Is Focus on Shareholder Value Killing Manufacturing?

There was a time when employee layoffs were considered a last resort during an economic downturn. Instead, corporations placed a high value on retaining highly skilled employees who are the key to continuous growth. But times have changed. Today layoffs have become a standard tool of doing business.

Prior to 1980, American corporations made an attempt to balance the needs of all stakeholders including employees, customers, shareholders, suppliers and management. They viewed each of these groups as essential to their success. Back then, IBM Corp. (IW500/12) Chairman Thomas Watson Jr. spoke often of balancing the company’s interests. He published a seminal document in 1963 that emphasized three beliefs: “The most important was respect for the individual employee, the second was a commitment to customer service, and the thirds was achieving excellence.”

More recently, in 2010 former IBM CEO Sam Palmisano set a course designed to deliver $20 earnings per share by 2015. The plan, called the “2015 Road Map," called for a shift to faster growing businesses, increased productivity, and dividend and share repurchase. The plan  resulted in hundreds of thousands of layoffs.

Later, IBM CEO Virginia Rometty, who replace Palmisano in 2012, pledged to follow the plan. Struggling to meet the goal in 2014, she backed away from the EPS goal, but in interviews stated her commitment to the plan's "framework" saying: "The essence of that [plan] was continue to move this business to higher value, and continue share repurchase. None of that changes."

There are many other examples of companies using layoffs to achieve financial goals:

1. Carrier Corp., Indianapolis, Ind., has two plants in Indiana, both of which are profitable. But its parent company, United Technologies Corp. (IW500/19), decided early this year to layoff all 2,200 employees and move the work to Mexico. Even though the company’s current rate of sales growth is 8%, the company’s CFO said that Wall Street wants the company to "post a 17% increase in earnings per share for the next two years." The company decided that the only way to meet the earnings requirement was to cut costs and terminate employees.
2. IBM has been laying off workers since 2011 but the company refuses to reveal the exact number. IBM’s CEO Ginny Rometty has "talked a good game" about focusing on shareholder value, according to the New York Times DealBook Columnist Andrew Ross Sorkin. Since 2000, he notes, IBM has spent some $108 billion on buying back its own shares. To help finance this share-buying spree, IBM loaded up on debt. "While the company spent $138 billion on its shares and dividend payments, it spent just $59 billion on its own business through capital expenditures and $32 billion on acquisitions," he wrote. "All of which is to say that IBM has arguably been spending its money on the wrong things: shareholders, rather than building its own business.”
3. The Timken Company was forced to split into two companies, one making steel, and the other making bearings. According to an article in the New York Times the new bearing company then slashed its pension fund contributions to near zero and cut capital investment in half. At the same time it has quadrupled its share of cash going to stock share buybacks.

The strategy to cut employees to enhance shareholder value and boost the stock price does work and there are many recent examples.

• Merck & Co. Inc. (IW500/29) laid off 16,000 employees in 2013, and their stock price went up 20%
• German industrial giant Siemens AG (IW1000/41) cut 15,000 employees and its stock rose 20%
• Cisco Systems Inc. (IW500/21) disclosed back in 2013 it was eliminating 4,000 jobs. Cisco's stock went up 18%. The Company also revealed that it was giving CEO John Chambers a raise, $15.2 million in stock awards and a $4.7 million cash bonus.
• CEO Meg Whitman of Hewlett Packard slashed thousands of jobs in the last several years and shares went up nearly 50%. .

Where Shareholder-Focused Strategy Started

The idea of favoring shareholder value over employees can be traced back to articles written by Milton Friedman in the early 1970s. The U.S.’s most famous free-market economist argued in a 1970 essay for the New York Times Magazine that “the social responsibility of business is to increase its profits.” So began a 40-year period where corporations favored shareholder value and profits over all other stakeholders.

