Investors are revolting

Thursday 9th November 2000

Failing shareholders has cost New Zealand nearly $7 billion

By Joseph Healy

They rule with an iron fist in America, Britain and, increasingly, around the world. They're hunting complacent chief executives in Germany, France and Italy. And you can even hear them asking rather indelicate questions of Japan's imperial corporate leaders. This isn't news. Your company is already at the altar of shareholder returns.

This is what US business thinker Gary Hamel wrote about the increasing power of shareholders in his excellent book Leading the Revolution (HBS Press, 2000).

So it's somewhat perplexing to anyone who believes in the supremacy of shareholder interests that there are those in corporate New Zealand who seem to see shareholder interests as secondary to other priorities. The savings of New Zealanders have been, and are being, invested in businesses that then use those savings in a way that erodes wealth. One might argue that our much-heralded savings problem is, in fact, an investment problem.

New Zealand shareholders are being disadvantaged by a series of corporate failings, not all of which are unique to New Zealand:

Corporate values that reward company size and ignore any link to shareholder value (see "Why CEOs are paid badly", Unlimited October 2000);
Executive incentives that are unaligned to shareholder interests;
Other shareholder agents who fail to constructively use their "voice" to bring about better governance;
A sterile and often legalistic view of corporate governance that has more to do with the administrative duties of the board than their fundamental economic duty as agents of shareholders;
The dominance of accounting and legal skills over rigorous economic thinking and entrepreneurial/innovative flair;
The role of banks and the equity markets in financing and monitoring wealth creation; and
The fact that our high dividend policies are essentially liquidating many businesses. Had our public companies re-invested profits paid out as dividends into growing their business since 1991, I estimate (based on a post-tax cost of capital of 12%) that the NZSE would be worth close to $7 billion more than it currently is.

Simplistic one-liners serving only to derail meaningful debate? Possibly. But the erosion of savings that these failings are helping to produce comes at a significant opportunity cost to us as individuals and to the economy as a whole. This "wealth affect" has ramifications that influence not only our current stock of wealth, our consumption and borrowing habits, but the taxes we pay and our future pension assets.

Using economic value added (EVA) as a proxy for shareholder wealth creation - essentially sustainable net operating profit after tax, less the cost of debt and equity capital - the performance of corporate New Zealand (with a few notable exceptions) does not make good reading (see "Wealth erosion" table).

Corporates are failing shareholders

When aggregated over nine years, total wealth erosion from our top 40 companies has been approximately $15 billion, $18 billion with Telecom excluded. And that ignores Brierley Investments which lost some $4 billion of wealth alone over that period. These numbers are staggering, given the total current NZSE40 market capitalisation of $46 billion. When extending this analysis to a database of 500 companies (private and public), the loss in 1998 was $6.5 billion. The ANZ Bank is in the process of updating research for 1999. Don't expect to see much change.

The EVA logic is simple: unless a company is creating sufficient sustainable profit to cover its cost of equity - the risk-adjusted return required by shareholders - then it is not making a profit at all, despite what the traditional accounting statement or tax authorities might say. Economists have long understood this.

In global product and financial markets, it is not viable for businesses to continue to erode shareholder wealth. Rational investors go to where expected returns at least equal their risk-adjusted requirements.

There can be no doubt a major part of the explanation for the exodus of capital from New Zealand is the disappointing performance of our major corporates in creating shareholder wealth.

Just compare the performance of our NZSE40 index relative to other Anglo-Saxon OECD markets, even after taking into account Telecom, which has been a dominant positive influencer (see "Where has all that value gone?" table).

Competing priorities

The reason why companies must see shareholders as supreme is intuitively obvious. To achieve outcomes beneficial to shareholders a company must ensure that the interests and needs of other stakeholders are also met, if not exceeded. No business entity, even a monopoly, can sustain growth in shareholder value unless it cultivates excellent employee and customer relationships.

In a well-managed business, there is no need for a trade-off here. As Harvard professor Michael Jensen recently stated, 200 years in economics has told us that social welfare is maximised when each firm in an economy maximises its total market value (monopolies excluded).

The problem with many New Zealand companies is that they believe they have competing priorities, so that value systems, focus, responsibilities and accountabilities become blurred and ultimately no one wins. Disillusioned shareholders leave, asset prices deflate, companies are taken over, jobs and customers are lost.

If, as Hamel says, companies are already at the altar of shareholders, there's a good deal more kneeling to be done.

Joseph Healy is a director and head of corporate finance and private equity at the ANZ Bank. Email him on healyj@anz.com

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