Blackrock’s Larry Fink is cautioning
CEOs about giving in to activists. He suggests that CEOs are influenced by
short term activists to increase shareholder distribution-dividends and
repurchases. He prefers, and I agree,
CEOs should first focus on investing their capital in new growth investments.
This assumes of course that firms have positive NPV projects in which they can
invest. This becomes more challenging the further we are into an economic
recovery. All too often CEOs feel the
pressure to grow and the lure of size when the opportunities just are not
there. This results in value destructive growth-both organic and over priced
M&A. Not all CEOs are as skillful as Warren Buffett in making investment
allocation decisions. Hence, not all CEOs can have Buffett’s zero payout
policy.
Some firms simply have more cash than they can profitably
reinvest given where they are in their life cycle. Firms should view
distributions as a residual capital allocation decision involving the
following:
1)
List all projects offering positive NPV
2)
Match opportunities with available internal
resources -operating cash flow plus liquid resources
3)
If opportunities exceed internal resources, then
raise external capital
4)
If opportunities are less than internal
resources, then return the excess to shareholders
Shareholders can search market opportunities to redeploy
their capital to higher valued use better than managers trying force the issue.
Next, Fink proposes a protective tax based mechanism to
shield CEOs from dividend seeking activists by raising taxes on investments not
held for at least 3 years. This would supposedly discourage short term actions.
Again, he confuses an investor’s holding period with the market’s investment
horizon. Capital markets are like time machines allowing investors to realize
cash flows now by liquidating investments. Conversely, they can postpone
consumption by increasing investments. The market price for each action is
based on the same identical formula independent of the investor’s time horizon;
namely the stock price is based on some estimate of future long term cash flow
discounted for its risk. Efforts to penalize so called short term investors,
however defined, will only reduce market liquidity and entrench management.
Value is created on the asset, left hand, side of the
balance sheet by managers skillfully exploiting market opportunities. You
cannot, however push on a string when the opportunities just are not there.
Returning excess capital under those circumstances is not a sign of weak
management, but of good stewardship. It is difficult to create value on the
liability, right hand, side of the balance sheet. Nonetheless, you can destroy
value by getting the right hand side wrong by being too stingy with dividends.
J
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