The fourth contributing factor for the increasing importance of shareholder value is the time bomb ticking away under the public pension systems of most developed countries. In these countries, mandatory public pensions represent the largest part of the income of retirees, with Germany and Sweden leading with respectively 95 percent and 91 percent of retiree income derived from public pensions. Most of these public plans are set up as pay-as- you-go systems where contributions by workers today are used to pay the retirement of current retirees. This system worked fine as long as there were relatively few retirees in relation to contributing workers. This is changing.
In 1990, for example, there were almost two workers in Germany to support one retiree. By 2035, this number will drop to one retiree per worker. As a consequence, the average contribution rate for a German worker to the mandatory public pension system will rise to 34.1 percent of gross wages in 2035 if no actions are taken, compared with 19.7 percent in 1996. This is the stuff of which revolutions are made.
Although avoiding a pension crisis is possible, there are no easy fixes. Most analysts agree that these countries have no choice but to move to some form of funded pension system, where at least a part of the premiums that workers pay are actually set aside for their retirement. The challenge is how to make it through the transition from pure pay-as-you-go to partially or wholly funded. While there are several variations of funded pensions systems, they all lead to the same conclusion—there is no solution unless the savings in the funded part of the system generate attractive returns.
With this in mind, one solution would be to increase premiums by a sufficient amount to build a surplus that can be reinvested, with the combination of premiums and investment returns covering the future shortfall. Here is a simplified example of how this might work in Germany. If the additional premiums were invested in German government bonds, which historically have yielded real returns of about 4 percent, the necessary incremental premium would amount to 3,103 marks, a 13 percent reduction in disposable income. If, on the other hand, these savings were invested in Germany’s private sector, where real long-term returns between 1974 and 1993 have averaged 7.4 percent, these premiums would drop to 2,068 marks. If the German private sector were as successful as its U.S. equivalent, which generated real long-term returns in the same period of 9.1 percent, the annual premiums would drop to 1,706 marks, a reduction in disposable income of just 7 percent.
Thus, in combination with measures such as gradually increasing the retirement age, the burden can be reduced to a level where political consensus becomes feasible, if the investment funds generate good returns. Defusing the pension fund bomb dictates that the private sector be held to a standard where generating high returns on invested capital and creating opportunities to invest additional capital at high returns is of paramount importance. It is not coincidental that California’s public employee retirement fund is one of the most vocal advocates of creating shareholder value in the United States, and has made it clear that it expects shareholder value to be a priority in other markets.
If the funded plans are to work and intergenerational competition is to be avoided—whether in Germany or other developed nations—then there must be steady pressure on companies to generate shareholder value.
Aug
15