indeed declined, the absolute dollars invested in research and development at AAPL have continued to increase quite sharply.
Much having to do with ‘the law of large numbers’ applies to Apple, and this is also the case when it comes to R&D. Continuing to increase R&D (or even keeping it flat) as a percent of significantly increasing sales over the long run would probably be irresponsible. Trees cannot grow to the sky.
The same goes for AAPL’s capital expenditures. There should be some efficiencies from ever-growing scale. Therefore, it is absolutely warranted for Apple to return some of its excess cash to shareholders, as it is currently doing.
IBM has been widely criticized (more deservedly, in my view) for financial engineering. One of the poster children for share repurchases, IBM has more of a long-running practice of shrinking its outstanding share base through aggressive stock buybacks funded by increasing net debt. Critics, including Ms. Foroohar, take the criticism too far and condemn the practice of share repurchases too broadly.
There is nothing wrong with stock buybacks as a consistent way to distributepart of the total remuneration to shareholders. It is very important that the actual number of shares outstanding does consistently drop when a company has a practice of meaningful stock buybacks.
Many companies use stock as an important component of their executive compensation. There is also nothing wrong with this practice in and of itself. Aligning the interests of management with that of shareholders is actually a positive, provided that the programs focus on long-term performance.
It is very important that a company uses only excess cash generation to repurchase stock in the long haul. Increasingly, as Ms. Foroohar notes, corporations are issuing debt to finance large share buybacks. To the extent there is a significant increase in net debt as a result of stock repurchases, it is definitely a red flag for financial engineering.
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