Abstract
It would be difficult to overstate the immediate relevance of Predatory Value Extraction. Ample scholarship exists concerning the pitfalls of the financialization of the American corporation, particularly as it pertains to the slowdown of productivity and the ascent of income and wealth concentration, as well as employment insecurity. Yet William Lazonick and Jang-Sup Shin present a remarkably unique insight that incorporates decades of economic research combined with impressive historical knowledge of corporate business evolution, replete with extensive case studies and empirical evidence. This book is an attempt to identify, explain, and rectify a long-run trend that shifted the primary activity of corporate managers and owners from value creation to what the authors call “predatory value extraction” of the American economy.
A central theme to the book is the transformation of corporate governance from a “retain and reinvest” resource allocation regime to “downsize and distribute.” This shorthand (which the authors refer to as “old economy” versus “new economy”) summarizes the American economic trajectory in two periods. The postwar period was characterized by value creation in which companies retained employees and profits, and internally reinvested them in productive capabilities that could create higher quality, lower cost products. After the 1970s, corporate resource allocation shifted to prioritizing cash distribution to shareholders and downsizing, facilitated by the prominence of maximizing shareholder value (MSV) theory, a product of elite business universities in the 1980s.
Throughout the text, the authors are methodical in dissecting and countering the arguments that have been used as an ideological justification for the facilitation of value extraction, while also building their own case for a solution. For example, they pick apart the underlying logic of MSV ideology, which holds that the retain-and-reinvest model inefficiently hoards cash flow and labor away from their most efficient uses (specifically, to shareholders instead of empire-building managers). According to MSV ideology, shareholders are the only economic actors within a corporation that bear risk in their contribution, and thus are the only actors that have a legitimate claim on corporate profits. The authors show that shareholders are not the only risk bearers in a corporation (workers and taxpayers bear risk of uncertain returns as well), and they use decades of corporate records to show that when shareholders actually contribute value rather than extract it from a company, it is the exception rather than the rule.
Keeping with the theme of value extraction versus creation, the authors show how the evolution of legal bodies such as the US Securities and Exchange Commission (SEC) set the stage for a triad of value-extracting insiders (executives), outsiders (corporate raiders turned hedge fund activists), and enablers (institutional investors) to loot the business corporation. Lazonick and Shin note the specific turning point of the SEC’s adoption of Rule 10b-18 in 1982, which effectively legalized stock buybacks for stock price manipulation. This ruling, plus the insider knowledge of how to profit from legally undisclosed open market repurchases, boosted the extractive use of resources by managers, carefully detailed by the authors, enriching the abovementioned triad. With data to back up their argument, the authors maintain that buybacks took on a primary position in the capital allocation plans of many formerly innovative companies to the detriment of low cost, high quality product creation.
A key insight of the book is confronting the illusion that stock market performance always represents value creation. The authors claim three reasons for stock market increases: innovation, speculation, and manipulation. They show how the dot-com bubble pushed the major internet company stocks (Cisco, Microsoft, Intel) into record territory with speculation as the main driver; that is, a market capitalization increase before any innovative products are actually developed. Then after the bubble burst in 2000, companies began a rapid program of stock buybacks to manipulate stock prices.
The overarching narrative of Predatory Value Extraction is a detailed account of a gradual transformation of legal, institutional, and ideological frameworks that dovetail to erode the foundations of sustainable prosperity in the United States. Each component of this complex history is given thorough attention independently as well as in its interaction with the other components. Particular attention is paid to the evolution of institutional investor activism following watershed rulings by the SEC, ostensibly in the name of balancing out the power between shareholders and managers. The authors demonstrate how mandatory proxy voting, for example, combined with institutional investor expansion in shareholding harmed value creation in corporate enterprise when these proxy advisors are arguably the least capable of making Yes/No decisions on corporate governance questions that require industry-specific knowledge and expertise accumulated only through years of experience.
Ultimately, this book’s purpose is clear from the beginning and maintains a consistent narrative. It depicts how the conflation of value creation and extraction powered by MSV ideology and decades of accumulated regulatory changes set the stage for concentrated wealth at the top of the income distribution, and uncertain employment for those near the bottom. Lazonick and Shin have offered an important contribution to the emerging literature on industrial organization and its relationship with problems of inequality and stagnation in the United States. Their contribution, however, remains just a part of the overall puzzle of the changing uses of corporate capital resources. Most striking, the direction of causality between increased financial payouts and reduced innovative investment is not immediately clear. An existing literature points to the growth of monopoly power in markets that has actually diminished potential opportunities for profitable investment in physical capital and human resources. From this perspective, stock buybacks result from, rather than cause, a diminution of real capital investment in specific market characteristics that have changed considerably since the postwar period. The exclusion of this line of thinking is perhaps the biggest missed opportunity of the book. A more robust analysis of the pay-productivity divergence in the United States would need to grapple with the causes of the postwar years of accumulation outside the purview of this text, to see a fuller picture of the stagnant economy the authors aim to explain today. This explanation is important because if the modern market structure is fundamentally different from that which the authors called the old economy, in which trends of industrial concentration had not yet removed opportunities for profitable investment, then just rectifying the problematic features of financialization would be insufficient to reverse the sorts of macro-pathologies the authors seek to reverse. Yet it should be kept in mind that this book’s purpose is merely to emphasize a particular part of a bigger conflux of forces that have led to the above stated pathologies in the American corporation. The legal, academic, and institutional changes to industrial organization resulting in hyper-financialized US corporations powered by MSV ideology have significant explanatory power when it comes to the historic and modern economic troubles of our times, and it can be plausibly argued that regarding such a topic, there is no greater authority than these scholars.