Big Blue’s got the blues. On Monday, IBM’s stock tumbled by 7 percent after it unveiled a dismal quarterly earnings report that showed a 4 percent drop in revenue — the 10th consecutive quarter of flat or declining sales. Revealing these mournful numbers, the company also announced it would abandon a policy that set it apart from all other firms: the 2010 pledge from then-CEO Sam Palmisano to raise the earnings per share of its stock to $20 by 2015.
No other company had so explicitly promised to raise the shareholders’ return on their stock. Maximizing shareholder value has been the North Star of U.S. corporate policy for decades now, but no other firm pursued it so openly — and disastrously — as IBM.
There are two ways to increase a company’s earnings per share: Either you increase the earnings, or you reduce the number of shares. Unfortunately for IBM, it had trouble keeping up with the rapid pace of change in the high-tech world. Its earnings flat-lined. To meet Palmisano’s pledge, the company embarked on an orgy of buying back its stock. This had already been an unstated policy at IBM; Palmisano merely made it more explicit. Since 2000, IBM has spent a mind-boggling $108 billion — $12 billion of that in the first half of this year — buying back shares. It devoted another $30 billion to paying dividends. The Financial Times calculated that from 2003 to 2013, the company devoted nearly 80 percent of its cash to rewarding shareholders through buybacks and dividends.
In 1993, IBM had 2.3 billion outstanding shares; 20 years later, it had 1.1 billion. As the Wall Street Journal’s Dennis Berman has pointed out, at that pace the company would have no publicly traded shares at all by 2034.
The rise in earnings per share at IBM entranced big-time investors. No Carl Icahns barraged its managers with complaints that it wasn’t returning enough to shareholders (a complaint Icahn has repeatedly lodged against Apple and other companies more successful than IBM). Palmisano’s pledge, and the company’s history of buying back its shares, even persuaded Warren Buffett, who had previously shied away from investing in tech companies in a nod to the sector’s penchant for creative destruction, to become IBM’s biggest single shareholder. IBM’s appeal, Buffett explained to CNBC, was clear: “They have this terrific reverence for the shareholder.” Indeed, so great was this reverence that IBM even incurred major debt to finance its repurchases.
Over the past year, however, some analysts began arguing that increasing earnings per share by decreasing the number of shares wasn’t really much of a strategy. David Stockman (once Ronald Reagan’s budget director) called the company “a buyback machine on steroids.” A company that once employed thousands of mathematicians and engineers to build the world’s smartest machines had changed its focus from product to finance. The engineering that mattered most at IBM was financial. But placing so high a premium on rewarding shareholders ultimately proved unsustainable. On Monday, Buffett’s investment lost $1 billion as Big Blue’s stock sank.
What makes IBM’s decline a matter of moment to more than just company shareholders is that the course IBM elected to follow is more the norm than the exception among U.S. corporations. William Lazonick’s survey of the country’s largest publicly traded companies — those listed on the S&P 500 from 2003 to 2012 — found that they devoted 54 percent of their net earnings during that time to repurchasing their own stock, and another 37 percent to shareholder dividends. Before the 1980s, by contrast, U.S. corporations retained more than half their net earnings for such things as new investments. That share steadily shrank as the goal of maximizing shareholder value and pressure from predatory large investors combined to make increasing earnings per share more important than, say, research and development. (That share also steadily shrank as CEO pay became linked to rising share value.)
Not every company that has subordinated expansion and investment to shareholder payouts has suffered the fate of IBM, of course — and IBM itself remains big enough to fund more productive investments, especially since it has now abandoned Palmisano’s pledge. But its tale is nonetheless emblematic of a sad national story: how a nation that once made the world’s smartest machines opted instead to try to make the world’s smartest deals — many of which turned out to be abysmally dumb.