Wal-Mart, Profits Shrinking, Bets Big on Buybacks Rather Than Growth

Wal-Mart’s 2016 net income was $14.7 billion, over a billion dollars less than the prior two years which was a billion less than the year before, 2013.

Full disclosure: I don’t like Wal-Mart. Their relentless push to commoditize destroyed countless local stores and small brands that sold through those channels. Their employee compensation stinks except at the C-Suite. Their stores are depressing to visit. I don’t currently live in the US but, back when I did, would go there with visitors from foreign countries who wanted to see what it looked like, an anthropologic exercise.

Founder Sam Walton’s billionaire heirs donated essentially nothing to their own Walton Family Foundation which has about $2 billion in assets thanks to tax shenanigans. Family values. They did support Hillary over His Orange Highness, despite that they normally support Republicans, but that just shows they’re not psychotic. Besides, Hillary used to act like she is from Arkansas and even had the accent. Alas, I digress.

Besides Wal-Mart’s $14.7 billion profit they have $6.9 billion in cash. There is $198.3 billion in assets and $118.3 billion in liabilities so, unfortunately, they’re not going bankrupt anytime soon. They also collected $485.9 billion in gross revenue, an enormous amount of cash. Financials show a five-year R&D investment of zero.

Wal-Mart announced a $20 billion stock buyback and the market went bananas, bidding their stock up about 4.5 percent. Investors must assume that buybacks are going to get customers flying through the front doors somehow.

OK, I’m honesty not sure investors why are so enthused. Wal-Mart has bought back $95.7 billion (inflation adjusted) of their own stock, $19.3 billion of that in the last five years alone. The company is not new to stock buybacks.

But are buybacks for Wal-Mart a good idea? They claim to be making leaps in eCommerce but those claims feel hollow. Everybody knows the top three eCommerce companies are, in order, Amazon, Amazon, and Amazon. Now that Amazon is buying physical stores they can ring up more of the relatively low-margin grocery business that makes up a lot of Wal-Mart revenue. While Wal-Mart is buoyed by their 4.5 percent bump it’s more than offset by a 6 percent drop in June after Amazon announced their Whole Foods acquisition. Amazon is so far ahead in eCommerce that Costco’s stock went down when they announced a new eCommerce initiative: investors don’t like even the thought of competing with Amazon.

Rather than trying to compete with Amazon or buying back their own stock — on track to become the next Sears — why doesn’t Wal-Mart try something different?

It’s a radical idea but how about, as a start, making the stores a pleasant places to visit and work. Invest in infrastructure and employees instead of stock buybacks. Do something different in eCommerce rather than sell the same range of cheap stuff. There is still eCommerce innovation: Alibaba’s AliExpress is, if nothing else, different.

Wal-Mart’s revenue is still much higher than Amazon’s; they sell a massive amount of merchandise. But buying that stuff in a Wal-Mart store remains a serious pain point. To shop at Wal-Mart, the way most people do, first, drive to a store. Park. Deal with the “greeter” — a security guard — and the grunge. Walk around to search for whatever it is you’re looking for under harsh lights. Their employees look oppressed with the creepy dated blue vests. Wait in line to checkout. Bag your stuff. Carry it back to the car then from the car to your house. The experience has the personalization, comfort, and warmth of a DMV, a machine that craps you out with a little more stuff and a little less money than when you walked in.

Buybacks are theoretically for companies that have nothing better to do with their money. Apple, with their $260 billion stash, is an example. But even Apple could, and probably should, buy a European carmaker, avoiding the repatriation problem while fulfilling their strategic desire to create an iCar (and still have a bundle leftover).

Unless the corporate treasury is literally overflowing, Apple-style, managers who say they have nothing better to do with the corporate treasury than buyback their own stock are either incompetent — unable to create new businesses — or dishonest. In either case good corporate governance demands that Board’s have a responsibility to find better managers.

