Dialogue: Time shareholders had a bigger say

By BRUCE SHEPPARD*

No one should underestimate the importance of an efficient capital market for a healthy economy.

Without an efficient capital market, it is difficult to raise capital to exploit new opportunities for the common good, or to form meaningful associations between individuals who wish to pool capital for such a purpose, or for the providers of capital to trade with each other efficiently. Where a capital market is inefficient, confidence in investment is eroded and all members of society suffer accordingly.

Before looking at the need for a shareholders association, it is worth considering capital markets in more detail. What's wrong with our capital markets? What can be done to improve their efficiency? What role can shareholders play in improving that efficiency for the benefit of the community?

The main purpose of a capital market is to bring opportunity, capital and management together and to allow trade between the capital providers. If markets work efficiently, confidence grows, which in turn generates capital.

If management, as one of the partners in an enterprise, behaves with integrity and works with great industry and intelligence, shareholders will have confidence in the enterprise and the individuals concerned. Shareholders will then support the listed enterprise and its share prices will increase, feeding confidence.

The emphasis here is that management and the providers of capital are in partnership with each other, and the individual providers of capital are equally also in partnership with each other, and when all participants in such an enterprise behave with the utmost good faith towards each other, a content and happy partnership is created.

So, what's wrong with our capital market and its corporate participants?

Clearly, many companies on the New Zealand Stock Exchange are undervalued based on international ratios, and many are also well managed. For all that, over the last 15 years, the New Zealand Share Market has consistently under-performed compared with most other share markets.

In the main, our market performs badly because investors have limited confidence in either the market or the management of the companies in it. As a result, investors cannot be found for new issues, capital formation is frustrated, economic development is curtailed and share prices generally fall rather than rise.

This in turn delivers negative returns, which feed the lack of confidence. A negative confidence loop develops and the process continues.

In order for companies' intrinsic value to be recognised, this confidence feedback loop must be broken.

What contributes to negative confidence?

1. The New Zealand Share Market has mainly small companies (in global terms) with a domestic focus.

2. These rarely appear on international investors' radar screens. And companies without global brand recognition or technological advantages are unlikely to attract significant foreign support.

3. Many of our heavyweight companies have been run by management for their own benefit.

4. New Zealand companies are good export managers but often fail when trying to build business units overseas. Many managers seem to be motivated by personal greed and self-interest and lack the skills to expand their companies beyond the domestic market.

5. The Stock Exchange appears to believe that flexible rules (waived eight out of 10 times) are the best way to attract new listings and maintain old listings. In essence, it believes that the well-being of our market relies on a flexible regime.

Successful foreign markets adopt the view that rules should be made to govern the market efficiency for the benefit of all shareholders, and that these rules should be rigorously policed.

As a result, investors have more confidence and are prepared to take up new issues and invest in new companies more readily.

In turn, this delivers higher returns and better capital formation. At the end of the day, you judge which business model appears to work.

Most recent rights issues to shareholders and attempts at capital formation have been under-subscribed. In addition, if you can think of many quality new listings brought to our market in the last 10 years, tell me. I can't see them.

6. Government leadership has also been laissez faire. Shareholder remedies in the Companies Act are often "self help" while Government agencies have generally been under-funded, focusing on fraud detection and prosecution rather than monitoring and policing market efficiency and sharp conduct.

To sum up, I believe the New Zealand Share Market performs badly. Our companies do not feature on the international stage, virtually none of them has international brand recognition and very few of our corporate managers have shown they can build businesses with an overseas focus.

When this is combined with a poor track record of management, poor strategic/substantial shareholder integrity and poor private and public regulation of the market, the result is investor apathy and this feeds the loop further.

New Zealand institutions have shown limited interest in policing the corporates in which they invest because, for most of them, the investments in New Zealand companies are not significant.

Small shareholders have found themselves alone, isolated and disenfranchised, and and this had made them disinclined to challenge management.

Some of these fundamental problems can be overcome. The Government has already taken the initiative with a new takeovers code and promised reviews of insider trading regulations and disclosure requirements.

It has also indicated that agencies will get more money to police corporate activity.

Now that the Government has taken this lead, the private sector must follow.

1. The Stock Exchange must take a sharp look at its conduct and philosophy and study successful foreign markets.

2. Institutions must stop doing Wall Street Walks, and focus on becoming advocates for their own and their partners' interests in the companies in which they invest.

3. Shareholders need to feel that they have a say.

The role of the Shareholders Association will be to monitor corporate performance. It will expect companies and their managers to demonstrate the utmost integrity in their relationships with shareholders. In addition, the association will help to give shareholders a voice.

* Bruce Sheppard, chairman, Shareholders' Association.