Free-market capitalism says that the only purpose of business is to create shareholder value and that the unfettered market can regulate itself. This is no longer the capitalism described by Adam Smith; it is financialization, which is defined as the “growing scale and profitability of the finance sector at the expense of the rest of the economy and the shrinking regulation of its rules and returns."

In 1970, only 1% of the Fortune 500 CEOs compensation was in stock options. Today stock and stock options account for 80% of CEO compensation. According to a study released in 2010 by the Institute for Policy Studies, CEOs who cut the most jobs during the recession earned significantly more than their peers.

“Combined, the CEOs at those 50 firms made $598 million and laid off 531,363 workers -- accounting for more than three quarters of the 697,448 announced layoffs at the top 500 firms. The study also found that 72% of them announced their mass layoffs during periods of positive earnings reports, and that those companies enjoyed a 44% profit increase in 2009. "These numbers all reflect a broader trend in Great Recession-era Corporate America: the relentless squeezing of worker jobs, pay, and benefits to boost corporate earnings and maintain corporate executive paychecks at their recent bloated levels," the study authors said.

During the time that shareholder value and stock prices became more important than employees, the U.S. has suffered from:

1. Growing Manufacturing Unemployment – From 2000 to 2010 manufacturing lost around 6 million jobs. Since the recovery from the Great Recession only 828,000 employees have been hired in manufacturing.
2. Slowing GDP Growth - Since 2000, GDP growth has averaged a very weak 1.8%
3. Increasing Pay Gap - The wealthiest 1% have captured almost all of the growth in income since the 2008 crash.
4. Increasing Offshoring - Outsourcing of manufacturing jobs to low-cost countries has been the most popular strategy, and EPI asserts that between 2000 and 2007 3.6 million manufacturing jobs were lost. After the Great Recession, between 2007 and 2014, another 1.4 million manufacturing jobs were lost.
5. Growing Trade Deficit - Our total trade deficit has grown to $10 trillion in the last 30 years.
6. Increasing Low-Paying Service Jobs - Instead of creating manufacturing jobs the economy is creating jobs in retail, food service, and other low-pay service jobs.
7. Reducing Research and Development - Successful R&D in private companies depends upon the flow of new ideas and trained people stemming from basic research and pre-commercial R&D. In the early 1960s, federal research spending was more than half of the total R&D spending; by 2012, it had fallen to 31% of total R&D. The decline of basic federal research is a very bad trend because this research is the lifeblood of all R&D, and most experts believe that declining basic research will eventually lead to declining GDP growth.
8. Shrinking Supplier Base - According to the Economic Policy Institute, since 1998, the U.S. has lost 82,100 manufacturing establishments.
9. Struggling Manufacturing Sector - American manufacturing has been in recession since October 2015.
10. Faltering Capital investment – The survey by the Aspen Institute and the MAPI foundation found that “U.S. capital investment spending has faltered since the dot-com speculative bubble which burst in early 2000. It has not kept pace with the economic growth, profits, and cash flows or virtually any other metric one could use to benchmark investment spending. Net private investment totaled $860 billion in 2006; by 2013 it totaled just $524 billion. The slowing pace of investment has contributed to slower productivity, economic growth and, ultimately, to a slower rate of improvement in living standards.
11. Slowing Consumption – According to the Federal Reserve Bank of St. Louis, consumer spending is not coming back anytime soon because of stagnant wages, lower wealth, tight credit, and fragile consumer confidence.

The support of free market economics and stock prices has been very profitable for high-income earners and shareholders. But the success of this strategy has driven a huge wedge between business and the public. This is a short term strategy that is not good for employees, the country, the economy, manufacturing, or business in the long term. When the entire focus is on short term profits, shareholder value, stock prices and their own compensation, CEOs are taking their eye off what it takes to create the new technologies and innovation to compete in a globalized world. 

Who Wins With a Shareholder-Focused Strategy

The record shows that companies are increasingly disconnected from their employees and other stakeholders, by laying off workers in huge waves, keeping average wages low and threatening to move operations abroad at any time. So the big question is who are the winners? If you are a shareholder or a CEO of a Fortune 500 company, the last 40 years have been a sensational ride. But if you are in the middle class and a worker the future is a fog of insecurity.