It is unfathomable to believe that Wal-Mart, with declining profits and increasing competition, has nothing better to do than spend an entire year’s worth of profits plus their entire cash reserves buying their own stock. Before their buyback bump Wal-Mart was trading at $79. Five years ago Wal-Mart was trading at $75.81. It’s also impossible to believe that management thought the stock is currently discounted. If anything their relatively flat share-price has escaped the retail armageddon but won’t forever: it’s overvalued, even before the buyback announcement.

The only believable narrative is that Wal-Mart executives do not know what to do about Amazon so they’re buying time and bumping their own bonuses with a pathetic buyback. OK, there is a certain poetic justice in watching Wal-Mart writhe in the same cauldron of disruption they dished out to local stores way back when but that doesn’t mean they shouldn’t at least try to genuinely grow their business rather than play games to jack up EPS.

Prof. Robert Ayres and I proved that the higher a ratio of inflation-adjusted buybacks to market cap results in lower long-term growth. Before this latest announcement, Wal-Mart purchased $95.7 billion. When we ran our study, Wal-Mart had a market cap of $227.7 billion, a 42% ratio of buybacks to market capitalization. Not bad, especially for a retailer; they’re one step above lackluster McDonald’s. But as their market cap declines along with that of other retailers, and their buyback program increases, they can easily slip into the danger zone, a high growth to market cap ratio that signals slower growth.

It’s unclear whether Wal-Mart’s Board asked CEO Doug McMillon if there really weren’t any growth opportunities for the company before agreeing to the buybacks. Whether Wal-Mart might create better long-term value for customers, employees, and shareholders by  investing the $20 billion in something more interesting than buybacks? I’m virtually certain this conversation never took place, which is almost as depressing as shopping at Wal-Mart.

Sneaky Trump Tax Subsidizes Coal & Nuclear Power Plant Owners

Robert Ayres & Michael Olenick

The libertarian bible is Ayn Rand’s Atlas Shrugged. There are two groups of villains in Rand’s dystopia, looters and moochers. Heroes are producers, who create products and services.

I’ll reserve judgment on my own feelings on the book other than to say it’s a perennial  favorite for conservatives. The Library of Congress ranks it as the most influential American book ever written.

Rand’s looters are government officials who rig markets to favor various constituent groups, chief among them existing industries faced with disruptive technology. For example, one of her heroes builds a new type of steel and sells it to the heroine, who runs a railroad. Existing steel companies successfully pressure the government to nationalize the processes and patents “for the common good.”

Rick Perry is Trump’s appointee to the Department of Energy, an agency Perry once vowed to eliminate. Given the excitement in Trump-land many have forgotten about Perry. Sure, Perry is a bona fide idiot but in an administration where somebody called “The Mooch,” discussed, on-the-record, being “cock-blocked” by Trump’s now former Chief of Staff, Perry begins to look almost normal.

But make no mistake, Perry is the typical parasite we’ve come to expect from Trump.

Perry has started a pre-ordained process to subsidize coal and nuclear plant operators, taxing people through artificially high electricity rates to subsidize costly coal and nuclear plants.

What’s the problem with coal and nuclear plants, besides that they’re expensive? Coal pollutes. Badly. Nuclear, when it works well, leaves radioactive waste behind that has a half-life of 24,000 years. When it does not work well, like it didn’t at Three Mile Island, Chernobyl, and Fukushima, it tends to create ecological disasters.

Besides that the two sources of power have serious environmental problems they’re more expensive than alternative energy sources that do not. The US Energy Information Administration released a report on the various costs of energy, here. Spoiler alert: nuclear power costs a fortune to generate. Coal comes next. Then solar. Then wind. Then natural gas. Hydroelectric is marked “N/A” in 2015 but, in 2013, it was cheaper than coal.

The price of wind declined 25% from 2013 to 2016 and the price of solar declined 67%. Assuming those price declines continue — and with the newfound Chinese enthusiasm for renewables that seems a given — it won’t be long before renewables cost less than any fossil fuel.

For Perry, the former Governor of Texas — who works for a guy that promised to Make Coal Great Again — this is a meltdown (I couldn’t resist).

