Monday, October 4, 2010


In writing this article, I feel like a solitary and forgotten soldier in a trench - the enemy in front and the threat of friendly fire from the rear. So I hope a white flag will be respected just long enough for me to state a case before I fall prey either to an enemy bullet or misguided shelling from behind. For what I want to explore is perhaps the unthinkable to many: the inherent benevolence of shareholding.

There is a principle in free enterprise which has been its most laudable attribute and the mainstay of its defence. That attribute is that it is the best and most efficient way of moving resources to where they are most needed. Many argue that the fact that it has not done so, as evidenced by the severe imbalances in the world today, is an indictment of the “system” itself. My response is that a laudable concept was severely perverted by reliance on, indeed the encouragement of greed, acquisition and unbridled consumption. At the same time I have presented the case for the opposite: the rescue of this approach by a re-examination of motive based on benevolence in turn founded on the basic rules of transaction.

One of the most essential functions of an efficient market is to move private “capital” to where it is most needed in the production of goods and services and as a contributor to creating tangible value. An expanded view of its role includes the facilitation of demand through debt and to enable the transfer of risk through derivatives such as futures and options. The latter, first recorded in the 3rd-century BC was seen as a benign method of promoting market efficiencies.

It paints a pretty picture from a space shuttle. Money flows to people to make things, to others to help buy things, and then to a few speculators to reduce some of the stress. Well, back on earth we can see that it all went terribly wrong. Globally, debt has exploded to what many believe is unmanageable levels estimated at about $64 trillion in public (government) debt alone and $700 trillion in notional amounts in derivatives, in turn geared to create 70% froth in the cappuccino economy. Investment in productive capacity, where customers are served, tangible value is added and jobs created, has been left behind like a Cinderella in rags. The Financial Times reported recently that since their founding in the 90’s the hedge funds Quantum and Paulson have together made more money than either Walt Disney or McDonalds. Business Report columnist Anne Crotty (BR15/9) has likened the industry to a dung beetle that has assumed a dominant position in the body from which it previously fed. “The tail is now wagging the dog”. Competing for capital has put pressure on companies to maximise short term shareholder returns.
Since the days of moving from barter, capital, whether in sea-shells or shillings, has always been part of the inescapable process of wealth creation. Broadly today, the production of goods and services in private hands has to obtain capital either through debt via financial institutions and others, or through share capital. This can range from getting money from a few pals to issuing a large number of shares for sale to the public on formal exchanges. Sometimes it starts with a few pals, and ends with a huge corporate with millions of shares widely held by a number of investors. South African legends are Pick ‘n Pay and Liberty Life.

While most of the media and investor attention is focussed on returns in a reward context, it can and has to be seen also as relative measured contribution. This contribution is the use of the capital. Ownership is always retained by the investor. One has to exclude share appreciation as part of the operational reward because this reflects the investment risk and reinvestment. It is similar to an appreciation of any other asset such as property or hard assets. This is in any case only realised as a profit or a loss on the sale of the asset, at which time the operational reward (and contribution) passes to someone else.

clip_image002I tried to resist showing my Contribution Account “cartoon” again, but I am more drawn to it in discussing shareholding than with the others – labour and state. The account shows that at 35% on average (again depending on the type of business) shareholders are second to Labour in the measured contribution to wealth creation. Because of the very different implications, the shareholder contribution is split between savings (retained income at 20%) and payout to the owners (dividend at 15%). The latter is also a deviation from the standard value-added statement, which adds interest and refers to it as “providers of capital”. All of the financial executives I worked with agreed that interest was better classed as an “outside cost”.

The two great attributes of capital’s contribution are: it’s willingness to reinvest a large part of its reward back into the company as reflected in the ratio between retained income and dividend; and being the last to get its share of the pie. But apart from the use of capital and exploring growth opportunities, shareholders appoint leadership and through the board guide the company’s strategic direction. This aspect has highlighted a crucial aspect of shareholder motive. If it is share price only and maximum return in the shortest possible time; and they appoint a predator in the chair with all the incentives to achieve this, they could find themselves feeding off a rancid carcase or facing Crotty’s giant dung beetle.

Then there is accountability: a debate that is long not exhausted and so far has not been fully addressed in the discussions on governance and the King reports. The “Propriety Limited” concept has served market orientated economies well. But as bizarre and extreme as it seems, under growing social pressure and increasing legislative controls, the day may come that, for example, the ageing former registered shareholders of a Union Carbide are called to account for having a vested interest in the company at the time of the Bhopal incident. The debate around contaminated underground water in South Africa has a smack of frustration that former shareholders in the culpable but now defunct mines can no longer be held accountable for the damage.

clip_image004As to shareholder motive? These are as varied as the compositions of shareholders are: from the single owner of a gardening service to the quoted corporate giant; from the institutional investor and pension fund to the portfolio manager and individual home based trader. The old strategic wisdom of “short term profitability for longer term wealth creation” may be making a comeback with the focus on sustainability. But I believe one thing is consistent: the intrinsic contribution of share ownership in companies that make a positive difference to our lives. Guided by this litmus test investment can be as, if not more successful, than if it were guided simply by numbers. Enron for one would not have looked very attractive whereas Capitec does. The real power of shareholders, as in all else, lies in the contribution they make within the guiding rules of legitimate transaction. Irrespective of motive, behaving this way gives a head start: sincerity a giant leap. Good share investment is rooted in the idea that you invest in a company as if it were your own; that the best holding is forever; that you judge company leadership by their honesty, ability and passion for the business and that you understand the nature of the business. Sound familiar?

I have now dealt with all three contributors to wealth creation. Although their proportional contribution varies from time to time, company to company, and sector to sector, there is no hierarchy of importance. As hackneyed as the concept may appear, they are a team that works at its best in giving the best of themselves for a common purpose of service to others.

I believe it is possible at the level of wealth creation to create pockets of excellence and a large degree of protection against contamination by external financial viruses, policies, ideologies and conflict. It is at this level too that one can effect meaningful change that could influence the surrounding environment. The wonder of the universe lies not in its infinite vastness but in a single atom.

This post can also be read on MONEYWEB

1 comment:

  1. Jerry, I do like your thinking, especially around the principle of motive based on benevolence, founded on the basic rules of transaction...and your ending statement.