When did American-style capitalism go off the rails? You might argue the moment came when some evil genius invented the collateralized debt obligations that would play a starring role in the 2008 financial collapse. Or perhaps it came when the Glass-Steagall Act, the eminently sensible Depression-era hangover that separated commercial banking and investment banking, was killed off in the 1990s.
I would argue the pivotal moment came in November, 1982, when the U.S. Securities and Exchange Commission (SEC) unveiled a rule that opened the floodgates to share buybacks. Since then, American (and Canadian and British) corporations have collectively spent trillions buying back their own shares, a colossal exercise in legal stock manipulation that has enriched executives beyond belief and pleased short-term investors, but deprived companies of fortunes they could have used to make themselves more competitive.
The buybacks appear to have done more harm than good to several tech biggies in particular. What, in the name of the mobile gods, was BlackBerry thinking when it devoted $3 billion (all currency in U.S. dollars) to buying its own shares in 2009 and 2010, while its phones were getting clobbered by Apple’s iPhone? Clearly, the company was thinking about refloating its sinking share price, not launching the best products to ensure its survival.
The SEC’s welcome mat to buybacks was known as Rule 10b-18, which came into force shortly after the agency was infiltrated by Ronald Reagan’s deregulation-mad cronies. The rule received scant media attention. In essence, the SEC legalized large-scale buybacks. Open-market share purchases would be allowed if the total on any given day did not exceed 25% of the company’s average daily trading volume over the previous four weeks. Before then, the de facto limit was 15%.
The rule change triggered a quiet revolution. The biggest companies, like ExxonMobil and IBM, could repurchase hundreds of millions of dollars of shares on any given day.
Buybacks were enormously popular with shareholders, too, and fed nicely into the new cult of shareholder value. Data compiled by William Lazonick, a Canadian-born economist at the University of Massachusetts Lowell, reveal that Standard & Poors 500 companies spent an astounding $3.5 trillion on buybacks from 2001 through 2012--—an average of $600 million per company per year. Perversely, the buybacks peaked in 2007, the pre-crash bubble year, destroying the notion that executives believed their own companies’ shares were a good buy because they were fundamentally undervalued.
Some of the biggest winners were executives who had loaded up with stock-option plans. The typical sequence: buyback announced, shares rise, executive stock options exercised and shares sold. Lazonick calculated that executive pay, primarily driven by exercising stock options, was three times higher in real terms between 2004 and 2007 than it was between 1992 and 1995, when the buyback pace was much slower. What the executives gained, their companies lost as innovation gave way to stock manipulation.
Three tech heavyweights—Intel, Microsoft and Cisco—used buybacks with abandon. From 2003 to 2012, according to SEC filings, Intel’s repurchase tab came to $59.7 billion, almost matching the $62.4 billion it spent on R&D. Microsoft spent $114.4 billion, equivalent to 148% of its R&D budget. Cisco’s total was $74.8 billion, about 165% of R&D. We’ll never know what those three companies would have accomplished if they had devoted that loot to R&D, employee training or acquisitions designed to strengthen their core operations or take them into new growth markets.
What we do know is that the three have been laggards. Microsoft, creator of a notable string of tech duds, among them the Zune music player and the Kin handset, has been a chronic underperformer. Intel has underperformed its peer group since 2005. Cisco, which was the world’s fastest-growing tech company in the 1990s, has gone nowhere over the past five years.
Then there’s BlackBerry. Its market capitalization was $80 billion (Canadian) at its peak in 2008, just before the company rolled out buybacks that matched its R&D budget. At the end of this past September, Canada’s former tech champion was worth a mere $4.3 billion (Canadian). Finland’s Nokia, another share buyback enthusiast, has also suffered a BlackBerry-style collapse and handed its mobile phone division, once the world’s largest, to Microsoft in September.
What about today’s tech stars--—Google, Samsung, China’s Huawei and Apple? The first two eschew buybacks, and Huawei is private. Apple has used them sparingly, and they were almost never used during the soaring Steve Jobs years. The lesson is clear. Used lavishly, buybacks are the disease that destroys innovation and industrial leadership.