Perry’s still-in-existence Department of Energy has asked the Federal Energy Regulatory Commission (FERC) to begin the rule-making process to subsidize both the cost and profits of coal and nuclear plants.

Perry’s puppet-master’s constituents, with their aging nuclear and coal plants, argue that renewable energy from wind and solar is variable so that backup generators are sometimes needed for days with calm winds or cloudy skies.

For now, let’s ignore the rapid pace of battery progress (which I’ll get to later) and take this assumption as true. There is an easy solution: turn on the inexpensive natural gas plants to make up the difference. In fact, right now, that is exactly how things work: energy companies constantly sell backup energy capacity to one another.

But, under Perry’s scheme, companies would be required to purchase a certain amount of this backup energy from fuel plants that store 90-days or more of fuel on-site. Why 90-days? Because it’s completely impractical to store 90-days of natural gas on-site but easy enough to store that much coal and nuclear fuel.

This is an old-school Rand-style looter giveaway from a bunch of self-described “conservatives” trying to rescue a dinosaur industry that’s choking the world.

Just to clarify: Republicans, through Rick Perry, are working to increase electric bills to subsidize and protect coal and nuclear plant owners. Trump and Perry specifically require people to pay not only for plants but guaranteed profits to the owners of filthy old generation technology. Knock knock to objectvists Rand Paul and Paul Ryan, you’ll both be introducing veto-proof legislation to block this, right?

Now let’s return to the subject of standby electrical power generation. Of course it is needed and natural gas works just fine. End of argument. But even natural gas won’t be needed indefinitely.

There is plenty of capacity that either exists or is in the works and renewables are rapidly dropping in price and being installed. Germany, on average, produces 35% of overall electricity from renewables. But much of the remaining 65% is for factories so on weekends, where fewer factories operate, the percentage is even higher. On Sunday, April 30, 2017, Germany produced 85% of electricity used from renewables.

Longer-term, the solution might come from cars. The price of electric cars is dropping quickly. Electric cars are simpler than internal combustion engines and experts agree will last far longer. More to the point, they already have enormous batteries. So cars can be charged from solar, during daylight hours, then used to power houses during evening hours, then be recharged, from wind power, during sleeping hours. Plus, the economies of scale will make batteries, for battery farms and in-home storage, both cheaper and more efficient over time.

There are other systems to store renewable power and one or more will eventually be perfected.

So the US already has plenty of back-up generation from low-cost natural gas and new technologies are likely to add more as they evolve. Perry’s alleged problem isn’t even real and his solution, subsidizing coal and nuclear plants, is a form of pure theft, a transfer from the most deserving, clean renewable and safe plants, to the least deserving, filthy and dangerous one’s.

Trump and his cronies cabinet are on-track to go down in history as the worst in US history, both individually and as a group. Thanks to Congressional dysfunction much of what they’ve done is by decree and can be expeditiously undone once sanity is returned to the White House. Until then be prepared for higher electric bills to pad the pockets of people who built filthy coal plants decades ago.

This isn’t to say the original engineers were bad — they used the technology they had — but it’s been disrupted and that’s how disruptive innovation works. Low-cost alternative technology that is not ideal is invented. It matures and eventually replaces the existing tech. This is almost always a good thing.

Channeling Gandhi, first they ignored the new tech. They they laughed. Now they’ve enlisted Rick Perry. But the fight is hopeless; it is only a question of when renewables will dominate, not if.

By the way, for anybody interested here is how Rick Perry signs his name to official correspondence.

rp

 

Robert Ayres is a Professor Emeritus at INSEAD.

GM Creates the Perfect Blue Ocean Commuter Car

The top speed between home and work is 90 kph. My daughter I are rarely able to go that fast. Sometimes we’ll stop on the way home, trying to fit our SUV — big enough for the guests we frequently have — into small parking spaces. Recharging every night or two is no problem. Plus my employer has vehicle plug-in spots so I could recharge at work.

Our newest friends just came to Europe from the US. They’re looking for cars but don’t want to spend too much. Their needs are similar to ours.

