How to make BEE work for the workers
Affirmative action programmes get in the way of competition for resources and promote economic inefficiency. 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, earn less and sacrifice potential jobs.
Costs and opportunities foregone can only be inferred because it is so difficult to isolate the influence of one force among the many that determine economic outcomes. BEE in SA can have a powerful influence on the direction of economic policy itself. The valuable rights to participate as essential BEE partners in state initiatives drive the policy agenda itself.
The incentives encouraging 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 startups, 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 that they give up potential rewards for bearing SA risks is surely discouraging to them. Moreover, imposing such conditions on ownership cannot be regarded as restitution for the past injuries imposed on previously disadvantaged black South Africans. That might be regarded as the moral case for taking arbitrarily from some to give to others. The new foreign owners are surely unlikely to have benefited 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 BEEqualified owners to enable them to take up the shares on offer. Interest and debt repayment is facilitated by a flow of dividend payments. If all goes well, the empowerment shares will, in time, be unencumbered by debt and have acquired significant value that may be cashed in.
If the dividends did not flow sufficiently and the value of the company lagged interest rates, the debt would be written off and the empowerment stake would be worth very little. Upside without downside may, however, encourage more risktaking than is desirable — an
empowerment state of mind that can be dangerous to all shareholders.
The idea for a better, less discouraging, way to meet BEE objectives came to me from Stern Value Management’s Erik Stern. This 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.
However, the trust would be imputed with a cost for the capital allocated to it, which would be regarded as noninterest-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 the 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 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, which would determine the value of the company and the net asset value of the trust.
A return could amount to a large capital sum, which would be happily shared, equally, with all employees.