Mind over matter - compensation from the high technology industry

Reason, June, 1998 by James V. DeLong

Wherever you turn, every medium of communication is saturated with the terms information revolution and intellectual property. The root cause of the fascination is simple: Lots of money is involved. Both individuals and business organizations have become aware that their rewards depend increasingly on mental products - in the form of education, patents, copyrights, trade secrets, databases, computer-assisted employee cooperation, and general know-how - and less on machines, buildings, and raw muscle.

The size of the stakes would itself be enough to generate an explosion of interest, but another factor also counts: a high degree of uncertainty over who, exactly, will collect this loot. Will it be the individual inventors who generate the ideas? Teams of innovators? Entrepreneurs who translate concepts into commercially viable products? Venture capitalists? Long-term stockholders? Consumers? The obvious answer is that all these groups will share in the bounty, but this answer leaves a lot of latitude about the precise details of the split - and billions of dollars hinge on the answers.

Wall Street seems to assume that a huge share will go to the stockholders. When Nervous Nellies fret that current stock price levels are extraordinary by all historic measures, and hence ripe for correction, the bulls point to the growing importance of intellectual property and information. The familiar yardsticks of companies' value, they say, are based on old industrial models in which the most important assets were plant and equipment, plus some allowance for the value of an ongoing business. But, continue the bulls, as value becomes more dependent on a firm's mental assets and less on its physical embodiments, those old measuring rods lose cogency. From this perspective, current market levels reflect the future earning power of mental assets that are not reflected in old-style balance sheets.

Take, for example, Microsoft, the flagship of the armada of new companies whose value is almost entirely mind-based. Microsoft has 2.4 billion shares of stock outstanding and, at press time, is valued by the market at about $220 billion. The company's physical existence is minimal: It has about $12 billion in cash, investments in other companies, plant, and equipment. That leaves $208 billion as the value of its patents, copyrights, trade secrets, brand name, presence on Rolodexes of customers, and the brains of its 25,000 employees. You can pare the physical component of value down even further. Microsoft's existing products are worth almost nothing in the sense that if the company announced it was freezing its designs and planning no further improvements, its products would be obsolete in a couple of years - and the company's value would drop precipitously. Clearly, no analysis based on physical assets captures the essence of this company or others like it.

So you can make a serious case that almost all of Microsoft's value lies in the new-style form of information and intellectual property, and mostly in the brains of its staff. But while Wall Street bulls may be right about that, it's far from clear that stockholders will snag those brain-based earnings in the long run. Consider that, in 1997, Microsoft produced earnings of $3.5 billion. Of this, zero dividends were paid to the stockholders - the same payout they have gotten every year since the company produced its first earnings of a penny per share back in 1982. Employees, on the other hand, not only got their salaries, they also got 96 million shares of Microsoft stock, which they were entitled to buy at bargain prices under various option plans. The company spent $2.4 billion buying shares to meet this commitment, and if this sum were added to the company's wage bill, Microsoft's 1997 earnings would drop by two-thirds.

Roger Lowenstein, a columnist for The Wall Street Journal, cited these figures as an example of a general phenomenon that companies are "transferring ever-appreciating portions of their profits to workers...motivated not by warm-hearted charity but by cold-hearted reality. Capital is in surplus; skilled geeks are at a premium. No surprise that labor is grabbing a bigger share of the capitalists' pie." Indeed, Microsoft looks a lot like a cooperative venture of its employees. At the end of 1997, the officers and directors, the people defined as "insiders" by the Securities and Exchange Commission, owned 35 percent of the company's stock. Many lower-level employees also own shares. While the company will not say how much stock is held by employees other than the "insiders," it is commonly reported that at least 6,000 of them own enough to be millionaires. In addition, it is known, again through SEC-required disclosures, that employees hold options to buy another 22 percent of the stock, at an average exercise price of $21. In sum, then, we know that the employees have a claim on at least 57 percent of Microsoft's value, plus an additional unknown percentage for the shares already owned by the lower level-employees.