Fuel prices here are about double what they cost in the US. That SUV that we like, and that we do frequently fill with people and things (though not always), seems to have a hole in the gas tank. Plus there are the fuel strikes.

In the Baojun E100 GM has created the perfect car. For some reason they’re only selling them in China and, even then, only selling 200 of them. Maybe it’s a loss leader though they can jack up the price and I’m sure they’d sell countless of them in Europe. Even Americans with short commutes might buy them.

This car is a no-brainer. Limiting distribution to one country is … well, GM.

The Daily Mail reports the Baojun is supposed to “take on” Tesla’s Model 3.

When I’m not pontificating about buybacks and economics I’m studying innovation and growth; that’s my day job. More to the point the growth I study is at the INSEAD Blue Ocean Strategy Institute where I am an Institute Executive Fellow, a senior research fellow.

The Baojun is not going to “take on” the Tesla Model 3, or the Chevy Bolt. It could compete with a SMART Car but that’s iffy since entry-level SMART cars, powered by internal combustion engines, start at $12,000, over twice the price. Electric SMART cars, that have about the same range and a similar feature set, start at $23,800.

The Baojun does not compete with Tesla, or the Bolt, or the SMART Car: it’s in a category by itself. It renders the rest of them irrelevant.

This is an example of growth, of substantive innovation. Looking at the Baojun it’s unclear how GM produces it at a low enough price to sell for $5,000 but — unless they’re taking a massive loss on every car — they’ve made some change to enable this.

It’s not features: the Baojun is tiny but big enough for two people, a computer and school bag, and a couple bags of groceries.

There is a full-blown GPS system plus it works with Apple CarPlay and Android Auto. The GPS “screen” is your phone. This makes sense: there’s no need for an expensive separate GPS screen.

It’s top speed, ten kph above the fastest speed limit for our daily commute, is just fine. It’s range is more than enough. I’m not sure about safety but nothing moves fast enough during our morning and afternoon commute to do much damage anyway.

The only problem with the Baojun is that it’s impossible to buy one.

Silicon Valley Rejects Shareholder Value Theory: Disrupting the IPO

I’ve written about problems with Shareholder Value Theory (SVT). The constant need to pump an ever-appreciating stock price to anonymous shareholders, the vast majority who contributed nothing to a company, rewards short-term thinking. Buybacks and other financial tricks tower over innovation and growth initiatives.

It looks like Silicon Valley has tired of the nonsense.

Here is an article about a new public company, Social Capital Hedosophia Holdings Corp. (SCH): Fixing the ‘Brain Damage’ Caused by the I.P.O. Process. Their prospectus is here: Social Capital Hedosophia Prospectus.

Missed the IPO? Don’t worry; you were supposed to. Trading on the NYSE the company’s ticker is IPOA.U. Trading opened on September 14 at $10.31; a week later they’re at $10.63. The company has a $600 million pile of cash but no products or services; they exist to buy tech companies.

SCH is a combination of two firms, the well-known Social Capital and stealthy Hedosophia.

Social Capital is founded and managed by Venture Capitalist Chamath Palihapitiya. Their portfolio includes Slack, Forge, Box, Brilliant, and a sizable group of unusually high-quality companies. Palihapitiya sounds like somebody you’d want to stranded on an island with: he’s be interesting company and probably figure a way off. He tends to make a lot of money for himself and the people he works with.

Less is known about co-founder Hedosophia, a venture firm founded in 2012, that filings state has over $1 billion in holdings. The firm’s webpage is retro 1990’s, appearing on the second page of a Google search for the company name and referencing a street address which, on Google Maps, is a nondescript building with no signage. Hedosophia’s founder is 34 year-old Ian Osborne, of Osborne & Associates and Connaught. These firms have apparently acted as financial advisers “for eight of the fifteen most valuable private companies in the technology sector.” It’s unclear why the secrecy is necessary; it gives off a Le Carré vibe.

