Strategic Control and the Role of Executive Compensation in the Innovation or Financialization of Firms

Hopkins, Matt

Abstract

Economists look to the middle of the 20th century as a period wherein the U.S. economy, driven by “Old Economy” firms, produced greater economic equality and strong economic growth. Since the 1980s, in spite of the development of “New Economy” firms, there has been a trend toward greater inequality, employment insecurity, and reduced productivity. The shift is in part a result of the ongoing financialization of the firm, which entails incentivizing top executives to adopt resource allocation strategies to boost stock market yields rather than plough profits back into innovative enterprise. As a result, top executives risk eroding or destroying productive capabilities built over decades. The broader financialization of the U.S. economy affects both “Old Economy” firms active during the post-war years and “New Economy” firms which grew to prominence toward the end of the 20th century.
Financialization generally occurs when firms complete an historical transition from “retain-and-reinvest” to “downsize and distribute”: instead of retaining corporate revenues to reinvest in productive capabilities, top executives use their power to allocate resources to engage in layoffs and divestments which raises cash to increase distributions to shareholders in the form of stock buybacks and dividend payments. In this thesis I argue that financialization as a mode of value extraction exists in tension with innovation as a mode of value creation. The Theory of Innovative Enterprise (TIE) posits that innovation is the process of producing higher quality, lower-cost products than previously were available. As key members of the firm’s strategic control, top executives support innovation by using their power to allocate economic resources to satisfy the social conditions of innovative enterprise: strategic control, organizational integration, and financial commitment. Executives, assuming they have the ability to invest in innovation, may face significant pressure and incentives to financialize. Financialized resource allocation by definition threatens financial commitment as a social condition of innovative enterprise. The tension that arises between the need to invest in innovation and demands to financialize was increased by the rise of an active “market for corporate control” that developed during the 1980s through U.S. stock exchanges. The resulting imbalance of power over resource allocation decisions means that certain corporate insiders and outsiders may be positioned to extract value from the firm in excess of that to which they contributed.
I argue that the tension between innovation and financialization is revealed through an historical analysis of the firm’s changing strategic control. The strategic control of firms tending to “retain and reinvest” firm resources into an innovative strategy generate economic value that, following a strategic shift, serves as a basis for corporate financialization. As a process of value extraction, financialization has negative impacts on income, employment, and productivity of the economy. To contribute to the development of the TIE and the financialization debate, I conduct case studies of an “Old Economy” and a “New Economy” firm, rooted in the TIE, that operated in the Chemicals and Medical Device industries. I provide insight into the ways in which top executives, as evidenced by their strategic choices, invested in innovation or transitioned the firms to financialization. In a third essay, I apply the findings of my case studies to the problem of executive compensation. I find that, in lacking a TIE, and notwithstanding an almost systemic failure to measure executive pay correctly, both proponents and critics of high executive pay in the U.S. are unable to determine whether stock price changes that drive the compensation of executives in their efforts to produce “shareholder value” are driven by innovation, speculation, or manipulation. My findings from each case study support the “shareholder value” thesis as an important explanation for corporate financialization, a reflection of the ideological dominance of agency theory in framing the corporate governance debate. “Maximizing shareholder value”, as a still-dominant ideology of corporate governance in the U.S. argues that firms should incentivize executives to use their power to allocate resources to boost stock prices, including by manipulating them with open market stock buybacks. My findings suggest that policy makers should advance, in particular, regulations that ban stock buybacks as a means of stock price manipulation, stock-based pay as the primary form of compensation given to top executives, and reform compensation disclosure rules to ensure that actual realized gains, and not “fair value” measures, are the standard measure of executive compensation for the purposes of compensation disclosure.

Citation

Hopkins, M. Strategic Control and the Role of Executive Compensation in the Innovation or Financialization of Firms. (Thesis). SOAS University of London

• Thesis Type: Thesis
• Deposit Date: Jul 25, 2025
• Publicly Available Date: Jul 25, 2025
• DOI: https://doi.org/10.25501/SOAS.00552617
• Additional Information: 275 pages
• Award Date: 2024