Investors pay heavy price for excessive regulation

By Michael Coote

Friday 15th November 2002

Risk aversion is the new agenda of businesses and their investors worldwide. In the normal course of events, risk is weighed up against return to make a judgment about whether to invest.

The pendulum seems to have swung in the direction of risk as the determining factor. A number of consequences hostile to investment returns are likely to follow. The effects will probably be systemic and long term.

So far as businesses are concerned, the unwinding of the excesses of the 1990s is creating a situation in which a small sure return is seen as more justifiable than a larger gamble. Company boards are more likely to function as compliance committees than wealth creators.

As a result, businesses are less likely to shoot for the stars and make their shareholders rich. If listed, such newly conservative companies will not produce the capital growth previously expected from equities.

Worldwide, there is a trend for greater regulation as governments react to public outcry over the equities bear market. It seems to make no difference what the political regime is. In New Zealand, under social democracy, an ingrained institutional opposition to capitalism is driving policies that can only reduce the return on investment and make this a less attractive country to invest in.

Yet in the US, surely the doyen of capitalism, a combination of litigation and legal changes is producing the same effect. Now is not the time to be in business where you are likely to suffer harsh judgment and public execution for simply human failings.

New Zealand has been urged to converge more with Australia as a regulatory role model for investment markets. Certainly, Australia is much more regulated. But is it demonstrably any safer to invest in? And what are the costs borne by investors to procure this supposed safety?

Regulation costs money. Every new compliance requirement adds to company expenditure and detracts from shareholder returns. The effects are likely to be regressive on smaller enterprises.

In some cases, the competitive forces that cause smaller companies to grow into bigger ones may be reduced for want of opportunities at sufficient risk level. Not only are the direct costs to business to be calculated but the indirect ones are as well.

Regulatory regimes are paid for by taxpayers or the regulated industries concerned. If by taxpayers, one more drag on the public purse is created. If by industries, they absorb these costs to the loss of their investors or pass them on in higher prices to consumers.

To live in New Zealand and watch the way in which shareholder wealth is casually destroyed by ever-extending legislation is to experience life in a madhouse. But other countries that should know better are doing the same thing.

Yet there is a trade-off between reducing the risks investors should take and increasing the returns they need to seek. An apparent lack of connection is evident in government thinking on this.

Governments around the world recognise their baby boomers must save more for retirement. Logically, the cost of doing business should be reduced to increase the rate of return on capital. In doing so, governments would diminish the amount of income it would need to pay in pensions via redistribution.

Conversely, if governments legislate increased costs to business, then savers must put more of their earnings aside. To do so, savers must reduce consumption, which in turn lowers company profitability and thus returns to saving shareholders.

Economic growth is hindered or, alternatively, if people do not save enough the state is eventually bankrupted.

The facilitation of effective retirement saving should be an overarching policy goal that influences policy decisions in other areas such as business regulation and investor protection.

But regulatory moves seem more to do with hindsight over money that is already lost than with the foresight implied in making retirement saving policy the defining framework within which other laws should be structured.

We cannot have our cake and eat it, too. If individuals are to save more, and those savings are not so excessive as to deteriorate the return on capital of companies they invest in, then there can only be one rational conclusion: the state must commit itself to eliminating all arbitrary and unnecessary costs to doing business.

The amount of regulation should be a reason to decide whether to invest in an economy. On the face of it, a highly-regulated economy should look like a safe bet. That, indeed, is how many economies sell themselves.

But it should be apparent from the collapse of the already highly regulated US sharemarket that no amount of lawmaking will remove risk from an investment, and that if avoidance of risk is made by law into a business objective, then returns worth having are unlikely to result.

Where this leaves investors is to look to the Wild East, the Asian economies about which we have heard so many bad things because of apparent lack of legal controls.

The argument against freewheeling Asian economies has collapsed since the supposed paradigm of capitalist probity, the US, imploded over issues of greed, corruption and incompetence.

Investors need to recognise risk is proportionate to return. If they want higher returns, they must take more risk.

In particular, they should stay away from markets that have been regulated witless by a climate of fear and punishment.

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