RBA

One of the tenets of contemporary capitalism is that when it comes to capital, companies can’t be trusted — that shareholders know better, especially when it comes to handling and investing the cash that companies generate. Shareholders should be continually rewarded through dividends and share buybacks — it’s called capital management and the mere mention of the phrase in a company’s statements (a special dividend or capital return) can send the shares higher, while a noted reluctance to engage in the process can send shares sharply lower in a matter of hours.

In Australia, we have the added drive of fully imputed dividends to make capital management even more appealing, and a $2.3 trillion pot of gold in our superannuation system. That makes for an attractive target for investment managers, analysts brokers, investment bankers, accountants and all sorts other fee merchants and coupon clippers — along with the corporate executives whose remuneration is linked to share prices they can goose with a share buyback.

In August, we looked at what appeared to be hard evidence that Australia’s financial markets were becoming markedly less efficient at capital formation, based on some fairly brave research by Industry Super Australia that questioned one of the key rationales of compulsory super. Markets had become significantly more interested in chasing equities rather than new, productive investment that created growth.

Now it appears the Reserve Bank might have similar views on the tendency of the investment community to send companies the wrong message on priorities — especially when it comes to capital management versus investment. In a speech in Sydney yesterday the bank’s deputy governor Guy Debelle suggested shareholders rather than company board or managers posed a problem for much-needed private investment:

“Investment could be held back if firms have become more risk averse or if they have reassessed the likelihood of bad outcomes. While it is difficult to differentiate between these two, there are some signs that suggest that one or both have changed post-crisis. Liaison (by the RBA) suggests some managers are less willing to take risks, and have tightened investment criteria since the crisis. Companies have reduced their gearing and increased their cash holdings, and hurdle rates remain relatively high despite falls in borrowing rates.

“Related to the latter point is that there are some indications that the stock market is rewarding cost reduction rather than investment spending where the payoffs are multi-year rather than immediate. That is, the risk aversion may be coming more from shareholders than a company’s executive or board.”

Debelle went on to note, crucially, “there appears to be a desire to have ‘excess’ capital returned to shareholders through buybacks and dividends, rather than utilising that capital for investment with uncertain returns.”

His comments came on the same day as  a group of academics suggested dividend imputation could be cut to fund corporate tax cuts. That is not a new idea: back in 2006, Nicholas Gruen suggested dividend imputation could be ended on efficiency grounds:

“… given dividend imputation’s apparent inefficiency in reducing Australia’s cost of capital, Australia can sensibly finance a lower company tax rate through the abolition of imputation. Company tax could be then lowered by as much as 11 percentage points – which would reduce the company tax rate to 19 per cent. The subsequent increase in economic growth could allow an even lower rate over time. This would make a major contribution to economic growth without adverse equity effects.”

That argument seems to be one the RBA would not object to. But it is certainly one that would be very much rejected by those in the financial community that Debelle was aiming at.