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03 June 2015

Shareholders Bear the Pain



There’s an ongoing argument in financial theory about whether or not investors want the companies they invest in to pay dividends. One side is obvious; if you put money into an enterprise, then surely your expectation is that it will produce a regular return? Well, yes, up to a point. The other side of the debate suggests that actually, you should be indifferent as to whether the return is in the form of a dividend or whether the enterprise is better to re-invest that money in the business, thus increasing its value and making your shareholding worth more. To obtain income in those circumstances, you would then sell part of your shareholding. The debate is complicated by the different treatment of capital gains and dividend income for tax purposes, but it is a legitimate issue for investors  - and therefore corporate entities - to consider.

A Damning Statistic

Both those arguments acknowledge the importance of investors as the providers of capital. Something I read recently suggests that in certain areas that relationship has been forgotten or wilfully ignored. In the banking industry, before the financial crash in 2008, for every £1 paid in remuneration costs, 75 pence was returned to shareholders in dividends. The latest figures are 2 pence returned against each £1 of remuneration. Now, there is clearly a distortion caused by the fact that the banks - at least those that have accepted governmental bail-out funding - are not entirely free to make their own dividend decisions, but that is nevertheless a pretty damning statistic. And the position outlined in the first paragraph doesn’t apply; there has been no significantly balancing share price growth. 

All Bankers are Evil?

I don’t subscribe to the populist view that all bankers are evil; most go to work, do their jobs as well as they can and go home. However, there are two issues on which the eyes of the world have focussed. First, there is the actual, punishable-by-court-or-regulator wrongdoing. Things like rigging LIBOR or the forex market, or miss-selling unnecessary products to unsuspecting retail customers. Obviously, and rightly, that sort of thing creates mistrust. Then there is the whole issue of payment. Salaries, bonuses, all at levels that seem to the outsider utterly ridiculous; after all, it’s not that difficult. That breeds contempt, as much as mistrust. Put those two things together, and it’s relatively easy to see why many would regard my view as excessively benign.

A One-Way Street

But that ratio I mention above poses yet another problem, one which may be systemic and structural, and just as important. What it tells us is that the providers of capital - effectively, legally, the owners of the banks - are being seriously disadvantaged versus the employees. Any intelligent investor knows that if the company doesn’t perform, then the return on his investment will be meagre, or even non-existent. However, it seems reasonable to assume, in those circumstances, that the employees do not maintain their earnings at or near the same level, while the shareholders shoulder all the losses. What we have allowed to be created is a one way street, where employees - who are the ones guilty of the bad behaviour, where there is bad behaviour - are effectively protected from the effects of it by the cushion of the shareholders’ funds. The regulators seem to have singularly failed to work this one out. The ludicrous provisions to limit bonuses (while allowing the same amounts to be added to fixed costs in the form of allowances) has not a snowball’s chance in hell of resolving the issue. 

To Lance the Boil

The reality is that despite everything that has happened, the situation has not changed; it's not just the absolute level of remuneration, it's also the way the relationship between employee remuneration and shareholder earnings has got seriously out of balance. Until it’s brought back under control and those setting remuneration are forced - because they won’t do it voluntarily - to rebalance the way the business is run, the problem won’t go away. I don’t as a rule like more laws, more regulations, but in this case, unfortunately, without compulsion to create an environment where remuneration is linked to shareholder return - not to profit: specifically to what is paid out to investors - this boil is not going to be lanced. 

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