Friday 12th May 2000
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The original objective of ANZ's research was to understand why our equity market had performed so poorly relative to other Anglo-Saxon OECD markets, even after adjusting for total shareholder returns. At an early stage, we developed a number of hypotheses which our developing research has tended to support.
We then looked at the cause and effects and the linkages that exist within our economy. We concluded there are structural problems which, if addressed, could better enable our markets to operate more efficiently. This would allow the sub-optimal performance evident in our equity index, and other economic measures to be addressed.
We have no desire to make "stinging indictments." Rather our objective was to foster a debate on what we view as an important corporate and economic issue. To raise the profile of this issue and encourage business leaders to focus on it, we hosted two conferences over the past six months in conjunction with Stern Stewart & Co. (EVA is Stern Stewart's registered trademark).
At both conferences, we had Joel Stern, a world authority on shareholder value, as a guest speaker. Roderick Deane also played an active role and chaired the second conference. We extended invitations to some 700 senior business and policy leaders.
Economic Value Added (EVA) is not just critical, it is fundamental to how businesses should operate. Well run businesses know the importance of a "balanced scorecard" approach and the need to ensure the reasonable expectations of other stakeholders are met, if not exceeded. However, all measurement systems must ultimately support EVA. In a market based economy, there can be no question about that. Directors and executives are entrusted with other people's money; they must ensure they manage the affairs of the firm to maximise the value of that invested money on a sustainable basis. Those running businesses who have a different view, should publicly state that maximising shareholder value is not the top priority. Accountability to shareholders is really important.
There is a concerning misconception about the role of EVA within a firm. Most, if not all, sophisticated businesses measure EVA in some way. The problem is that the EVA system is often buried in the financial control routines and is viewed as a financial tool, rather than a motivational and behavioural tool. It is not a question of "understanding" EVA, or having some numbers in the monthly board papers. It is a question of centring the whole business value system on consistently growing and importantly tying executive compensation to EVA.
No EVA system, regardless of how elaborate, will work for shareholders unless it is a behavioural tool operating throughout the firm. The acid test here is the extent to which executive compensation is aligned to EVA creation. If there is no link, then EVA is simply an arithmetical calculation carried out by the folks in financial control and not recognised, let alone owned, by anyone else in the firm. It can be abstract and worthless.
Right now the statistical relationship between executive compensation and returns to shareholders is weak. There should be a strong positive correlation. The key point here is not what executives get paid, but how they get paid. The more million-dollar plus executives we have the better for everyone in the economy, so long as compensation is aligned to sustainable EVA enhancement.
Businesses are first and foremost economic not accounting entities. Yet our performance benchmarks and dominant analytical language is steeped in accounting conventions, paying little regard to economic measures such as the fixation on earnings per share and price/earning ratios can create flawed incentives and bad decisions. It is not obvious to any reader of financial accounts how well a business is managing all the factors of production critical to economic success. EVA analysis, done well, captures these key and fundamental measures. We suggest consideration should be given to making it mandatory that there is a commentary on EVA performance and how executive compensation is linked, in the annual report of public companies.
In trying to understand the causes and effects which have created the poor EVA performance in corporate New Zealand, we identified a number of structural weaknesses which are linked and can be grouped together under the heading of corporate governance. This goes far beyond the traditional narrower definition of corporate governance which concerns itself with the role of the board and the chief executive. We are defining corporate governance to reflect the forces that operate within a market to ensure a healthy dynamic tension in the monitoring of firms. In this regard, the media and public opinion is crucial.
Most important of all are active investors - institutional investors. In small domestic economies with shallow capital markets, the commercial banks also have a key role to play.
We argued the wealth erosion of the magnitude that we estimate is a matter that has a direct impact on the economy. If we are not covering the cost of capital, we are delivering sub-optimal returns on scarce economic resources. There are several direct and indirect consequences of this which effect the real economy. While certainly a private sector matter, the government has at least a stewardship role in developing the economy. This is not a matter that lends itself to a laissez-faire approach. There is nothing political about it.
In the UK and the US, government agencies play an enabling role in such matters. We have suggested government agencies should work with the private sector in understanding the issues, defining the solutions and helping put the architecture in place to help the solution work. This is a complex issue and there are different views.
No one is suggesting there are easy solutions or that there is a model that we should readily copy from other jurisdictions. What we should avoid, however, is placing this in the "too hard basket" or looking on it as someone else's problem. All relevant stakeholders have to be involved. After all, we share a common objective of increasing economic wealth.
The final point is that ANZ has a passionate interest in this topic because it is important to us that our customers are generating EVA and growing. As a major supplier of capital to corporate New Zealand, we feel a responsibility to work with customers to ensure they are getting all the assistance they need so that the link between EVA financial policy and strategy execution is coherent and seamless.
We won't hesitate to recommend against M&A transactions if we believe they will be shareholder value negative, even if there is a success fee at stake. We also believe that there is scope for major banks who are the dominant providers of capital in small domestic economies with shallow capital markets, to redefine their role in monitoring economic performance.
Joseph Healy is the head of Corporate Finance, ANZ Bank (NZ)
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