John Menadue. Risk-averse business.

Jun 16, 2015

Current Affairs

The Reserve Bank has pushed interest rates to record lows but business continues to be reluctant to invest.

Capital investment will fall by a record 25% to $104 b. in 2015/16 compared with what companies expected to spend a year earlier. In the March quarter of this year spending by companies on new equipment and buildings fell 4.4%, the sharpest fall since the global financial crisis.

In this blog on 30 October last year, see below, I wrote about how Australian business was becoming risk-averse – rather than investing in new ventures it was handing money back to shareholders in share buy-backs and generous dividends. This was at a time when corporate profits were high, but apparently the animal spirits of business was in short supply.

The Reserve Bank governor, Glen Stevens, has been repeating his frustration about the timidity of Australian business.

The head of Corporate and Investment Banking at Citi said in the AFR on 21 May this year that the Australian share market has shrunk considerably over the last decade. He said that the All Ordinaries market capitalization had fallen from 1.2% of GDP a decade ago to 0.9%. He commented ‘Australian shareholders focused on getting their money back rather than reinvesting it. … There has been a loss of mojo in Australian boards. There is a conservatism compared to what we see in the US but also a short termism of our fund management industry. … The Australian Bourse is now a capital returns exchange and not a capital raising exchange.’

It is also significant that a lot of money is being made in property and not in areas such as manufacturing, services, transport, biotechnology and telecommunications. The recent 200 Rich List showed that almost half of our 200 most rich people were in property, retail and financial services. Almost a quarter of the richest 200 were in property. Clearly a lot of money is being made in the low value-added end of the business spectrum. It is often easy pickings for the rent seekers in the property sector to secure favourable zoning outcomes.

Business will claim that political uncertainty is the problem. And there is some point to that with the lack of credibility in the government’s budget repair policies and the highly political nature of so much of its infrastructure funding.

But a real problem is the short termism and lack of risk in large parts of our business sector. The frustration of the Reserve Bank is understandable that having pushed interest rates so low, the business sector is not responding with investment.

Repost: Australian business is ‘too risk averse’ (posted 30/10/2014)

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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