17/07/2017 Capitalism the Apple Way vs.

Capitalism the Google Way - The Atlantic

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Capitalism the Apple Way vs. Capitalism

the Google Way
Whichever companys vision wins out will shape the future of the economy.

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17/07/2017 Capitalism the Apple Way vs. Capitalism the Google Way - The Atlantic

Tim Clayton / Corbis / Getty

MIHIR A. DESAI | JUL 10, 2017 | BUSINESS

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17/07/2017 Capitalism the Apple Way vs. Capitalism the Google Way - The Atlantic

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While lots of attention is directed toward identifying the next great start-up, the dening tech-industry story of the last
decade has been the rise of Apple and Google. In terms of wealth creation, there is no comparison. Eight years ago, neither
one of them was even in the top 10 most valuable companies in the world, and their combined market value was less than
$300 billion. Now, Apple and Alphabet (Googles parent company) have become the two most valuable companies, with a
combined market capitalization of over $1.3 trillion. And increasingly, these two behemoths are starting to collide in
various markets, from smartphones to home-audio devices to, according to speculation, automobiles.

But the greatest collision between Apple and Google is little noticed. The companies have taken completely dierent
approaches to their shareholders and to the future, one willing to accede to the demands of investors and the other keeping
power in the hands of founders and executives. These rival approaches are about something much bigger than just two of
the most important companies in the world; they embody two alternative models of capitalism, and the one that wins out
will shape the future of the economy.

In the spring of 2012, Toni Sacconaghi, a respected equity-research analyst, released a report that contemplated a radical
move for Apple. He, along with other analysts, had repeatedly been pushing Apples CEO, Tim Cook, to consider returning
some of Apples stockpile of cash, which approached $100 billion by the end of 2011, to shareholders. Cook, and Steve
Jobs before him, had resisted similar calls so that the company could, in the words of Jobs, keep their powder dry and
take advantage of more strategic opportunities in the future.

But there was another reason Apple wouldnt so readily part with this cash: The majority of it was in Ireland because of the
companys fortuitous creation of Apple Operations International in Ireland in 1980. Since then, the vast majority of Apples
non-U.S. prots had found their way to the country, and tapping into that cash would mean incurring signicant U.S. taxes
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due upon repatriation to American soil. So Sacconaghi oated a bold idea: Apple should borrow the $100 billion in the
U.S., and then pay it out to shareholders in the form of dividends and share buybacks. The unusual nature of the proposal
attracted attention among nanciers and served Sacconaghis presumed purpose, ratcheting up the pressure on Cook. A
week later, Apple relented and announced plans to begin releasing cash via dividends.

The results of Sacconaghis report were not lost on Silicon Valley, and Google responded three weeks later. At the time, the
share structure that the company put in place when it went public in 2004 was becoming fragile. This original arrangement
allowed Googles founders to maintain voting control over the company, even as their share of ownership shrunk as more
shares were issued. The explicit premise was that this structure would protect Google from outside pressures and the
temptation to sacrice future opportunities to meet short-term demands.

But by the time of Apples announcement in March 2012, this bulwark against outside inuence was eroding, as Googles
founders continued to sell stock and employees were issued shares in their compensation packages. A few weeks after
Apples concession to shareholders, the founders of Google announced a new share structure that would defend against a
similar situation: The structure gave the founders shares 10 times the voting power of regular shares, ensuring theyd
dictate the companys strategy long into the future and that Google was, in the words of the founders, set up for success for
decades to come.

What has happened to Google and Apple in the wake of these events is the dening story of early 21st-century capitalism.
Apples decision in 2012 to begin paying dividends didnt satiate shareholdersit sparked a wider revolt. Several hedge
funds started asking for much larger payouts, with some of them ling suits against Apple and even proposing an iPrefa
new type of share that would allow Apple to release much more cash in a way that didnt incur as high of a tax bill. In 2013
and 2014, Apple upped its commitments to distribute cash. From 2013 to March 2017, the company released $200 billion
via dividends and buybacksan amount that is equivalent to, using gures in S&Ps Capital IQ database, more than 72

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percent of their operating cash ow (a common metric of performance that is about cash generation rather than prot
accrual) during that period. And to help nance this, Apple took on $99 billion in debt. Sacconaghis vision had come true.

What has Google done in that same period? Google is, like Apple, making loads of money. From 2013 to March 2017, it
generated $114 billion in operating cash ow. How much has the company distributed to shareholders? In contrast to
Apples 72 percent payout rate, Google has only distributed 6 percent of that money to shareholders.

