Incentives to be Shareholder focused

Capex® Stratagio™ has been developed specifically as a tool to help management ensure increased business investment returns.

The need for such an entrepreneurially inspired but disciplined approach to capex decision making became clear when as consultants we realised that through poor governance many corporates were failing to achieve adequate returns on capital expenditure.

The starting point, of course, was to recognise that capital expenditure programmes are predominantly funded from retained earnings (i.e. shareholders funds). We also knew of many companies where operating with poorly specified or non-existent returns on capital objectives was endemic. In such cases it is easy to blame poor governance in general. Poor governance was generally to blame but the specific fault lay in failing to place capital where it could produce the required returns.

Former Comalco New Zealand CEO Kerry McDonald charges (2002) that “what’s lacking are effective management infrastructures – a lack of commitment to developing the tools, practices and processes that let good managers and leaders achieve the best results.” And Deming (1990) asserts that poor capital allocation can be due to the fact that a business does not have a well-designed capital allocation system in place allowing management to optimise shareholder value.

Internationally, it is very clear that good corporate governance achieves a triple win: it attracts capital; increases the share price and reduces cost of capital. That adds up to a powerful risk management safeguard for shareholders.

For example, a McKinsey and Co (2000) survey of 200 institutional investors showed a stunning 75% said that good governance practices (commitment to shareholder value, majority of independent directors and transparent reporting) were at least as important as financial performance when evaluating investments! Also it found that institutional investors are willing to pay a premium for good governance – as much as 20%.

Importantly, a reputation for good governance as well as laws protecting shareholders can make a substantial difference in terms of attracting international capital and in reducing the cost of capital

More compelling evidence is provided by Gompers et al (2001) in their study of 1500 companies. They found a ‘striking relationship’ between corporate governance and company value. They also found that companies with weaker shareholder rights were valued lower and were associated with lower profits, lower sales growth, higher capital expenditure, and a higher level of corporate acquisitions.

Another independent study by Russell Reynolds Associates (1998) surveyed 374 institutional investors in Australia, Britain, France and the United States. These institutional investors held 65% of the world’s then US23,400 billion shareholdings. They found that 71% had refrained from investing in certain companies because of their reputation for poor corporate governance.

Globalisation has had a profound impact on capital markets. The economies of many different countries have become hugely dependent on foreign investment. In view of this, corporate governance must also be viewed in an international context and conform to international best practices

A reputation for good governance, along with laws protecting shareholders can make a big difference in attracting international capital and in reducing the cost of capital. The world financial crisis has certainly underscored the importance. There are few easier ways to boost shareholder value.

The Capex® Stratagio™ can play a vital part in helping you do so.