Joseph Healy: Corporate Governance and Wealth Creation in New Zealand

Reviewed by ROGER KERR*

"This book is about corporate governance and how businesses create wealth and thereby contribute to economic prosperity when they focus on shareholder value."

So begins Joseph Healy's book Corporate Governance and Wealth Creation in New Zealand, published last week.

It is a timely contribution. There has been confusion in the debates about the proper role of business, the quality of business management in New Zealand, the performance of the sharemarket, and the links with economic growth.

Contrary to some previous interpretations of his messages, Healy's book is not about "bashing" corporate New Zealand; his objectives are constructive. But nor does he put business above criticism, and rightly so.

Healy emphasises that business is the wealth-creating institution of society. The prime responsibility of a manager is to increase shareholder value.

Firms must take a long-term, not a short-term, view, and act ethically and responsibly.

"Management policies," Healy says, should "give paramount importance to shareholder value and reject, as false gods, the priority given to triple bottom line and sustainable development."

His categorisation of this view as a "third way", incidentally, is misleading. The book acknowledges that it is "orthodox finance and economic theory as regards the critical role of the firm".

Healy is a passionate advocate for the use of the tools of economic value added (EVA) and market value added (MVA) for focusing corporate managers on shareholder value creation.

They are also relevant to co-operatives and the state-owned enterprise sector, where a number of firms are still not meeting their cost of capital.

There can be confusion about the meaning of EVA measures, which the book does not entirely escape. Two points are worth highlighting.

First, competition makes only normal profits, that is, zero excess profits, the central tendency. Thus for the market as a whole, average EVA should come out at close to zero. Companies should strive for out-performance, but competition will force them to distribute benefits of innovation and higher productivity to customers and employees.

Second, company profits contribute positively to national income, whereas only profits in excess of the cost of capital contribute positively to EVA.

The first point suggests that average EVA for New Zealand firms is unlikely to be greatly out of line with other markets. Stern Stewart figures confirm this expectation, as do long-term sharemarket trends.

Gareth Morgan recently pointed out that in the 17 years since financial market deregulation in 1985, sharemarket returns in New Zealand averaged 10 per cent compared with 12 per cent in world markets.

The second point is relevant to assessing the economy-wide impact of the finding that companies on the NZSE40 index destroyed $21 billion of shareholder value between 1991 and 2001.

These companies probably account for only around 15 per cent of GDP, and Healy does not dispute Bryce Wilkinson's estimate (p257) that the losses probably represent no more than a 0.2 per cent reduction in national income in any year.

The losses mirror big company failures in Australia and the United States in this period.

While Healy does not name names, they were concentrated in four companies: BIL, Carter Holt Harvey, Air New Zealand and Fletcher Challenge (FCL alone accounted for some $9 billion of the total).

Many other large New Zealand companies, such as Telecom, Fisher and Paykel, The Warehouse, Lion Nathan, Sky City, Auckland International Airport and ASB Bank, performed well.

Nevertheless, the loss of value in poorly performing companies is rightly a matter of concern for their shareholders, which raises issues of corporate governance.

Healy finds that New Zealand board structures and policies are generally in line with international practice. It is a pity that he did not explore the role corporate governance may have played in the egregious cases of value destruction. FCL, for example, had an unusual level of management representation on its board, and adopted anti-takeover devices (in the form of its employees share scheme and choice of listing rules).

Healy stresses the importance of the takeover mechanism. His statement that "an active market for corporate control is vital for shareholders (and the economy), and any barriers that restrict the efficient operation of takeovers is damaging to shareholders" is implicitly a criticism of the recent decision to replace shareholder choice by the restrictive Takeover Code.

The book puts forward other ideas on corporate governance. Some I have sympathy with, such as the idea that directors' liabilities should be trimmed and refocused on shareholder value, but others seem less persuasive.

For example, he argues that New Zealand managers are "badly paid" but is not clear that he is comparing like with like internationally. It is also not hard to think of some who have been over-paid.

Little consideration is given to problems that can be associated with stock options and other high-powered performance incentives. Nevertheless, he is right to argue that there should be high rewards for high performance.

Another criticism is that New Zealand companies pay "excessive" dividends. However, the discussion fails to explore the impact of tax and other regulations on dividend policy, and the more orthodox view that management should not be left with free cash flow.

Institutional investors are criticised for not being sufficiently active in corporate governance. Is this a role for which they are well equipped, compared with large shareholders or specialist investment companies?

A general problem with these arguments is that they imply parties are acting irrationally and against their interests - which raises the question why competitors have not emerged to do a better job.

The book also does not recognise clearly enough that with the separation of ownership and control, principal-agent problems can be mitigated but not eliminated.

Nevertheless, Healy is right on the big issues. He notes that for prosperity "the quality of Government policies is essential; they must provide for a high level of economic freedom".

He gives primacy to shareholder value, points out that honourable failure in business is not a disgrace, but rightly criticises business shortcomings.

Healy's views deserve careful scrutiny. I hope that directors, analysts, academics and media will debate them seriously.

Dunmore Press $44.95

* Roger Kerr is executive director of the Business Roundtable.