SCH is a Special Purpose Acquisition Company, or SPAC. The last and only time I came across a SPAC it was used to take the law firm of David J. Stern public. Stern is the crooked foreclosure lawyer who fabricated paperwork to expedite foreclosures, earning himself two yachts, a mansion and, eventually, permanent disbarment. That SPAC initially traded under the ticker CACA (there are some things you can’t make up) then changed to DJSP, David J. Stern Enterprises. DJSP worked out great for the shorts at least: Stern’s firm quickly went bankrupt. Though, I digress…

The purpose of SCH is to to enable flexibility in the cumbersome IPO process. On one hand, it’s impossible to feel bad for 30-something tech executives flying private jets and repeating the same Power Point dozens of times to potential investors. Especially since, absent a disaster, they will reap a fortune at the end of the process. But those rules can also harm ordinary employees who are subject to rules, because of their tiny stock grants, that are meant for Masters of the Universe.

I watched this happen with a number of companies during the first dot-com boom. Regular employees held locked out stock and watched their chance to finally buy a house or pay off student loans vaporize. Many were taxed on phantom income that never materialized under rules I won’t pretend to understand much less explain. These were not top-tier b-school alum; they were writers, computer programmers, online forum moderators — people who knew nothing about capital markets — and ended up owing a fortune. Their bad for not studying the rules more? Maybe, but since the rules exist to protect the clueless those same rules could have done more to protect them.

SCH’s SPAC is supposed to change this. The idea is that one or more companies would be backed into the SPAC and skip the normal IPO process. No roadshow, no lockouts, and fewer worries about pricing. One bucket of capital goes to the company or companies, a controlling batch of stock goes to the SPAC, lawyers prepare lots of paperwork and, voila, the company is public sans IPO.

Another potential model would be multiple businesses put limited shares in the SPAC and it functions more like a publicly traded private equity firm. Social Capital’s hiring of private equity guru Marc Mezvinsky (yes, Hillary’s son-in-law) as vice chairman, and the use of plural verbiage in filings, suggests they might pursue this route. Plus, they explicitly call out purchasing only one firm as a risk factor although that is normally how SPAC’s work.

Like I said, the only time I’ve seen a SPAC in real-life it was a disaster. During it’s short life I communicated daily to DJSP investors, warning them. At first they weren’t thrilled. “I’ll kill you – no, I’ll have you paralyzed from the waist down,” is how one eloquently put it as I explained my data showing DJSP to be garbage. “Knock it off, look at the data, and direct your anger towards Stern,” I answered.

We continued communicating after the failure — they eventually became more friendly — and said it hadn’t worked out well in the past either. Their business model was to use SPAC’s to take Chinese companies public in US markets. But a disproportionate number of the companies turned out, in hindsight, to have elements of fraud. They purchased Stern’s operation because the two-year window to acquire a company was closing and they wanted to avoid fraud by focusing on a US business. Of course, instead of avoiding fraud, they ended up with arguably the worst SPAC in history. There are benefits to SPAC’s but also risks.

Which brings us back to SCH and Social Capital. Chamath Palihapitiya has the magic touch for a VC. He was an early Facebook employee, introduced to Zuckerberg by Sean Parker. His motives, an ability to focus on long-term value, is exactly what we like to hear. He says the right things, has the right history, and sounds like a person you want to trust. As an added benefit there is nothing that I’ve come across which even hints that you shouldn’t. With the market price of their empty SPAC increasing, despite no news, somebody else agrees.

But is it a genuinely good idea to ditch the traditional IPO path? There’s no question the as-is method is disruptive (in the traditional sense), cumbersome, expensive (though SCH charges 20% of the acquisition cost), and lengthy. Great for investment banks and their insiders; not so great for everybody else. Palihapitiya points out the need to disrupt his own VC industry in the same way tech firms have disrupted and upended dinosaurs. Further, an ability to better protect employees and more equitably distribute stock and options sounds like an improvement, especially after seeing those Silicon Valley employees financially drowned in the undertow of upside-down options.