The paths taken by Apple and Google manifest alternative answers to one of the main questions facing capitalism today:
What should public companies do with all of the money that theyre making? Even as corporations have brought in
enormous prots, there has been a shortage of lucrative opportunities for investment and growth, creating surpluses of
cash. This imbalance has resulted in the pileup of $2 trillion on corporate balance sheets. As companies continue to
generate more prots than they need to fund their own growth, the question becomes: Who will decide what to do with all
those protsmanagers or investors? At Google, where the founders and executives reign supreme, insulated by their
governance structure, the answer is the former. At Apple, where the investors are in charge because of the absence of one
large manager-shareholder, its the latter. (To be clear, even though Apples previous eorts to stie investors concerns
were no longer tenable, the company can still aord to spend mightily on research and development.)

Why has each company taken the approach that it has? These two strategies reect dierent reactions to an issue central to
modern capitalism, the separation of ownership and control. In short, owners arent managers, as they once were when
businesses existed on a smaller scale. And when owners have to outsource running the company to executives, this leads to
what economists call the principal-agent problem, which refers to the issues that come up when one person, group, or
companyan agentcan make decisions that signicantly aect anothera principal.

Having investors dominate, as Apple does, is a good way of handling one principal-agent problem: getting managers to do
right by their owners. Rather than spending money on failed products (remember Google Plus?) or managers pet projects,

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Apple has to face the disciplining force of large investors. In a way that individual shareholders would have trouble doing,
larger investors can act swiftly to put a check on managers who might pursue goals that enrich themselves, such as wasteful
mergers, excessive executive compensation, or lush perks. And, after all, a companys prots theoretically belong to
investors, so why shouldnt they decide how they are put to use?

Proponents of the managerial model embodied by Google worry about a dierent principal-agent problem. Rather than
being concerned about managers ignoring investors, they are concerned that investors wont serve the people who would
benet from the long-term success of the company. Those professional investors are both the principals for the CEOs but
also the agents of many other shareholders. The hedge funds that pressured Apple are the dreaded short-term investors
who are interested only in quick wins and dont serve their longer-term beneciaries, such as pension funds, that allocate
capital to them in the rst place. As investors, hedge funds are impatient, and, the argument goes, ruining the economy by
shortening time horizons.

Whos right? Which principal-agent problem is more vexing? Stock-market returns are one, albeit imperfect, way of
answering this question and since the initial developments, Google has far outperformed Apple. But that pattern is ipped
if the time frame is restricted to the past year. So it wont be known for many years to come if Apple or Google has a sharper
nancial strategy.

More importantly, though, how do these strategies impact the lives of everyday people? A capitalist system aims for the
ecient allocation of capital, and indeed, workers have a better shot at seeing median wages increase when money is being
put to its most productive use. So to an extent, how they fare under each system has to do with who is deciding where and
how prots get invested. When managers reallocate prots, that reallocation benets from the capabilities and knowledge
that companies have built over decades, but suers from the possibly poor incentives of managers. When investors are the
ones reallocating prots, however, the scope of the reallocation can be broader, theoretically leading to more innovation; at

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the same time, those investors dont have preexisting organizational capabilities and they may suer from their own short-
term time horizons.

Even if one considers the disparities in the shares of wealth accruing to labor and capital problematicand there certainly
are other strategies for addressing those disparitiesmaking sure that managers and investors are dividing their
responsibilities on capital allocation eciently is critical for making the economic pie as big as it can be. And in that regard,
while the problems of Google's model are signicant, they are also well appreciated. The excesses of Apple's model and the
widespread deployment of share buybacks are just as dangerousand not nearly as well understood.

So which model of capitalism will win out? The dominant corporate-nance pattern for the last decade has been Apples.
Companies have been distributing cash via share buybacks and have borrowed money to nance these distributions at a
rapid rate. As American stalwarts such as Deere, IBM, Amgen, and 3M cede power to investors, its like watching leveraged
buyouts unfold in slow motion.

The importance of these two models might soon escalate dramatically. Theres a real possibility that tax reform at the
federal level will unlock the oshore cash that corporations have amassed, and the subsequent ood of money will have to
be reallocated in the economysomewhere, somehow.

ABOUT THE AUTHOR

is a professor at Harvard Business School and Harvard Law School. He is the author
MIHIR A. DESAI
of The Wisdom of Finance: Discovering Humanity in the World of Risk and Return.

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