Spendthrift culture weakens investment

In the final of a three-part series, business editor JIM EAGLES investigates the costs of not reinvesting profits.

The high-dividend policy followed by most New Zealand companies in recent years has clearly been at the price of reduced investment in growth.

But has that lack of investment had a wider impact on wealth creation and the economy?

John Redmayne, a director with PricewaterhouseCoopers, has no doubt about the effect on the sharemarket.

"In crude terms," he says, "if the dividend yield in the US is 1.25 per cent and in New Zealand it is 6.2 per cent then their sharemarket is going to go up by 5 per cent a year more than ours."

The ANZ Bank's corporate finance department has calculated that if all the dividends paid out by listed New Zealand companies since 1991 had instead been invested in business opportunities returning the weighted average cost of capital of 12 per cent per annum, the NZSE's market capitalisation would be close to $8 billion higher.

In other words, the market index would have risen by a further 17.5 per cent, making it one of the fastest-growing in the world in the past 10 years.

Needless to say, that is a totally hypothetical proposition. But it does serve to highlight that there is an opportunity cost in handing back profits to shareholders instead of reinvesting them.

Dr Graeme Camp, a former share broker who is now a lecturer in accounting and finance at Auckland University's business school, is convinced that the high-dividend approach has been hugely damaging not just to the sharemarket but to the New Zealand economy.

"The end result of free cashflow being distributed in the form of dividends rather than being reinvested in business opportunities is that we miss out on a lot of economic growth."

In a sense, money which could have been used to develop local factories is instead spent on imported goods at The Warehouse.

"Put simplistically," says Dr Camp, "consumers are not offered a choice between imports or locally produced products, when the latter would develop factories or services which could create jobs, earn foreign exchange and generate wealth in our economy."

Dr Camp argues that the problem lies with directors focusing too much on tax issues and not sufficiently on how best to create wealth for shareholders.

"The best use of a company's cash resources, from the perspective of maximising shareholder wealth, is to invest them in ventures which will produce an attractive return, and the tax issue ought to be secondary," he says.

"Furthermore, that outcome is also the most desirable for the economy."

Paul Conway, senior economist with WestpacTrust, believes the key impact of dividend policy in New Zealand is on "who does the spending: companies or shareholders?

"In the US, where corporates retain most of their earnings, they are the ones doing the spending and they tend to put the money into productive capacity.

"In New Zealand it is the shareholders who get the money and, being consumers, they are more likely to consume it.

"Obviously consumer spending does have benefit but, over the long term, I'd say the overall impact of having spending decisions taken by consumers rather than companies is less beneficial to the economy."

It is, he says, disappointing that New Zealand companies seem unable to find worthwhile opportunities to invest their profits because it is "certainly detrimental to economic growth".

Mr Conway says the statistics show that the quantity of investment in New Zealand is quite good but it tends to be funded not by retained company profits but by "new capital inflows from offshore".

That rather exacerbates New Zealand's well-established inability to fund its own capital requirements.

Or, as Mr Conway puts it, "We don't save enough to fund our own development so we have to borrow the savings of foreigners."

Over time, the consequence is high levels of both overseas debt and overseas ownership of New Zealand companies.

"There are some quite complex issues involved there," Mr Conway says, "but I would argue that the overall impact is not beneficial to our economy."

Joseph Healy, head of regional investment banking and private equity at the ANZ Bank, believes it is such an important issue that he is writing a book on the topic.

In a draft opening chapter he suggests the present focus on dividends "requires a fundamental rethink."

"The evidence suggests that our high-dividend culture is part of our sub-optimal performance problem."

The problem, as Mr Healy sees it, is that the high-dividend habit is "resulting in the systematic liquidation of the growth value in many businesses ...

"The trade-off is often lower levels of investment, lower R&D, lower levels of risk-taking, short-termism, lower innovation, etc."

Mr Healy readily concedes that there there are no universal truths on dividend policy which apply to every company.

His concern is that the high-dividend model has become the norm in New Zealand.

"For businesses with little hope of growing value in the future, this is appropriate; for many other good businesses it is inappropriate."

International literature on the issue takes a similar view.

One of the leading textbooks on the topic, Principles of Corporate Finance, devotes a whole chapter to analysing the dividend question, only to acknowledge that there is no definitive way "to resolve the dividend controversy".

Its authors - Richard A. Brealey, of the London Business School, and Stewart C. Myers, of the Massachusetts Institute of Technology - conclude: "Many people believe dividends are good; others believe they are bad; and still others believe they are irrelevant.

"If pressed, we stand somewhere in the middle - but we can't be dogmatic about it."

But what is clear is that a country where companies normally reinvest 72 per cent of their profit in growth opportunities is likely to see more economic expansion than a country where companies reinvest only 18 per cent of profit.

That should be a cause for concern by all New Zealanders.