Financial Institutions
for Innovation and Development:
Functions and Drivers
of the Stock Market
William Lazonick
Japan Conference on
Financial Institutions for Innovation and Development
Session on business models in ICT
July 30, 2015
©William Lazonick
WINNER OF THE 2010 SCHUMPETER PRIZE COMPETITION
The shift from the Old Economy
business model (OEBM) to the
New Economy business model
(NEBM) has resulted in the stock
market becoming much more
central to the operation of the
firm than previously
Published in September 2009 by the
Upjohn Institute for Employment Research
1. What is New, and Permanent, about the
“New Economy”?
2. The Rise of the New Economy Business
Model
3. The Demise of the Old Economy Business
Model
4. Pensions and Unions in the New Economy
5. Globalization of the High-Tech Labor
Force
6. The Quest for Shareholder Value
7. Prospects for Sustainable Prosperity
A greatly increased role of the stock market in allocating capital and
labor in NEBM compared with OEBM
OEBM
NEBM
Strategy,
product
Growth by building on internal
capabilities; business expansion into new
product markets based on related
technologies; geographic expansion to
access national product markets.
New firm entry into specialized
markets; sale of branded components to
system integrators; accumulation of
new capabilities by acquiring young
technology firms.
Strategy,
process
Corporate R&D labs; development and
patenting of proprietary technologies;
vertical integration of the value chain, at
home and abroad.
Cross-licensing of technology based on
open systems; vertical specialization of
the value chain; outsourcing and offshoring.
Finance
Venture finance from personal savings,
family, and business associates; NYSE
listing; payment of steady dividends;
growth finance from retentions
leveraged with bond issues.
Organized venture capital; NASDAQ
listing; low or no dividends; growth
finance from retentions plus stock as
acquisition currency; stock buybacks to
support stock price.
Organization
Secure employment: career with one
company; salaried/hourly employees;
unions; defined-benefit pensions;
employer-funded medical insurance in
employment and retirement.
Insecure employment: interfirm
mobility of labor; broad-based stock
options; non-union; definedcontribution pensions; employee bears
greater burden of medical insurance.
What functions does the stock market
actually perform in the corporation?
• Creation: possibility of stock-market listing induces new
venture capital to support new firm formation
• Compensation: possible or actual listing makes stock a
currency for remuneration (especially stock options)
• Control: stock-market listing affects the relationship
between share ownership and managerial control
• Cash: the stock market can be a source of corporate
finance, but through distributions to shareholders it may
perform a negative cash function
• Combination: stock market can be a currency for M&A
Functions of the stock market under OEBM
• Creation: listing requirements on NYSE too stringent for
a quick IPO
• Compensation: stock options for executives of established companies but as a tax dodge (eliminated in 1976)
• Cash: stock market was important source of cash in late
1920s when companies took advantage of speculation
• Combination: stock market served as a currency for
M&A, but through conglomeration weakened OEBM
Functions of the stock market under NEBM
• Creation: quick exit on the Over-the-Counter market
vastly facilitated by creation of NASDAQ in 1971
• Compensation: stock options for to lure prof-tech-admin
employees from secure OEBM employment
• Combination: stock market served as a currency for
M&A, but through conglomeration weakened OEBM
• Control: listing could separate ownership from control,
but creation, compensation, and combination functions
led strategy to focus on stock-price performance
• Cash: too much cash raised in highly speculative IPOs,
and as companies grow buybacks become paramount –
with a highly negative cash function
What drives the stock market?
1. INNOVATION: in 1980s and 1990s rise in stock prices is
a result of innovative enterprise; “retain-and-reinvest”,
especially by New Economy firms that pay no dividends
2. SPECULATION: an acute case of so-called “irrational
exuberance” in the late 1990s, which, as it turns out,
was not at all irrational for insiders to the system
3. MANIPULATION: in 1980s “Old Economy” companies
downsize labor forces and distribute cash to shareholders – by the 2000s, NEBM dominant, but now
leading companies are doing massive stock buybacks
for the sole purpose of manipulating their stock prices
Stock-market drivers: S&P500 & NASDAQ
SPECULATION
MANIPULATION
INNOVATION
(New Economy)
MANIPULATION
(Old Economy)
Stock-market drivers: Cisco
SPECULATION
2002-2015Q3:
buybacks=$97.2b
109% of profits
Dividends another
13% of profits
MANIPULATION
INNOVATION
Destructive use of stock for combination
• See Carpenter, Lazonick, and O’Sullivan, “The Stock
Market and the Accumulation of Innovative Capabilities
Industrial and Corporate Change 2003: focused on
Lucent, Nortel, and Alcatel responding to the Cisco
model
• Lazonick and March, “The Rise and Demise of Lucent
Technologies,” Journal of Strategic Management
Education 2011
• Lazonick and March, in progress: The Rise and Demise
of Nortel Networks
Buybacks and performance in communication technology
• Motorola: In 2005-2007, following the success of its 2G
Razr cellphone, did $8.0b in buybacks, 100% of NI, and
then failed to compete in 3G phones. After losing $4.3b,
2007-2009, Motorola spun off Motorola Mobility in 2010,
sold to Google in 2012.
• Qualcomm: makes high-end chipsets for smartphones
and reaps billions from IP in CDMA, but, while buying
back $19.45 since 2005. Distributions to shareholders
2005-2014 79% of NI (47% buybacks) – now being
attacked by a hedge-fund activist
• RIM (Blackberry): World leader in smartphones, but
faltered after spending $3.0b on buybacks in 2009-2010
(1.3 times R&D)
Buybacks and performance in communication technology
• Microsoft: In the 2000s a belated imitator of other more
successful companies. Began buybacks in1990. 19962015 107% on NI to shareholders (68% buybacks, 39%
dividends; total of $168b on buybacks=1.3 times R&D
spending. Bought Nokia handsets, and has taken a huge
loss on it,
• Nokia: a longstanding stock-option culture and Europe’s
5th largest stock repurchaser, $37b, for 2001-2010, has
been in sharp decline. Has had a virulent stock-option
culture since the late 1990s,
Two US companies that refrained from buybacs
Apple: did buybacks and dividends in decade from 1986
with Steve Jobs gone – then retaining its earnings,
transformed itself from a troubled niche player at the
beginning of the 2000s into the world’s most profitable
company by the end of the decade – BUT now under Tim
Cook, and with the help of hedge-fund activists Einhorn
and Icahn, has the biggest buyback program in history
(see Lazonick on HBR Blog Network, October 2014)
Google: no buybacks (founders Page and Brin control
resource allocation through dual shares); has mobilized its
financial resources to build on its competitive success in
one line of business to innovate in other lines, including,
with its Android operating system, smartphones
World leaders do not do buybacks
Ericsson: the world’s leading communication equipment
company – got rid of stock options in 2003 after adapting
their use to the Swedish business model -- does virtually no
stock buybacks
Huawei Technologies: a nonpublic employee-owned
company that, through investment in R&D, is now the no.
1 global communication equipment company, despite
being shut out of the US market
EXCEPT THAT Samsung has done buybacks to fight off a
US hedge-fund activist