September 2021
Affirmative action programmes get in the way of competition for resources and promote economic in-efficiency. They assist a minority of favoured participants in the economy, easily identified, and harm the many more, mostly of the same pigmentation, who pay higher prices or taxes and earn less and sacrifice potential employment opportunities. Costs and opportunities foregone that can only be inferred – because it is so difficult to isolate the influence of one force amongst the many forces – that determine economic outcomes. BEE in SA can have a powerful influence on the direction of economic policy itself. The very valuable rights to participate as essential BEE partners in government initiatives drives the policy agenda itself.
The incentives that encourage previously disadvantaged South Africans to acquire ownership stakes in SA businesses on artificially favourable terms must reduce the expected returns on capital. It means less upside and no less downside for established businesses or start-ups and so fewer projects qualify for additional investment in plant or people. An important source of capital for SA start-ups will be foreign investors. Demanding they give up potential rewards for bearing SA risks is surely discouraging to them. Moreover, imposing such conditions on ownership cannot be regarded as a form of restitution for the past injuries imposed on previously disadvantaged black South Africans. That might be regarded as the moral case for taking very arbitrarily from some South Africans to give to others. The new foreign owners are surely very unlikely to have benefitted from apartheid.
The typical empowerment deal taken to widen the composition of owners on racial grounds is funded by the established owners. They provide loans to the new BEE qualified owners to enable them to take up the shares on offer. The interest and the debt repayment are facilitated by a flow of dividend payments. If all goes well the empowerment shares will, intime, be unencumbered by debts and will have acquired significant value that may cashed in. If the dividends did not flow sufficiently and the value of the company lagged interest rates, the debts would be written off and the empowerment stake would be worth very little. Upside without downside may however encourage more risk taking than desirable. An empowerment state of mind that can be dangerous to all shareholders.
The idea for a better less discouraging way to meet empowerment objectives came to me from Erik Stern of Stern Value Management. That is don’t sell the shares, rather give them to an empowerment trust established for employees. One employee – one share in the Trust -regardless of status. No loans raised or interest to be paid, or dividend policies to be driven by the empowerment interests. The trust however would be imputed with a cost for the capital allocated to it. Regarded as a non-interest bearing loan capital, the notional value of which would increase at a rate equivalent to the required returns on such risky capital in SA, say of the order of 15% per annum.
The initial capital plus the compounding required returns on it would then be subtracted from the Asset Value of the Trust. On any liquidation of the assets of the Trust, only its net asset value would be paid out to its beneficiaries and the loan capital returned to the company. Employment incentives and bonuses would be based on the difference between realised and required risk adjusted returns. Potential dividends would ideally be reinvested in the company and allocated to cost of capital beating projects, so adding further to the value of the company and the Trust.
The potential upside to be given up by the original shareholders would then be in proportion to the Economic Value Added (EVA) delivered by the firm. That is the difference between the actual returns and the required returns, or cost of capital, multiplied by the capital invested and reinvested in the company, that would determine the value of the company and the NAV of the Trust. In a return on capital focused company this could amount to a very large capital sum to be happily shared, equally, with all employees