There are a substantial number of companies rejecting the as-is path to an IPO. SCH’s prospectus highlights that there are 150 private tech companies valued at more than $1 billion but only 200 public tech companies. Firms are actively rejecting the as-is solution for initial public offerings though it remains unclear if that is because they wish to avoid investor pressure or whether they want to avoid the hassle of the IPO process. If their concern is investor pressure are they worried about an unwelcome letter from Carl Icahn or worried about turning into the next Snap or Twitter, with a languishing stock price?

I’m not a finance person but there seems to be a math problem. SCH has $600 million cash. They’re required to buy a controlling interest in voting, and at least 50 percent of outstanding shares, of at least one business worth more than $1 billion — their preference is to buy a company valued at $2-3 billion. Normal IPO’s deal with inadequate demand in the capital markets by selling a lower amount of stock. Need to raise $500 million but require a $2.5 billion valuation? Then sell 20 percent of the business to the public. But SPAC’s have different requirements; they must acquire controlling interests so they cannot take this route. I’d imagine somebody has thought this through.

Disrupting the IPO process to enable a long-term focus rather than short-term financial shenanigans seems worth the risk of innovation, though the risk of blindly betting on an acquisition should not be underestimated.

SCH has the potential to grow into a Y-Combinator like entity for mature companies; the premier go-to place for firms that need an exit but don’t want the hassle and expense of a regular IPO. If so, it’s shares are a chance to buy into a Berkshire-Hathaway at $10. Or it can end up like DJSP. While Stern’s demise was spectacular — everything he does seems to be large — SPAC’s do tend to historically underperform. Still, given Palihapitiya’s reputation and history, I’d bet on the former. But his management team must remain wary to ignore demands from the inevitable parasitic “activist investors” (formerly and more accurately known as raiders) to “derive value” with buybacks and other worthless financial gymnastics.

Shareholder Value Theory: History

In 1970 Ralph Nader led a campaign to “Tame G.M.,” in a proxy battle aiming for “social responsibility.”

The Harvard Crimson memorialized their demands. Quoting verbatim:

  • changing GM new car warranties to give more guarantees that the automobile will work;
  • improving health and safety standards for GM;
  • asking GM to “substantially increase” the number of non-white new car dealerships. At present, there are seven non-white franchises out of GM’s total of 13,000 national dealerships;
  • asking the company to meet Health, Education, and Welfare Department anti-pollution standards before the 1975 HEW deadline and to devote more research to study other pollutants in the environment;
  • requiring GM to develop a car by 1974 that can crash into a wall at 60 m. p. h. with no injury to the occupants. The National Safety Bureau has already designed such a car that works at 47 m. p. h.;
  • enlarge GM’s Board of Directors from 24 to 27 seats, adding three representatives of the public;
  • change the GM charter to restrict the corporation to operations which are not “detrimental to the health, safety, or welfare of the citizens of the United States…”;
  • set up a “shareholder’s committee” to study GM’s impact on the country, including an assessment of its efforts to produce pollution-free engines and safe cars, its effect on national transportation policy, and, in general, the manner in which it handles its economic power.

In response to-be Nobel Laureate Milton Friedman, thought leader of the Chicago School of Economics, wrote a scathing article in the New York Times. I’ve already detailed the article and will not repeat the core criticisms except to focus on one … noncustomer demands balanced against shareholder value.

Friedman begrudgingly admits that “social responsibility” and business practices that eventually increase share price sometimes align. “… it may well be that in the long-run interest of a corporation that is a major employer in a small community to devote resources to providing amenities to that community… That may make it easier to attract desirable employees, it may reduce the wage bill or lessen losses…” He then goes on to label these moves “hypocritical window-dressing because it harms the foundations of a free society.” He backs off telling companies to avoid these moves because “that would be to call on them to exercise a ‘social responsibility!'”

Let’s think about a world where GM ignored Friedman and listened to the reformers.

