The OECD has spent considerable time in its new Business and Finance Outlook trying to understand why financial market investors are so keen to take risk but corporate managers around the world are not.
It’s struck on the stickiness of the hurdle rate as one of the key reasons for the reticence of managers of the world’s top 1000 companies to invest.
But it also believes that the self-interest of managers and the aggressive approach of activist investors are playing a key role in holding back the much-needed corporate investment that is required to get specific countries and the global economy moving forward again.
The OECD says there are two fundamental reasons that the hurdle rate is so high:
First, real investors have a longer time frame compared to financial investors who believe (perhaps wrongly at times) that their positions can be quickly unwound.
Second, managers of MNEs operate in a very uncertain world and the empirical evidence suggests that equity investors ‘punish’ companies that invest too much and reward those that return cash to shareholders. If managers make an error of judgement they will be punished by activist investors and/or stock reactions in general and hence they prefer buybacks.
Now of course it makes sense to return cash to shareholders if there are no profitable projects to invest in. The OECD recognises that. But, they argue, the buyback phenomena is “not associated with rising productivity and better returns on equity”.
The OECD also acknowledges that it’s not all self-interest holding back investment. They say the emergency measures and zero rate policy settings are viewed as non-permanent and with uncertainty high, it could make “perfect sense” to return cash to shareholders.
But they also take aim at the remuneration structures of company executives:
Buybacks benefit company executives and mutual fund managers (whose performance is measured over short periods), both of whom are rewarded with stock options and awards.
The OECD cites a study from 2014 which shows that up to 80% of senior company manager remuneration is “derived from equity participation”.
Again there is a clear accusation that senior company executive self-interest is driving the current lack of investment. The OECD make the point forcefully, saying:
Buybacks enable executives more easily to meet quarterly and/or annual EPS (earnings per share) targets on which their remuneration is based. Driving up share price (or defending a fall) to push stock options ‘into the money’ (or keep it there) increases the personal gain of executives, while reducing the scope for investment.
That is incredibly strong language from a supra-national body and the OECD recommends changing remuneration packaging to align with long-term goals, not “short term EPS targets”. They also say that the attractiveness of borrowing to “carry out buybacks where the tax treatment of interest costs, capital gains and dividends are a factor” should also be reduced.
Business Insider Emails & Alerts
Site highlights each day to your inbox.