Arnold Kling  

Peter Thiel's Question

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Bryan has one angle. I have another. In this video, Thiel confronts Google CEO Eric Schmidt over the issue of Google's cash hoard. If you have $50 billion in low-yielding investments, are you not more of a bank than a technology company?

I think this question goes beyond any one company. It is a global paradox. If we look around, we see potential innovation in computers, biotechnology, and nanotechnology, among other areas. Why are investors not selling U.S. Treasury securities in order to invest in companies that are innovating?

1. Perhaps investment in these fields is already saturated, so that the expected returns are low. As Alex Tabarrok points out, this is the Great Stagnation interpretation. (Thiel is a stagnationist who Cowen credits with helping to inspire the book.)

2. Perhaps the typical household wants to hold a large share of assets in risk-free securities, even though other investments might yield more. Folks have been burned the past few years, and they do not know who to trust.

3. Perhaps the present is a period of great uncertainty about the path of technology going forward, and the option value of waiting to invest is particularly high. The classic paper is by Robert McDonald and Dan Siegel, reprinted here.

4. Everybody is in survival mode, more worried about the threat of bankruptcy than the opportunity of gain.

These hypotheses are not mutually exclusive. I lean toward a combination of (2)-(4), particularly (3). I should hasten to add that the source of uncertainty is not exclusively, or even mainly, public policy. There are genuinely conflicting views about where the "next big thing" is coming from. For example, as you know, there are folks who see education as ripe for disruption and those who dispute that view.


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COMMENTS (17 to date)
Lewis writes:

#3 seems appropriate to autonomous vehicles. There are uncertain regulatory barriers and patent fights ahead. But if things worked out, Google might want to suddenly roll out huge plants, marketing initiatives and fine-tuned engineering.

I wonder whether it is in Schmidt's best interest to disclose how far Google's most promising lines of research have progressed.

Mike W writes:

The "typical" household's investment in technology during the 90s was driven by the hype put out by the financial industry. As a result those investments were overbought and then crashed. Once burned...

Actually most investors should heed Ben Graham's advice and stay away from "growth stocks". Without a revenue stream there is no way for those outside the industry (including most mutual fund managers) to evaluate a company's earning potential and therefore a reasonable purchase price for the stock. A retail investor should invest the bulk of his portfolio in dividend paying blue chips. Any allocation to risky assets could go into technology stocks or a Las Vegas crap table...same odds.

Without the "dumb money" who would then provide risk capital? Those in the know about the industry and close to the company...venture capitalists and other tech companies.

There would be less tech capital available but it would be more efficiently and effectively utilized.

Joel writes:

5. If you spend the money on speculative R&D it's a (short-term, at least) drag on earnings and the stock market will punish you.

Jardinero1 writes:

In the old days, profits which could not be reinvested by the corporation were paid out as dividends to the shareholders. This freed the shareholders to invest the profits in what they perceived to be new opportunities for financial growth.

Bryan Willman writes:

6. When you are small and have few or no external stake holders, you can take large risks. When you have large and have many loss averse external stake holders, you cannot.

In other words, partly an effect of size and concentration.

Glen Smith writes:

I see more minimization of loss strategies in my corner of the technology world as opposed to minimization of risk. That would seem to point to number 3.

Tom West writes:

I tend to think (1) with a healthy dose of (4).

There may be some big innovations down the road, but shooting for those is akin to buying lottery tickets rather than sane investing. It's why it's a small(er) company that's going to find them, if any do.

Also, if things turn bad later on, trying to get back the money you paid out in dividends earlier on is pretty tough, so the "prudent" thing to do is keep the money for a rainy day.

SteveBlitzer writes:

The cash is there to buy potential competitors or make strategic or defensive acquisitions. Far from being a sign of a lack of innovation, it's a sign that Google and Apple fear innovative competitors.

collin writes:

I vote 5. and the tech companies seem to be about 10 -15 years behind pharma here. They not only lose focus on R&D dollars but create big R&D bureaucrasies.

Secondly, I think there is a fear of tech companies are becoming so big like the banks where they can not rightfully control the success in all areas. Look at Microsoft here.

