Pearls and Irritations

In August this year the Governor of the Reserve Bank of Australia, Glen Stevens, told a Parliamentary hearing that Australian companies were being ‘too risk averse’ by focusing on sustaining a flow of dividends and returning capital to shareholders rather than investing in future growth.

Research by Credit Suisse shows that non-financial companies in the ASX increased dividends by $5 billion in the twelve months to June 2014 and cut capital expenditures by $7 billion in the same period. This month the Boston Consulting Group in a new report said that ‘Australian companies paid out twice as much in dividends as their global peers in 2014’. It also commented that ‘Australian companies have been increasingly paying higher and higher dividends over the last four years and therefore investing less over time in their businesses’.

But these higher dividend payouts are only part of the story. Instead of investing in future growth major Australian companies are engaged in large scale share buybacks. Companies like Telstra, Suncorp and Westfarmers have all been handing back money to shareholders in buybacks.

These trends in increased dividend payments and share buybacks suggest too much of a focus on short-term returns and lost opportunities for growth.

A major driver of these increased payouts to shareholders have been executive pay schemes in which remuneration packages are linked to short term business performance and share options. The same phenomenon has been occurring in the US. In the Harvard Business Review of September 2014, Professor William Lazonick at the University of Massachusetts said

‘Five years after the official end of the great recession, corporate profits are high and the stock market is booming. Yet most Americans are not sharing in the recovery. … The allocation of corporate profits to stock buybacks deserves much of the blame. Consider the 449 companies in the S & P 500 Index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings – a total of $US2.4 trillion – to buy-back their own stock. … Dividends absorbed an addition 37% of their earnings. That left very little for investments in productive capabilities or higher incomes for employees. … The Chairman and CEO of BlackRock, the world’s largest asset manager wrote in an open letter to corporate America in March “too many companies have cut capital expenditure and even increased debt to boost dividends and increased share buybacks…. Why are such massive resources being directed to stock repurchases? Stock based instruments make up the majority of the pay of [senior] executives and in the short term buybacks drive up stock prices. As a result the very people we rely on to make investments in the productive capabilities that will increase our shared prosperity are instead devoting most of their companies’ profits to uses that will increase their own prosperity.”’

The showering of shareholders with increased dividends and share buybacks is not helpful to the long term development of new capital investment and new jobs, but it provides enormous benefits to senior executives with shares or share options.

It is called CEO capitalism.

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