Short term demands - Lynn Stout is a professor of law at the Cornell Law School and the author of The Shareholder Value Myth: How putting shareholders first harms investors, corporations, and the public. Stout says "the singular focus on stock prices can lead companies to make decisions that benefit only the short term." She goes on to say that, when focusing only on share prices, “it is very hard for companies to be innovative.” Stout makes the case that getting short-term results could hurt the company in the long term. She says, “they’re not going to invest in their employees; they’re not going to invest in customer support; they’re not going to invest in improving their products the way they should.” Her view is supported by the decrease in both capital investment and basic science research.

Losing talented people - A recent article in Industry Week, Look Out China, US Manufacturing is Headed for No. 1, argues that “While technology is a critical factor in future competitiveness, manufactures rank talent as the most critical driver of competitiveness." The contradiction is that employees are still being laid off by the boxcar load, despite the talk about talented people,

Every 5 years a survey is published on the skills gap and how important highly skilled workers are for the future. In fact, there are many articles today that claim we are short 500,000 highly skilled workers. I think there is ample data that shows massive cuts leads to loss of your best sales people, less research and development, and loss of the real high producers whom I call “Hunters.”

I agree with the supposition that talented people are the most critical factor, and outstanding performance comes when people are motivated to do their best. But how can people do their best when they are always facing the possibility of lay-offs by the supporters of shareholder value?  I also believe that losing "Hunter"s will lead to fewer sales, less new products, less innovation, and decreased productivity.

Industrial base – In terms of workers and number of factories the American industrial base continues to shrink. According to industry insider Dan DiMicco, former CEO of Nucor Corp. (IW500/68), “You have to protect and support a manufacturing base because: As history shows, If you are a nation that innovates, makes and builds things, you have a strong economy, you have wealth, you have real wealth creation where everybody participates, not just the wall street guys… everybody benefits, you have a growing middle class, and it works.”

To achieve this we have to all be supportive of the manufacturing base. To get back into the game will require manufacturers to increase capital investment, research and development, training, the speed of technological innovation. But more importantly, growing our manufacturing base will require a different attitude on layoffs, and retaining the creative people who can do the work. This kind of investment is a contradiction to maximizing shareholder value.

The Influence of Wall Street - This shift by the corporations away from satisfying all stakeholders and focusing only on shareholders and stock prices for short term results is driven by Wall Street. The current financial philosophy of Wall Street is extractive not productive.  We are not producing wealth by producing goods we are producing wealth by financial engineering. Andy Grove from Intel said “the result is a high-profit, low prosperity nation.”

Michael Hudson in his book on Wall Street parasitism says in an elegant but lethal indictment of the system, that the worker’s ongoing struggle to make ends meet is not a reflection of your lack of talent or drive but the only possible outcome of having a blood-sucking financial leech affixed to your body, your retirement plan, and your economic future. What has evolved, says Hudson, is that Wall Street banks have “become the economy’s central planners, and their plan is for industry and labor to serve finance, not the other way around. Hudson calls this a predatory financial system that is de-industrializing the economy.

One last point. As de-industrialization continues and the 1% pockets most of the money, the middle class and employees will struggle. This will increase a strong demand to expand the social safety net. I think the push for $15 per hour minimum wage is simply the opening volley on what will be demanded to help the average citizen. It is ironic that the supporters of free market capitalism would end up pushing the country towards socialism.

As a country our hope to compete in the future is innovation, and innovation comes from manufacturing. This means we have to reverse the strategies that are causing de-industrialization and go all out to grow our manufacturing base. We must stop the short term strategies of shareholder value and the predatory strategies of Wall Street. Consider who is willing to help get this done when you vote in November.

Michael Collins is the author of The Rise of Inequality and the Decline of the Middle class. He can be reached at mpcmgt.com.