CR

Michael Rulle writes:

Trained as a "dividends don't matter" guy, it took me sometime to reject this notion. Companies who generate cash hoard it. Management wants the flexibility to use it when it wants to. My bias is to believe great companies have one great idea which they grow and then milk to success over many years. (Coca Cola is a super star in this matter).

Problems develop when these companies believe they are smart enough to develop, copy, or create other great ideas (Microsoft). I think this is really hard to do.

Companies should pay 50% or more of their earnings to shareholders in Dividends. When they really have that super great new idea, and they are forced to return to the capital markets to sell it, owners and potential owners, not managers, can determine if it is worth it.

In fact, I think all companies should be financially structured similar to REITS, paying the majority of earnings in Dividends. We can eliminate double taxation while we are at it. Managers interests are not the same as shareholder interests. Somehow the public markets have lost power to managers.

Silas Barta writes:

@Bryan_Willman: That explanation wouldn't work for Google, in which two people still hold a >50% stake in the company.

@Michael_Rulle: If they have to come back to the capital markets for cash, they won't be able to respond nearly as quickly to new opportunities. What's worse, they'll be forced to tip their hand regarding the new innovation and lose the returns to prescience.

Jardinero1 writes:

Silas,

few companies ever move past the core business which made them big and profitable in the first place. If the core business is generating wads of cash and management can't figure out what to do with it, then management is duty bound to pay that to the shareholders. I doubt seriously that Google is going to stumble upon some new innovation that will require a short term investment of 50 billion or even 40 billion or even 30 or even 20 or 10 or 5 or even two or one. So Google would be fine if it paid out 20 or 30 billion in dividends over a four or five year period.

Dave Schuler writes:

@Michael_Rulle is one the right track. Public corporations have obligations that households don't; the analogy is mistaken. If, as Thiel suggests, Google has run out of ideas, the company is obligated to distribute the cash in the form of dividends rather than sit on it. When they do the individual shareholders will have the opportunity of spending it or re-investing it to maximize innovation and production.

The key problem, as Silas Barta notes, is that Google is really a private company masquerading as a public one. There's a basic problem of corporate governance and it's not unique to Google. Other companies sitting on large cash pads, e.g. Apple, have the same problem of corporate governance.

It's bad for the other stockholders and it's bad for the rest of us.

Glen Smith writes:

Yep, people need to remember that the 50B Google is sitting on is pretty much analogous to a tax free savings account. This is true for many corporations where the cash they sit on amounts to a tax free savings account for their biggest shareholders and even a way for those shareholders to defer and even eliminate taxation on their real incomes. Further, while management of other business may have a obligation to distribute cash if they have no idea how to use it for the business, they do not necessarily have any incentive to do so.

John David Galt writes:

The answer is obvious, and it's (4) and has been since at least 2008.

And there is no such thing as risk-free securities (and those traditionally so labeled, in both the US and Europe, are clearly about to collapse like a house of cards -- and no one wants to be left holding the Old Maid).

Both the dollar and euro (as well as real estate in most parts of the world) need to go through their predictable, natural price readjustments to give us a marketplace stable enough that it will once again be safely possible for anyone to invest. So long as government people deny this reality and work to postpone the adjustments, the depression will continue.

Anthony writes:

Steve Blitzer is at least partly right, though I'm not sure it's entirely a function of fearing innovative competitors. Cash hoards that large and a reputation for acquisitions will spur innovation in related fields - VC money and going public are not the only end-games for new tech ompanies; being bought by Google (or Apple, or Microsoft, or Oracle) is another possible end-point. Knowing that Google has $50 billion to spend to buy your company is a big incentive to try to develop something innovative. So by using that money once in a while to buy up a Blogger or Picasa or Keyhole (Google Earth), people outside Google will take bigger risks to innovate.

Jonathan writes:

Part of it is likely to be tax/accounting-motivated. For a good, short explanation, see here.

However, that doesn't explain why the offshore money isn't being put to other, more productive uses - a phenomenon which likely boils down to some combination of 1 and 3, enhanced by a natural impulse towards empire-building.

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