Investing in the future

There’s a fascinating “Room for Debate” discussion at the NYTimes entitled Profiting Profits or Reinvesting Them  with the prompt:

Corporations have gone from reinvesting about 90 percent of their profits into their business in the 1970s, to about 10 percent today, William Lazonick wrote in a recent Harvard Business Review article. Profits are instead being used to pay dividends to investors and to buy back stock to boost its price, benefiting the company’s executives. Can this trend be reversed to help fuel growth that benefits everyone?

Bill Lazonick is a friend and I’ve been meaning to write about his great article at HBR that inspired this debate. So I was thrilled to see it be the basis of a really rich discussion. His case is very clear. And he feels that change must come from regulators.

Lynn Stout, Law Professor at Cornell, makes the case for changing the definition of shareholder value and Peter Thiel co-founder of PayPal feels the root of the problem is a failure of imagination of corporate leaders: “The reason that big corporations aren’t using their profits to do new things is simply because they’re out of ideas, and the C.E.O.-politicians who run them are the last people we should expect to think of new ones.”

Unfortunately, the representative from the MBA world, Bruce Greenwald of the Columbia Business School, clouds the issue. He makes a few confusing statements that capital investment today “largely entails intangibles like acquiring customers, training workers and increasing product portfolios, all of which tend to be buried in operating expense….High profits with low levels of identifiable investment should be with us for the foreseeable future.” which doesn’t make sense. If companies were investing, they would either have lower profits or higher investments, not both.

What do ICountants have to contribute to the conversation? I’ll offer a few ideas and welcome more:

  • Greenwald is partially right about the accounting. Investments in intangibles hit the income statement. And there is no way to track the accumulated investment in intangibles. Think about an automated process at an insurance company or a manufacturing plant. These processes are around forever but they do not exist as long-term assets. Since they are invisible, no one is held accountable for the care and building of their intangibles.
  • These intangibles are the source of innovation and growth. Would investors look differently at a company if they could see this intangible infrastructure? It’s a little early to tell. One exciting new effort along these lines is the new fund at GaveKal Capital that tracks companies with strong innovation investment patterns.
  • And Bill’s point is that CEO’s getting three-quarters of their compensation from stock options and stock awards aren’t thinking about investing in the future.It’s this incentive that is a big driver of the failure of leadership described by Thiel.
  • But it’s too simplistic to expect that brilliant founders (or any of these factors) are the main answer. The lesson of intangible capital is that it is a holistic system. A leader can be critical in the functioning of the system. But the power is in the many individuals gathered together to create a unique set of answers to pressing problems. Complex problems needs holistic solutions.

There are some very clear calls here from people trying to change pieces of the system from the top down. Our work at Smarter-Companies is to drive change from the bottom up. I believe that if we can empower individual knowledge workers to take control of their organizations and their information, we’ll have a better shot at reversing the trend and building a more prosperous and profitable future.

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  • Wow Bill, great comments! 

    The examples of depreciation and ownership are powerful. This is what leads me to think that the solution has to be (at least) two-pronged:

    First, we should start tracking investments in all intangibles (irregardless of ownership so investments in developing people should be included) which would make financial patterns clear. I am of the thinking that IC is the ecosystem for innovation. So, properly defined, such spending addresses both. What would happen with that information? It wouldn't go on the balance sheet. At first it would be for learning and understanding. Standards of depreciation would have to come later.  But standards might not catch the loss of value that you describe at Kodak and Microsoft.

    Second, to get at the value creation potential of a company's owned and attracted resources, we will need other methods. This is why Smarter-Companies advocates and spends a lot of time on qualitative assessment. It's imperfect too but actually much better suited to answering questions around how a company's people, networks and systems are smart/innovative.

    And you're right, one of the major challenges today is that everyone is looking at pieces of the puzzle but very few are trying to connect the dots. We can't be afraid of the financial view. We need to embrace it. Intangible/Innovation Capital is the key to creating Financial Capital. Let's help connect the dots!

  • Both innovation and intangible capital (IC) present problems to companies in the sense that neither are adequately understood but there are more serious root causes of bigger problems. As Christensen recently wrote in an HBR article, current financial investment tools discourage the radical innovation required for renewal and survival and this misguidance creates "the Capitalist Dilemma". Regarding innovation, current economics and management theory don't enable the adequate calculation of the depreciation of value in an organization's IC that should be considered "negative innovation" as happened at Kodak with too much focus on chemical photography and not enough attention to digital photography that led to bankruptcy and is now happening to Microsoft with Windows on PCs. IC depreciates and eventually severely depresses valuation, so ignoring IC nicely hides the problem from investors including stock holders. In addition, current economic theory and Wall Street's hedge funds assume future cash flow (resulting from innovation) beyond a few months is assumed to be largely a random variable in the equation for a company's valuation (Black-Scholes model) . With an improved, new generation of innovation theory and practice, future cash flow would not be largely random, but is much more predictable. That would cause major disruption in Wall Street's management of investments including hedge funds. In addition, IC has a large component driven by the knowledge contained in workers but that knowledge is not owned by a company so therefore that part of IC can't be entered on a balance sheet. Since valuation such as EVA discourages ownership of any capital asset to get better a ROA, it would seem that not being able to own the knowledge of workers and put the asset on the balance sheet would not be problem.  But risk is increased when the core assets of a company are not owned and are mobile. Of course, those assets can be encouraged to remain with a company if they are awarded proper compensation but that is not current theory or practice for the security of worker compensation in an "employee at will" cost cutting culture and economic model that promotes offshoring and outsourcing. Integrated Reporting seems to be an attempt to address some of these problems.

  • Mary,

    The NYT and HBR articles are good, but really miss the  root causes of the problem. Here's what I put in another post today -

    The research and publication activity on intangible capital (IC) and innovation (IN) have parallel paths that don’t seem to be connected such as for IC: the OECD reports and Integrated Reporting and for IN: the recent “book” published by ITIF,

    (ITIF is a Washington think tank on innovation and the "book" says that both popular current theories in economics are obsolete and ineffective because they ignore innovation but are promoted as "gospel" by Republicans and Democrats, the economists at all , and the Federal Reserve  - I should  add that both theories also ignore intangible capital )  and as one of many other examples of major innovation policy initiatives that ignores intangible capital   - the RFI on a Strategy for American Innovation submitted by OSTP and the EDA as led by the White House.  

    “Connecting the dots” needs to happen between these communities of practice.

    - See more at:

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