Investor Focus Trend Pays Off

Although maximising shareholder value is widely accepted in Australia as managements' paramount goal, the chorus of dissent is growing louder.

The dissenters lament is that shareholder value comes at others' expense leaving, in its wake, higher unemployment and slower growth in the long term.

A new study by the McKinsey Global Institute should subdue the sceptics.  The study based on the performance of 2,700 companies from 20 countries over 10 years, found that shareholders and job seekers have a common interest:  high returns on capital.

The study shows that creating shareholder value is easier said than done.  Even in the US, where firms are very focused on shareholders' interest, only 55% of all firms and only 10 of the 50 largest firms studied generated above-expected returns for their shareholders over the 20 year study period.

In Germany -- the home of stakeholder capitalism where shareholder interest ranks on -- parr with that of management and unions -- less than 18% of companies performed above expectations.  On average, German companies under-performed by about 38% -- that is, their return, on average, fell 38% below expected yields.  The average continental European firm also achieved far below expectation.

The poor market performance of companies in Europe was not just the result of slower overall economic growth.  Indeed the study found that even after adjusting the data for macroeconomic conditions, the performance of continental European companies was 20% below expectation.  Whereas companies in the US, Canada and Australia, on average, performed about 10% above the return that prevailing macroeconomic conditions would have led one to expect.  Interestingly, the outstanding performance of companies in the erstwhile "tiger" economies of Asia -- Singapore, Malaysia and Thailand -- during the study period (1975-94) was almost entirely the result of a booming economy rather than the superior performance of management.

The study found -- not surprisingly -- a strong relationship between maximising shareholder value and productivity.  Companies which achieve above-expected returns also achieve above-average levels of productivity.

Importantly, however, it also found a strong statistical relationship between shareholder focus and job creation.  The negative shareholder spread in Europe was associated with an unemployment rate of about 2.5 percentage points above that expected, given macroeconomic conditions.  In contrast the US, Canada and Australia have cut their unemployment rates by 2 points by delivering more shareholder value.

What this means is that through maximising share values and productive firms also create more not less employment over the long term.

Indeed the study found evidence of a virtuous circle where a focus on shareholder value boosts productivity, employment and economic growth and in turn these outcomes give an additional boost to shareholders'.  Indeed it found that this "multiplier effect" will, over time, double the size of the original increase in shareholders value.

What this means for Australia is that we are on the right track.  Reductions in tariffs and other protective barriers have forced companies to set their benchmarks higher.  Corporate governance has become more transparent with management incentives more closely aligned to shareholder expectations.  Privatisation has increased the amount of capital under shareholder control and we are largely free of the concentration of ownership which characterises much of Europe.

This may mean tough times the corporate management, but it also means more jobs.

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