In our mythical 1970, after expanding their Board of Directors, GM decides to focus on several key areas of competition:

  • Quality & Reliability. Quickly realizing that the cheapest way to extend a warranty is to build more reliable cars, GM tasks their talented engineers with vastly improving reliability. Those engineers find a well regarded expert working in far-flung Japan, W. Edwards Deming, and convince him to come home and apply his methods — that were vastly improving the quality of Japanese products — to GM plants.
  • Safety. GM’s theoretical 1970 safety initiative finds that baby boomers, their largest up-and-coming customer group, prefer safer cars. There is a reason Ralph Nader’s book, “Unsafe At Any Speed,” became a bestseller. GM finds that safer cars cost slightly more to build but provide a competitive advantage and buyers are willing to pay considerably more.
  • Pollution. In 1970 American cities were choking with smog. Los Angeles was especially disgusting. Below is a photo of Los Angeles from that time and a more recent photo.åÊPollution was more than a social concern: it was a quality of life issue, a classic commons problem that Milton Friedman no doubt understood could not be solved with traditional market forces. GM’s early 1970 low-pollution cars sell well in car-crazed LA, a traditional trend setter that pushes them to the rest of the world.

  • GM makes an effort to train and launch dealerships with African American and Hispanic owners. They realize 7 out of 13,000 minority-owned dealerships, .054%, is ludicrously low. GM quickly realizes dealerships owned by African-Americans, staffed by non-racist salespeople, are more likely to be frequented by African-Americans. They sell more cars. Dealerships owned by Hispanic Americans hire Spanish and English speaking salespeople: they also sell more cars.

Every one of these “social responsibilities” that Friedman — and, by extension, followers of Shareholder Value Theory rail against — would have been, in hindsight, moneymakers. The inverse is also true; GM ignored these areas and their business was decimated by Japanese and German automakers.

Friedman’s assertion that “social responsibility” is nonsense is, in itself, nonsense. Despite that Friedman’s view became and, in large part remains, a dominant view it is simply wrong. In hindsight, had GM adopted these demands the business, and the shareholders would have been healthier wealthier. There is oftentimes no genuine conflict between shareholder value and social responsibility. Indeed, the opposite can be true: fulfilling social responsibility can increase shareholder value.

Original Shareholder Value Article – Milton Friedman to GM: Build Clunky Cars

On September 13, 1970, Milton Friedman published one of the most arguably economically destructive articles in history, “The Social Responsibility Of Business Is to Increase Its Profits,” in the New York Times. The article is available, in PDF form, for subscribers from the New York Times website.

Friedman advanced the idea that managers are agents of shareholders and that the only purpose of for-profit businesses is to increase stock price.

Managers have been debating Friedman’s “Shareholder Value Theory” for ages but nobody seems to have found the most obvious flaw from the seminal article. Milton’s sermon was directed at GM management who listened,åÊdecimating their brand, market share, and share price.

Specifically, Friedman raved against the notion that corporations have “social responsibilities” that, in this specific case, meant they should build safer, more fuel efficient and environmentally friendly cars. One can surmise this notion eventually extended, during a time when planned obsolesce was part of a business model, to quality.

In 1970, Friedman insisted businesspeople not concern themselves with issues beyond increasing shareholder value. “Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades,” wrote the Nobel laureate. Implicit is the message to GM: keep doing what you’ve been doing: build clunky, crappy cars because that strategy was profitable in the past. The Times, They Weren’t A Changin’ at GM.

In hindsight Milton Friedman was, by any measure, wrong.

No serious student of business, economics, law, history, or engineering could argue that Friedman’s business analysis was correct. GM, along with other US automakers, listened to Friedman, ignored the “reformers” (Friedman’s word), and went on to build a series of truly terrible cars. Automobiles that broke, blew up, hurt people, handled terribly, and guzzled gas. These cars were uglier than a Blobfish and polluted “like a 19th century coal-fired factory,” as Wired Magazine eloquently summarized the era.

Besides building awful automobiles those “social responsibilities” that Friedman raved against were important to many baby boomers who, in 1970, were trending to be the largest consumer group. That is, to appease faceless shareholders, Milton Friedman advised that GM and other businesses ignore demands from future customers.

