Dear Mr Penn,
In comments you made to the American Chamber of Commerce on Thursday 6th February, you have been quoted as drawing attention to the question of what companies are for, in which you challenge the orthodoxy around maximising shareholder value.
“The foundational Friedman concept that the sole purpose of business is to maximise value for shareholders has been debunked in a world where business and its role within society is being redefined.” - Penn focuses on footprint and fairness, Australian Financial Review, 7th February.
To be fair, you are not alone in questioning the primacy of shareholder value. No doubt, you are aware that over 150 CEOs of large corporations in the United States released a joint statement in August 2019, which effectively overturned decades of conventional wisdom around the purpose of the company. Their statement adopts a stakeholder approach and enunciates a commitment to customers, employees, suppliers and communities, as well as shareholders. https://www.businessroundtable.org/business-roundtable-redefines-the-purpose-of-a-corporation-to-promote-an-economy-that-serves-all-americans
What I would like to understand is that if Telstra abandons a shareholder-centric philosophy, what does this mean for the company going forward?
Let’s start with the unnecessarily complicated remuneration framework that your board of directors sets. At present, part of the Executive Variable Remuneration Plan rests on two pillars: a relative total shareholder return (TSR) target and free cash flow return on investment (FCF ROI) target. Presumably Telstra’s new stakeholder friendly position means that the board will abandon both of these pillars - particularly the relative TSR target - when setting the incentive structure for you and your senior executive team. These pillars could be replaced by an employee focused target for example.
I wonder how Telstra would have performed in the past on its commitment to employees? Not that well if your shrinking workforce is any guide. As you can see in the chart below, the number of company employees is now at a record low of circa 30,000. Would Telstra’s new stakeholder friendly philosophy mean that you would commit to not only arresting the long-term decline in employee numbers but aim for an increase by the end of your tenure as CEO? By including this as one of the new pillars in the company’s remuneration framework, you could be financially rewarded personally for achieving the target of employing more people. Most CEOs would be envious of that incentive structure, Mr Penn.
You’re also no doubt aware that the Government and the RBA Governor for some time have been imploring the corporate sector to invest in future growth opportunities. Specifically, Mr Phillip Lowe has communicated his concerns that businesses are using high and out-dated hurdle rates at a time when returns on risk free assets remain stuck at close to record lows. But like the employee engagement measure, your company has not fared well on this metric either. As you can see from the chart below, capital spending as a percentage of total assets is around 7 to 8%, well below historical norms.
As one of the most widely recognised and largest ASX-listed companies, Telstra could curry favour with the government, the central bank and the community by lifting investment and doing its bit to boost spending and aggregate demand in the economy. Would you be prepared to make that commitment in line with the new stakeholder friendly approach you’re espousing Mr Penn?
On a related note, you could also commit Telstra to boosting the wages of your employees, at a a time when the Government and central bank continue to bemoan record low wages growth in the economy. That would represent an excellent outcome for your workforce. But don’t forget what this would mean for another key stakeholder group; to preserve profit margins, would you need to pass on some or all of the higher wage costs to consumers?
This is the problem with making a commitment to so many different stakeholders Mr Penn; what is good for one group is often bad for another group. And if your competitors haven’t also embraced a stakeholder friendly approach, Telstra loses market share.
The stock market represents a competition for financial capital. Capital is a scarce commodity and shareholders rightly demand to be compensated for being at the bottom of the capital structure pecking order. If you are serious about shifting Telstra’s strategy away from maximising shareholder value towards a stakeholder friendly approach, I suggest you communicate this to shareholders and explain carefully what the implications would be for capital investment (higher), wages bill (higher), profitability and productivity (lower), balance sheet quality (lower) and dividends (lower).
A very small clientele of investors might be attracted to your virtue signalling. But I expect that Telstra would face a sharply higher cost of capital as most shareholders run for the exits.
Telstra’s board of directors would need to endorse your proposed shift in company philosophy. That might also be a stumbling block. The company’s employees, suppliers, the community at large and other stakeholders don’t have a right to vote for directors. Only shareholders do.
In his pioneering book, Capitalism and Freedom, Milton Friedman argues that if businesses are to have a social responsibility other than maximising shareholder value, how are they to know what it is? Mr Penn, what gives you (and other CEOs) the right to decide what the social interest is? As Friedman says, “It is the responsibility of the rest of us to establish a framework of law…”
Why should Telstra shareholders bear the burden of you deciding to pursue the social interest? I dare you to ask them and your board of directors, Mr Penn.
Best regards,
Global Founders Funds Management