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.