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Shareholder Value Achieving Clarity in Decision-Making

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Shareholder Value Achieving Clarity in Decision-Making Maximising Shareholder Value Achieving clarity in decision-making Technical Report Maximising Shareholder Value 1 Contents Preface . 2 1 Introduction. 3 1.1 Context – conformance and performance . 3 1.2 What is value-based management (VBM)? . 3 1.3 Shareholder value and the cost of capital. 5 Sir Brian Pitman . 6 2 Creating Shareholder Value – Strategy . 7 David Kappler . 9 3 Measuring Shareholder Value – The Metrics . 10 3.1 Shareholder value analysis (SVA) . 10 3.2 Economic profit (EP). 11 3.3 Cash flow return on investment (CFROI) . 13 3.4 Total business returns (TBR) . 14 3.5 Conclusions . 15 Steve Marshall. 15 4 Managing For Shareholder Value . 16 4.1 Governance and ownership. 16 4.2 Remuneration . 16 Jeremy Roche. 16 John Barbour . 18 4.3 Culture . 19 4.4 Structure . 20 Charles Tilley . 21 4.5 Stakeholders . 21 5 Drawbacks of Value-Based Management (VBM) . 22 6 Conclusion . 23 7 Bibliography. 24 2 Maximising Shareholder Value Preface After the market exuberance of the dot com bubble in the late 1990’s,the sobering up period that followed the bust brought with it a renewed interest in the concept of shareholder value. Since then,all kinds of companies have Although CIMA believes this is We aim to outline the main features of been publicly proclaiming their praiseworthy,there is a danger that strategic planning and decision-making, commitment to increasing long-term companies will assume that,once as well as how the chosen strategies value for their shareholders. One look corporate governance has been sorted can be delivered via integrated at the statements of directors or chief out,they will know how to manage for performance management systems and executives in annual reports can shareholder value. The truth is,many do changes to organisational culture and confirm this. not. These companies will carry on structure. much like before,only under increased To a certain extent this is old news. We scrutiny from both investors and the The briefing is divided into three have heard such pronouncements public. In fact,many executives see sections corresponding to the main before. The aim of publicly listed value creation as more of “a corporate VBM components: companies has always been to increase rallying cry rather than the goal of ● strategy – for value creation; the value of shareholders’ investment. serious strategic planning” (Armour and ● metrics – for value measurement; Mankins,2001). and But headlines such as,“Value is the acid ● management – encompassing test of good governance”,“Is good This briefing is an attempt to draw governance,remuneration,culture, governance good value?” or “Returning attention to the context,tools, structure and stakeholder value by governance”,all taken from techniques and philosophy of managing relationships. the Financial Times in the last few for shareholder value,or value-based months,show the influence that management (VBM) as it is sometimes It also provides insights from senior accounting scandals and the market known. It is not meant to be finance professionals with direct downturn of the early 2000’s have had prescriptive. Like other management experience of managing for value and a on corporate discourse. concepts,managing for value has been brief discussion of some of the key adapted by companies to suit their barriers and drawbacks of attempting The debate is now focused on the circumstances. There can be no “one- to implement VBM programmes. interplay between corporate size fits all” model. governance and company success. They As this is a briefing from CIMA,it is cross at a point where what matters is In CIMA’s Official Terminology,VBM is primarily aimed at those working in whether – and how – a company has defined as “a managerial process which finance. Finance professionals and created value for its owners. Corporate effectively links strategy,measurement accountants in business should play a governance,defined as “the system by and operational processes to the end of key role in VBM implementation. Few which the owners of the corporation creating shareholder value”. other professionals will have the same ensure that it pursues,does not deviate commercial awareness coupled with a from and only allocates resources to its It is generally understood to consist of broad understanding of both the defined purpose” (LSE and RSM Robson three key elements: financial issues and the business as a Rhodes,2004),has become an ● creating value,ie,ways to actually whole. ubiquitous topic here in Europe and increase or generate maximum future even more so in the US. value; However,the overview of VBM should ● measuring value; and also prove a useful introduction for ● managing for value,ie,governance, anyone keen to gain a basic management,organisation,culture, understanding of the subject. communication. (www.valuebasedmanagement.net) Maximising Shareholder Value 3 1. Introduction 1.1 Context – Enterprise governance is defined as: The Company Law Steering Group cited