Are shareholders to blame for low investment?
It's ultimately a matter of demand
In his Observer article this week Will Hutton tackles the question of why the business sector is not investing more. He refers to a report by City investment manager Andrew Smithers entitled UK: Narrower Profit Margins and Weaker Sterling Needed. Martin Wolf referred to it recently too. I've not been able to read it but the essential argument appears to be that businesses need to be making lower profits - by spending more on capital expenditure ie investing. A reason why they may not be doing so could be that executive pay is linked to share price performance. That leads executives to focus on higher profits, boosting share prices and therefore pay.
There might be something in that. However it does seem to rely on the assumption that shareholders simply demand higher and higher profits in the short term. Short termism does exist of course. But I would contend other forces are at work too. If a company is profitable but cannot find further areas for profitable investment, shareholders will eventually want that company to stop hoarding and give funds to its owners (ie the shareholders) so they can invest elsewhere. This, when it works well, is how the stock market channels funds to (hopefully) profitable investments. If a company decides that in fact it has found a profitable investment opportunity itself (eg a new technology or a new market), shareholders will often or usually back it - if they are convinced. It is after all their money (even if their wishes are mediated through investment managers). And most fund managers do not forget times when they have backed company plans that have gone pear-shaped (no investment is without risk).
Large and large/medium sized companies appear to have in general better balance sheets than, say, three years ago (there are always exceptions). Net borrowing is lower (ie they at least have more cash to offset some borrowing). Why is this? One reason is - well look no further than the Eurozone crisis and the injection of €489bn gross into the European banking system. That was to solve a problem - banks were under strain. The experience of the post Lehman's crisis has not been forgotten and no finance director wants to be in the position of relying too heavily on banks again. So better to have a stronger balance sheet.
But another reason investment is not happening (it's not recovered in the UK since the post Lehman's fall, as a % of GDP) could be that confidence in the future is low. This is what Keynes talked about. Interest rates can be at extremely low levels but little investment takes place. At such times, government has to step in. It has to boost confidence and even fill the gap with its own investment. Otherwise the risk is economic depression.
Stephen Beer, 19/02/2012
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