In 2015, Laurence Fink BlackRock’s CEO wrote a letter to the chief executives at America’s 500 largest companies telling them to stop returning extreme amounts of money to shareholders. Mr. Fink’s concern was the return of cash to shareholders was killing innovation as fewer dollars were budgeted to research & development or other capital expenditures essential for a company’s long-term growth. One of the primary culprits driving this phenomenon, per Mr. Fink, was the short-term motives of activist hedge fund managers.
Activist activity is on the rise, while corporate R&D budgets are on the decline. But the real question is, are activists to blame for killing R&D? Or could it be a little thing called “venture capital” who is the real culprit?
Hedge Fund Activism
In 2016, 519 activist campaigns were set in motion, according to FactSet. Of those, 319 were classified as “Impact Activism” which is defined as investors looking for board representation or strategy change to maximize shareholder value. Although these numbers are down from the highs of 2015, when 622 and 377 campaigns were initiated, respectively, activism has steadily grown since 2009 when 425 companies heard from investors.
Mr. Fink’s claim is also supported by the fact that 60% of activist campaigns in 2016 were from first-time activists, meaning that activist activity is only growing. Increased fundraising by activist managers is also fueling the debate, as Bill George, a Senior Fellow at the Harvard Business School, reports activist hedge fund AUM increased from $23 billion in 2002 to $166 billion in 2014.
R&D Commercialization Periods
In an article in Fortune magazine from December 2015, Bill George writes, “Spurred on by activist investors, these shareholders are arguing that research takes too long, cost too much, and carries to many risks.” He continues to point out that, “despite the efforts to accelerate innovation, basic research takes as long as ever because of the thoroughness, rigorous testing, and extended time required for commercialization.” These factors have led to the disappearance of many of last century’s key innovation factories like Bell Labs, DuPont, and Pfizer.
Is it Greedy Investors or is Silicon Valley More Efficient?
Studies are finding that corporate venture capital investing and M&A are a more cost-effective solution than internal research and development departments, which many believe is causing large corporate R&D divisions to become a thing of the past. As billions of dollars follow into venture capital companies each year the speed at which disruptive technologies emerge continues to shorten. Through investments in technologies and strategic acquisitions, corporations are gaining access to innovation fast than ever. Which means they rely less and less on their own R&D departments. “The world is moving too fast to depend on organic innovation alone. Investing in and partnering with startups is one way to keep pace with change,” says Amy Banse, managing director and head of funds at Comcast Ventures, in a TechCrunch October 2016 article.
Corporate Venture Capital Arms
In response to innovation, corporations are investing in startups to increase their access to new, cutting-edge technologies. PitchBook reports in 2016 there were 933 different corporations with venture capital arms including Microsoft, Salesforce, Intel, Google, Boeing and much more. They go on to say that corporate venture capital arms have participated in over 1,000 deals per year for the last four years. In 2016, CVC was involved in 15% of all VC deals with over $65 billion invested. Similarly, PitchBook reports that 73% of all private equity-backed exits were strategic acquisitions. Corporations have found the most efficient use of capital is to make strategic acquisitions, which can immediately drive sales, offer customers additional goods & services, and increase margins.
It is widely reported that activist investors pressure management to trim expense and use invested capital wisely to increase shareholder value. However, the industry disruption reverberating from Silicon Valley could be the louder voice influencing CEO decision on how best to innovate. Corporate R&D divisions made companies like GE, DuPont, and AT&T worldwide industry leaders, but as Moore’s Law influences innovation, it is Silicon Valley who has become the world’s innovation engine. To stay relevant, corporations are becoming heavy participants in this revolution. And R&D divisions are only the first casualty.