A board and governance level issue that doesn’t get nearly enough attention is whether firms are being run as value creators or value extractors. As economist William Lazonick points out, absent real pushback, it is all too easy for management to simply extract value from companies — value that was built up patiently, sometimes over years, by innovators. This is very bad news for our society as we shall see.
Financialization and value extraction in capitalist economies
The economist William Baumol attributed the spectacular growth of human flourishing in late-stage capitalism to what he calls the ‘free market innovation machine’ in which firms engage in an “arms race” to create the next innovation and stay ahead of others. This pushes everybody to do the very uncomfortable act of retiring the old and investing in the new.
It stands to reason then that performance in the long run has to do with making strategic decisions that allow a firm to continuously innovate. While this sounds obvious, there are very real tensions around the strategic decision to be innovative, most significantly about who shares in the in the value created by a successful innovating organization. This is reflected today in the decades-long debate over the distribution of resources between various stakeholders in a corporation — the shareholders, of course, but also employees, communities and others. For several decades, policy has tilted toward shareholders first, everybody else after or not at all.
William Lazonick is one of the most outspoken critics of this shareholder-first mindset. Since the Securities and Exchange Commission permitted open-market share repurchases in 1982, a concatenation of incentives have led to many management teams (and the boards who don’t stand in their way) engaging in what Lazonick calls the “legalized looting” of the American public corporation. He has a new book, Investing in Innovation: Confronting Predatory Value Extraction in the U.S. Corporation (currently available for free pdf download). In a previous book that doesn’t exactly pull its punches (Predatory Value Extraction), Lazonick criticizes the shift in management from a “retain and reinvest” approach to strategy to an “extract and exploit” approach.