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New Zealand's MISSING billions

Friday 28th April 2000

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Vanishing value
The market has haemorrhaged billions of dollars in shareholder value - what is being done about it? NICK STRIDE reports

The figures hit the headlines but the message did not.

During 1999, the companies making up the NZSE40 share price index destroyed $1.2 billion of value. Since 1991, excluding Brierley Investments, the annual economic value loss has totalled $14 billion. Add BIL and it is $17 billion. Take out Telecom - one of our few value-creators - and it is $20 billion.

To put this into context the market capitalisation of all listed companies is around $50 billion. The loss of shareholder value is the main reason our sharemarket index has trailed the rest of the world and to ANZ Bank's Joseph Healy it is "deeply concerning."

"This is not a matter that lends itself to a laissez-faire approach," says Mr Healy, the crusading head of corporate finance whose department produced the figures. "Where is the pressure for change going to come from?"

In a February presentation to the Treasury Mr Healy called for the establishment of a working group to look at what can be done about the vanishing billions.

It is not just an issue for big companies and their shareholders. This country stands near the bottom of Organisation for Economic Co-operation and Development (OECD) league tables and Mr Healy believes there is a link between corporate New Zealand's "hugely disappointing performance in creating shareholder value" and our economic plight.

"We are, after all, producing a substandard return on scarce economic resources," he says.

ANZ's wider study took in 500 companies with turnovers starting at $10 million and aggregate turnovers of $90 billion. It included the bank's clients and almost all the public listed companies.

Its analysis of their performance rests on the concept of EVA (economic value added), the amount of value firms create in excess of their cost of capital. In competitive markets, Mr Healy says, most firms are expected to earn up to their cost of capital. Those that do not are destroying value.

But of the 500 companies ANZ reviewed, only 34% covered their cost of capital. And 5% of them accounted for 60% of positive value added. In EVA terms they collectively lost $6.5 billion, or 7% of gross domestic product, in 1998 alone.

The problem, Mr Healy says, is not confined to boardrooms. It extends into executive row, into Parliament and into newsrooms and sitting rooms. He calls it "a structural problem - a systematic failure in corporate governance."

Corporate governance, he explains, is more than just the way boards direct their senior managers to run companies. It encompasses all the forces that influence the way directors and managers act, including banks, capital markets, law and regulation, shareholders, the media, and public opinion.

In this country, he contends, none of these forces is exerting the influence it ideally should. The result is "a fundamental lack of management focus on managing shareholder value."

One problem is board and management "fixation" with accounting-based multiples as measures of success.

"It's quite staggering in this day and age of almost revolutionary change in many industries and markets that people still apply EBIT or EBITDA multiples to determine value", Mr Healy says.

"Multiples restate the existing market view, perpetuate errors of judgment, miss areas of risk and also miss areas of opportunities."

Not everyone agrees EVA is the critical measurement.

"Certainly [accounting-based] measures have limitations. What really counts is return on equity," Business Roundtable executive director Roger Kerr says.

"But I would hope that any competent director or executive understands their limitations. EVA is not magic either and one should always be cautious about overenthusiasm for it."

Institute of Directors chief executive David Newman is also cautious. "I think EVA's important but I don't think it's critical. CEOs and boards look at other measures. Any board that locks itself into one particular measure is going to find itself fixated while other things move away from them".

Mr Newman suspects the same exercise done in the UK or Australia would show similar results. ANZ agrees but says that does not mean we should ignore our own problem.

Nor is there general agreement that companies are deficient in EVA analysis.

John Cairns, head of research at Cavill White Securities, says he struggles to identify top-40 companies that are not using economic measures. "Look at Carter Holt Harvey. Everything [chief executive] Chris Liddell has done has been on a cost-of-capital basis."

Forsyth Barr head of research Neil Paviour-Smith agrees. "I think you need to look elsewhere. A lot of companies have used EVA as a tool."

Mr Healy acknowledges economic value is not the only useful performance measure. But insufficient focus on it has distorted companies' decision-making, he says.

Examples are a high level of dividend payouts, consequent underinvestment in research and development and the high fixed component of managers' pay.

ANZ's proposed working group would have representatives from the Stock Exchange, directors, accountants, institutional investors, the Treasury and perhaps the Reserve Bank or Ministry of Economic Development. It would look, among other things, at the merits of a statutory requirement that public companies report EVA to their shareholders.

Mr Kerr is opposed, saying it is up to individual boards what measurements they use. So is Forsyth Barr's Mr Paviour-Smith. "The more you get government involved in business the worse it gets."

A powerful potential supporter is John Hagen, chairman of Deloitte Touche Tohmatsu and of the Financial Standards Review Board, the government body that approves standards before they become law.

"My initial reaction is to favour it. We should certainly be looking at it."

While there is disagreement with ANZ's analysis of the extent and cause of New Zealand's value loss problem few, it seems, argue with its thrust. "As a general comment I think ANZ are on the mark," Mr Paviour-Smith says. "I haven't heard anybody questioning the general picture ANZ's work paints," Mr Kerr.

Says Mr Healy: "To get out of the so-called 'foothills' of financial management requires some hard decisions and some real leadership and vision if those slogging it out are going to improve the lot of their shareholders."

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