conformance and performance the generation of maximum value for When corporate scandals started to hit “the set of responsibilities and practices shareholders as the ultimate objective the headlines in the US and,more exercised by the board and effective for companies and in principle the best recently Europe,the legislators’ management with the goal of providing means of also securing overall response was swift and efficient. Amid a strategic direction,ensuring that prosperity and welfare (Strategic flurry of reviews,consultations and objectives are achieved,ascertaining Framework,1999). It was a simple debates about business ethics,a whole that the risks are managed message that emphasised the need to new raft of legislation was introduced appropriately and verifying that the fine-tune the current system,rather in an attempt to restore faith in capital organisation’s resources are used than radically change it. markets. responsibly”. (Information Systems Audit and Control Most UK companies would describe On both sides of the Atlantic,much of Foundation, 2001). themselves as being in the business of this effort was focused on regulatory maximising value for their shareholders. and corporate governance issues. This It has two dimensions – conformance But how that value is defined, was hardly surprising,considering the and performance – which need to be measured and pursued is somewhat nature and magnitude of the problems. kept in balance. Too much emphasis on more contentious. The rhetoric of What’s more,it is unlikely that the one,as the current focus on governance corporate mission statements may be focus on corporate governance and risks doing,may detract from value divorced from the reality of firms’ day- regulation is going to wane in coming creation. to-day operations. months,despite the inevitable industry backlash. The reforms continue and,for This briefing complements the We have all witnessed,in the recent many,the effects of Sarbanes-Oxley in “Enterprise governance” report by accounting scandals,the extremes of the US and the new Combined Code in acting as a reminder not to overlook how companies can be run for the UK are starting to be felt. the performance side of the enterprise seemingly everything else except their governance framework. It covers the owners’ best interests. The collapse of There is a danger,however,that this philosophy and practice of managing Enron and Parmalat destroyed value for admittedly laudable attempt to for long-term value. both their shareholders and their improve the way in which companies stakeholders,such as the thousands of are regulated and governed will detract 1.2 What is value-based employees who lost their jobs and from the basics of value creation. Good management (VBM)? pensions. There are also companies, corporate governance may be a Defining VBM is not easy. There is,on such as Marconi,that failed as a result necessary prerequisite but will not by the one hand,a broad context of of strategic errors,not fraud. itself lead to superior performance – generating value for shareholders that which is,after all,what investors want is at the heart of the market economy. It is not hard to find less spectacular and expect in return for their money. But there is also a more specific examples of decisions that do not take concept that narrows VBM into a long-term value into account. In many At the beginning of 2004,the management approach,or even a cases,value-destroying decisions are International Federation of Accountants philosophy,characterised mainly by the not driven by greed or dishonesty. (IFAC),in partnership with CIMA, metrics used to measure performance. Instead,they are the result of pursuing published a report entitled,“Enterprise legitimate business objectives,such as governance – getting the balance In terms of the former- in the Anglo- growth or increasing market share. The right”. It argued for a more holistic way Saxon context,the maximisation of problem is that managers often lack of looking at companies. shareholder value has been widely understanding of the difference accepted as a principal,if not the only, between decisions that lead to higher bona fide corporate aim.The concept of profits and those that create value. “enlightened shareholder value” has been enshrined in the recent UK Company Law Review. The Review explicitly rejected the notion of pluralism – where a company is required to serve a range of interests wider than just those of its shareholders – as being “unlikely to command wide support”. 4 Maximising Shareholder Value Introduction It is interesting to note that 78 per cent McTaggart defines VBM as: Predictably,generating value became a of companies interviewed for a lot more difficult in times of market University of Washington study “…a formal,systematic approach to downturn (although 2002 research (Graham,2004) admitted to artificially managing companies to achieve the from PA Consulting claims that only smoothing earnings and sacrificing objective of maximising value creation companies with an explicit VBM agenda shareholder value in order to meet,or and shareholder value over time”.
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