Clichés about how businesses work are legion. Author of It’s the fault of the shareholders! False beliefs and real debates (PUF), published last April, the doctor of management sciences Christophe Bonnet passes the most fashionable to the grinder.
“Shareholders don’t take risks”
Shareholders provide companies with an essential fuel for their success: risk financing. A company must invest to design, produce and market products and services but, as future customer demand is uncertain, its projects are risky. Some succeed, others don’t. The risk of loss for the shareholders who bring the capital, even reduced by diversification – investing in several companies or projects – cannot be completely eliminated. Investors therefore expect remuneration that depends on the level of risk, failing which they cannot pursue their financing activity.
The remuneration of the shareholders is not fixed by contract, it depends on the success of the company. They can lose everything… or win a lot. The risk borne by shareholders is illustrated by the high volatility of stock market prices. The average profitability of the CAC 40, the index of the largest listed French companies, is close to 7% per year over a long period, but nearly 40% of the years end in losses. This volatility is particularly high during financial crises. Following the bursting of the Internet bubble in the early 2000s, the CAC 40 fell by 65% in two and a half years! It took more than twenty years for it to regain its previous level.
One would think that the risk disappears in the long term since the value of stocks eventually goes up after the crises. But to mitigate it, the shareholder is held precisely to remain with the capital. If he wants to recover his shares earlier, he runs a new risk: that of exiting at the wrong time.
“Shareholders demand 15% profitability”
The “15% myth”, very popular in France and relayed by many observers and media, leads to consider shareholders as greedy and disconnected from economic reality, since many companies are unable to reach this level of profitability.
The idea of a single profitability standard that would be imposed or demanded by shareholders is contrary to financial theory, according to which expected profitability is correlated with risk. Thus, a shareholder does not expect the same profitability from a start-up, whose probability of failure is greater than 50%, or from a CAC 40 heavyweight whose risk of bankruptcy is very low.
The tenacious belief of the “15%” is invalidated by all the empirical observations. The accounting profitability of French companies, measured by the ROE (profit/equity ratio), varies greatly depending on the company and the period. It is 11% on average over the last thirty years. The average return on investments in listed shares is around 7% per year in France, and 10% in the United States, over a long period. As for the profitability expectations expressed by shareholders in the surveys, they are close to 10% for individual investors and 5% for professionals. We are very far from a single and general standard of 15%!
“Shareholders are short-termists”
According to a widely shared view, shareholders’ sole obsession is to deprive companies of their cash to earn money, preventing them from investing and making them more fragile. There are, of course, shareholders with short-term objectives or very limited holding horizons, but the existence of a generalized short-termism has not been proven.
Let’s first look at the listed companies most valued by shareholders, based on their market capitalization. Can we argue that LVMH and L’Oréal, for France, or Microsoft and Apple, for the United States, have strategies focused on the short term? On the contrary, they are industrial or technological groups that have been investing and innovating for decades, while remaining leaders in highly competitive markets.
If the shareholders imposed on companies to ignore the long term, we should observe a downward trend in investments and liquidity, due to the excessive withdrawals demanded by the former. However, neither investment, including research and development expenditure, nor the average level of cash flow has fallen in France and the United States over the past few decades.
The financial markets do not seem to be short-sighted either. In the United States, the share of listed shares held by shareholders who hold them for more than three years increased between 1990 and 2015 to reach around 60%, and the proportion of listed companies making losses has increased, which shows that shareholders can be patient. In France, a large share of companies is owned by families or foundations, long-term shareholders.
Finally, the venture capital market, which finances young innovative companies from which no profit is expected for many years, has experienced rapid development over the past twenty years. The capital raised by French start-ups has multiplied by six in ten years! Some of them, the “unicorns”, are worth more than a billion euros, such as BlaBlaCar, Doctolib or BackMarket.
“Dividends enrich shareholders”
Dividend distributions by large companies regularly make the headlines, especially when they increase! The project to tax “super-dividends” was even debated last October. However, it is the profit that enriches the shareholders, not the dividend because, when a company distributes it, the share price drops by as much.
Let’s take the example of a shareholder who owns the shares of a company whose value is 10 million euros, including 1 million in cash and 9 million in other assets: equipment, brands, patents, etc. If the company distributes a dividend of 1 million euros, the value of its assets will fall by the same amount. Our shareholder will not be richer than before: he will have 1 million in cash but the company will only be worth 9 million. The illusion of the dividend is tenacious, even among well-informed financiers: receiving a dividend, even though no share has been sold, intuitively translates into a feeling of enrichment.
In addition, dividends allow the reallocation of capital from large profitable companies to young and growing companies, since they are most often reinvested by shareholders. Companies such as Eurofins Scientific (bio analysis), Neoen (renewable energies) or Soitec (semiconductors) have been able to succeed brilliantly in their markets by raising capital from shareholders who have trusted them, which has benefited their employees. and the French economy.
The debates on the taxation of the profits of multinationals and on the sharing of value between shareholders and employees are legitimate. But why want to overtax dividends when they do not enrich shareholders and contribute to the financing of innovative companies?
“Share buybacks hurt investment”
The repurchase of shares, more and more frequent in the big listed companies, consists for the company to repurchase its own shares to its shareholders, often to cancel them. This is the main means, after the dividend, of distributing cash to them. There is a widespread belief that stock buybacks are bad for investing. However, such causality is in no way confirmed by finance researchers, quite the contrary!
Surveys reveal majority of CEOs only resort to share buybacks when excess cash is available After that the investments have been financed, not before. The financial decision – buying back shares – comes after the industrial decision – investing to prepare for the future. Research shows that it is mostly large companies with excess cash and few profitable investment opportunities that buy back their shares. In a competitive economy, a shareholder who encourages a company to underinvest to increase its remuneration shoots himself in the foot because the performance and the value of the company will decline.
This is consistent with financial theory, which states that the value of a business is determined by its long-term earnings prospects, which depend on the investments it makes to remain competitive. In a competitive economy, a shareholder who encourages a company to underinvest to increase its remuneration shoots himself in the foot because the performance and the value of the company will decline.
Finally, like dividends, share buybacks encourage investment by allowing the reallocation of capital towards young and growing companies.