“The hunt for high returns breed crises”
The winners are those who adjust to lower returns on equity, said Thomas Franzén, former vice president of the Swedish National Bank, as he spoke on an NFU seminar October 24.
According to Thomas Franzén, there are strong reasons to believe that today’s financial targets of 15 or more per cent return of equity are unrealistic and unsustainable. But Franzén believes that it is worse than that: The hunt for high returns breeds crises.
How can it be that the requirements are so high? Franzén proposes three possible answers: Firstly, inflation and interest rates have dropped, but financial targets have not come down accordingly. Secondly, companies aim at paying almost half of the profits to shareholders in the form of dividends. A third reason for the high financial targets is that companies compare themselves with each other. Benchmarking is a fancy name for this behaviour. Herd mentality is another more appropriate description, says Thomas Franzén.
Franzén also points out that the targets have gradually become more influential on behaviour as reward schemes are designed to achieve the financial goals.
What consequences do these targets have?
According to Franzén, one effect is that they diminish the willingness to invest. The focus is on cost reductions. Engaging in risky activities and making high-risk investments is another way to try to achieve excessive return on capital.
As I see it, says Thomas Franzén, there is not much room for fiscal and monetary policy to make injections into the economies, which anyway risks leading to another big bubble of over-optimism. On the contrary Franzén thinks that we will have a prolonged period of weak growth and high unemployment. During that period the financial targets will be reduced. The pain and the length of this adjustment period will depend on how fast the administrative structures can adjust their financial targets. A number of CEO’s have announced their ambition to fight for unsustainable returns. They will be the ones imposing high social costs on people and prolonging social unrest, continues Franzén.
Thomas Franzén appeal to labour unions to take on their responsibilities as shareholders, and question the targets. He believes that ambitions for return on equity must be lowered in order to give a more stable financial future. Seeking unrealistically high returns will be disastrous. Some captains of industry have seen this, although not all, and fortunately there is now an open debate. We need understanding to realise this change, says Franzén, and the labour unions can play an active role in this change.
Read Thomas Franzéns full speech here.