The result was predictable. As my mentor Prof. Robert Ayres recalls, he bought a Honda. I’m younger but remember when my father replaced the family jalopy with a new Corolla. Subaru’s became cool. Japanese cars were fuel efficient, environmentally friendly, relatively safe, and incredibly reliable. They were built by companies that took exceptional care of their workers who, in turn, cared exceptionally about their businesses and the products they build. Japanese executives must have been aware of Friedman’s theory and actively rejected the advice; they took, and continue to take, those “social responsibilities” seriously.

Did Toyota and Honda ignore shareholder value? With booming sales and sterling reputations I imagine their shareholders were pleased. How about those GM shareholders that Friedman praised for voting against exploring social responsibilities? People who purchased GM stock in 1965 — the one’s Friedman praised for voting down social policy considerations — did see their stock increase in value … in 1993. I’m not sure how that constitutes shareholder value.

Milton Friedman’s Exhibit A on shareholder value — the notion that GE must reject a call for “social responsibility” and ignore buyer demands — resulted in one of the worst business disasters in history, the gutting of General Motors.

Others have pointed out that the rest of Friedman’s theory is bunk.

First are the business executives: those who run actual businesses, something Milton Friedman never did. As detailed in this article from Forbes, Jack Welch called it “the dumbest idea in the world.” Paul Polman, CEO of Unilever, referred to followers as a “cult.” Alibaba CEO Jack Ma reminds that “customers are number one; employees are number two and shareholders are number three.” Marc Benioff, founder and CEO of Salesforce, added it is “wrong .. the business of business isn’t just about creating profits for shareholders.”

Great business executives care about social issues. Apple CEO Tim Cook famously told an analyst, when questioned about Apple’s use of renewable energy, “I don’t consider the bloody ROI,” adding that Apple does “a lot of things for reasons besides profit motive. We want to leave the world a better place than we found it.” Google’s founding motto was “Don’t be evil.” They eventually dropped that because it set the bar too low. Facebook actively works on connectivity for poor countries. Well managed businesses are menschkeit, taking care of their customers, employees, and communities while earning a lot of money for shareholders. Lesser businesses, or those driven by short-term activist shareholders, are parasitic, milking their customers, employees, and the organization itself dry until there is little left for shareholders or anybody else.

Legal experts explain that Friedman’s theory, that managers are agents with a responsibility to increase stock returns, is outright wrong. Lynn Stout, distinguished professor of corporate and business law at Cornell Law School, argues Friedman bungled the law; managers are legally not agents of shareholders. She wrote a book on the subject, The Shareholder Value Myth. Prof. Stout writes “the idea of a single shareholder value is intellectually incoherent. No wonder the shift to shareholder value thinking doesn’t seem to be turning out well — especially for shareholders.”

Shareholder Value Theory remains alive and well. Michael Jensen and William Meckling published a 1976 article, “Theory of the Firm,” that repeated the myth managers are agents of shareholders. Despite that by 1976 GM’s struggles were apparent, and that one would think the question of agency is for lawyers rather than economists, their paper became and remains one of the most widely cited in academic literature.

Buybacks (or Corporate Suicide)

Prof. Robert Ayres asked me for help with a data project examining the relationship between buyback and growth in market value. Many have studied the effect on buybacks but rarely on overall market cap growth.

What we found was surprising.

Some items that pop out:

Sears spent $6.92 billion buying stock. The company is now worth $729 million. Over the past five years their market value has contracted by 87 percent.

HP is now worth $30 billion. But HP spent $81.56 billion buying their own it’s stock. The company has contracted 25 percent in market value in the past five years.

Xerox spent $8.6 billion; it is now worth $7.2 billion. The market value contracted 30 percent over the past five years.

Click here for Prof. Ayres thoughts.

Here is a working copy of the paper: SecularStagnation_rev_10-JUL-2017.

See also: Original Shareholder Value Article – Milton Friedman to GM: Build Clunky Cars