February 18, 2011    Volume 18, No. 3

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Companies Sink Billions More Into Stock Buybacks Than Into R&D Or Jobs

By Ken Jacobson
ken @manufacturingnews.com

President Obama on February 7 told the U.S. Chamber of Commerce that its members should "get off the sidelines" and invest the "nearly $2 trillion" in cash he described as currently "sitting on their balance sheets." But if large U.S. firms' actions in recent decades are any indication, their executives are far more likely to use that cash to buy back their companies' own stock than they are to spend it on new hires, plant and equipment or R&D.

Cisco Systems is a typical example. Between 2000 and 2009, the company repurchased $57.2 billion of its own stock, which easily exceeded its total profits, coming in at 129 percent of net income, according to research conducted by William Lazonick, an economist at UMass Lowell. And Cisco was far from exceptional among the giants in its sector, a number of which posted comparable figures for the decade: Hewlett-Packard, 118 percent; Texas Instruments, 106 percent; Microsoft, 91 percent; and IBM, 90 percent.

Nor did high-tech firms have a monopoly on this behavior. In his January 2011 paper "Reforming the Financialized Business Corporation," Lazonick found that share-buyback levels in the wake of the 2008 Wall Street meltdown declined nowhere near as drastically as net incomes for 437 U.S. companies that were traded on the S&P Index from 1997 through 2008.

While these firms' total profits plummeted from $584 billion in 2007 to $116 billion in 2008, they applied just a light pruning to their stock buybacks, cutting them from $549 billion in 2007 to $322 billion in 2008, which is reflected in the skyrocketing of their overall repurchase payout ratio from 0.94:1 to 2.78:1. They also increased dividends in 2008, so that their dividend payout ratio showed a parallel rise, from 0.41.1 in 2007 to 2.21.2 in 2008, according to Lazonick's calculations.

"Allocated differently, the billions spent on buybacks could have helped stabilize the economy," Lazonick argues. "Instead, collectively, these companies not only spent all their profits on repurchases but also ate into their capital."

Buybacks continued to decline in the course of 2009, but they bounced back in 2010. According to Standard & Poor's, share repurchases totaled $212.5 billion over the first three quarters of 2010, rising by 80 percent, 221 percent, and 128 percent, respectively, above figures for the corresponding quarters of 2009.

With the pace of buybacks recovering, the New York Times commented on their cost to the U.S. economy. "Rising corporate profits should spur hiring, but recent history is not encouraging," it editorialized on New Year's Day. "Part of the problem is that companies are more apt to spend their cash on stock buybacks and acquisitions that increase share prices but not hiring."

Failing to hire can have consequences both macro and micro. "As you hire," Obama told the U.S. Chamber, "you know that more Americans working will mean more sales for your companies. It will mean more demand for your products and services. It will mean higher profits for your companies. We can create a virtuous circle."

This vision recalls the boom years following WWII, when U.S. consumption was supported by wages. Rejecting it may imply acceptance of today's debt-fueled economy, and this complacency can lead to permanent decline. "When firms lay off experienced people at the same time that they're doing buybacks," Lazonick tells Manufacturing & Technology News, "they're saying, 'We don't have to use these people to look for the next opportunity. We can make plenty of money with what we already have.' " The nation loses resource as the unemployed "end up working at Home Depot and have their human capital degrade."

Another conspicuous casualty of stock buyback programs has been research and development. Hewlett-Packard cut its R&D spending by 20 percent, to $2.8 billion in its fiscal year 2009 from $3.5 billion in its previous fiscal year. At the same time, it was using $5.1 billion -- a sum equal to 65 percent of its $7.7 billion in fiscal year 2009 profits -- to repurchase its own shares.

Pfizer disclosed earlier this month that it had raised its authorization to buy back stock from $4 billion to $9 billion, an amount almost equal to its 2010 research budget of $9.4 billion. At the same time, it announced cuts in that research budget, which is on a downward slope, to between $8 billion and $8.5 billion in the current year and between $6.5 billion and $7 billion in 2012.

Among companies known for research, Lazonick's work demonstrates, this implied tradeoff between stock repurchases and research is far from a recent or transient phenomenon: It has been a fact of life for years. From 2000-2009, Microsoft spent $62 billion, or 15.5 percent of sales, on R&D -- a tidy sum, but still well below the $114 billion it spent buying back its shares.

Over the same period, GE spent $52 billion repurchasing its own stock -- twice the amount that, at the rate of 1.7 percent of sales, it spent on R&D, and topped that off with another $89 billion paid to shareholders in dividends.

Intel's figures were more balanced: Its repurchases in the period were, at 15 percent of total sales, more or less equal to its R&D expenditures, which ran at 14.7 percent. Still, Lazonick sees an irony in the fact that "while it and other companies were lobbying the government to put more money into the National Nanotechnology Initiative" (NNI) over the past decade, Intel was repurchasing $50.5 billion in stock -- "multiples of the $10-plus billion" in federal support that NNI received.

What explains this behavior among corporations on which many Americans, from the President on down, are depending for the technological innovation widely seen as indispensable to the future welfare, perhaps the very sustainability, of the nation's economy?

"People outside the financial sector have trouble understanding it," chuckles one Washington, D.C.-area bank official. "But if I make an investment in R&D, I have no idea what my return is going to be: It may pay off handsomely, but often I end up with little for my money, or with no return at all. In contrast, if I buy back my own shares, I know precisely what my return is going to be. I know in advance that it's acceptable, and I've locked it in."

Several questions arise: When did firms in America's high-tech sectors begin acting as if they are in finance? What is behind the avoidance of uncertainty that can lead them to prefer the safety of financial manipulation to the risk inherent in research? And what is their overriding mission: Is it still to make products, or has it become simply to make money?

These questions will be examined in the next issue of Manufacturing & Technology News.

William Lazonick's "Reforming the Financialized Business Corporation" can be seen at http://employmentpolicy.org/sites/eprn.cloud.ojctech.com/files/Lazonick%20Reforming%20the%20Financialized%20Corporation%2020110130%20%282%29.pdf.

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