To Maria Acknowledgments I am very grateful to the advisor of this doctoral thesis, Prof. Dr. Mª Antonia Tarrazón Rodón, for her support during the research period. During that time we spent countless hours discussing the numerous issues concerning shareholder value that are covered by this thesis. Prof. Tarrazón read the text with great care and attention, raising many thought-provoking questions and always offering the most insightful of comments. I also owe a debt of gratitude to Prof. Dr. Joan Montllor i Serrats who made many excellent and very useful suggestions. It is finally a pleasure to thank my father, Ludger Hecking, for his careful revi- sion of the text. The relation between shareholder value orientation and shareholder value creation · Table of contents TABLE OF CONTENTS I. TABLE OF CONTENTS I. Table of contents ........................................................................................1 1. Motivation of this doctoral thesis.................................................................... 5 2. The theoretical fundament of this research: the roots of value creation .. 17 2.1. The value of shareholders’ investment in a firm................................................... 21 2.2. Performance measurement ................................................................................. 27 2.2.1. Some traditional metrics.................................................................................. 28 2.2.1.1. Stock prices ............................................................................................ 28 2.2.1.2. Net income ............................................................................................. 29 2.2.1.3. Dividend payments ................................................................................. 30 2.2.1.4. Cash flow and free cash flow.................................................................. 30 2.2.1.5. Return on investments............................................................................ 31 2.2.1.6. Return on equity ..................................................................................... 31 2.2.2. EVA – a theoretically founded metric .............................................................. 32 2.2.3. General approaches to enhance performance ................................................ 33 2.3. Shareholder value drivers.................................................................................... 35 2.3.1. Investments..................................................................................................... 35 2.3.1.1. Investment projects................................................................................. 36 2.3.1.1.1. Corporative strategy........................................................................... 36 2.3.1.1.2. Project selection................................................................................. 38 2.3.1.1.2.1 Procedure of project selection...................................................... 38 2.3.1.1.2.2 Evaluation of projects................................................................... 40 2.3.1.1.3. Replacements.................................................................................... 41 2.3.1.1.4. International investments ................................................................... 42 2.3.1.2. The capital budgeting process as investment controlling ........................ 43 2.3.2. Managerial and organizational flexibility.......................................................... 46 2.3.2.1. Options to defer ...................................................................................... 48 2.3.2.2. Sequential exchange options to switch and time-to-build........................ 50 2.3.2.3. Options to abandon ................................................................................ 52 2.3.2.4. Options to alter operating scales ............................................................ 53 2.3.2.5. Growth options ....................................................................................... 55 2.3.2.6. Multiple interacting options ..................................................................... 55 2.3.3. Human resources............................................................................................ 56 2.3.3.1. Incentives for managers ......................................................................... 57 2.3.3.1.1. Importance of variable remuneration.................................................. 57 2.3.3.1.2. Conditions for a shareholder value efficient reward system ............... 60 2.3.3.1.2.1 Appropriate performance measures............................................. 60 2.3.3.1.2.2 Composition of rewards ............................................................... 63 2.3.3.2. Other human resources management (HRM) value drivers.................... 65 2.3.4. Dividend payments and dividend policy .......................................................... 67 2.3.4.1. The theoretical impact of dividend payments on shareholder value........ 68 2.3.4.2. The importance of the dividend decision................................................. 72 2.3.4.2.1. Theoretical importance of the dividend policy .................................... 72 2.3.4.2.1.1 Dividend cuts ............................................................................... 74 2.3.4.2.1.2 Share repurchase ........................................................................ 75 2.3.4.2.1.3 Share dividends ........................................................................... 76 2.3.4.2.2. Empirical evidence – a literature review on dividend policy................ 77 2.3.5. Growth ............................................................................................................ 79 2.3.5.1. Growth magnitudes and their impact on value creation .......................... 79 2.3.5.2. A special case: Growth of market share ................................................. 81 2.3.5.2.1. Theoretical analysis on market share growth..................................... 82 2.3.5.2.2. Empirical findings on market share growth ........................................ 84 2.3.5.2.2.1 Empirical results I: Increasing market share implies value creation under certain conditions............................................................... 85 1 The relation between shareholder value orientation and shareholder value creation · Table of contents 2.3.5.2.2.2 Empirical results II: Market share – value creation relationship cannot be proved ......................................................................... 86 2.3.5.2.2.3 Empirical results III: A meta-analysis ........................................... 89 2.3.5.2.3. Conclusion of theoretical and empirical findings on market share growth................................................................................................ 90 2.3.6. Corporate control: mergers, acquisitions, and alliances .................................. 91 2.3.6.1. The nature of shareholder value variable corporate control .................... 92 2.3.6.2. Creating value for shareholders of the acquiring firm.............................. 93 2.3.6.2.1. Financial motives and conditions for a successful merger ................. 94 2.3.6.2.2. Implementation and execution of a successful merger....................... 98 2.3.6.2.3. The most common errors in mergers ............................................... 104 2.3.6.3. Creating value for shareholders of the target firm ................................. 105 2.3.6.3.1. Theoretical considerations ............................................................... 105 2.3.6.3.2. Managerial behavior ........................................................................ 106 2.3.6.4. The alternatives: alliances and internal growth ..................................... 112 2.3.7. Liquidity of shares ......................................................................................... 113 2.3.7.1. Liquidity of financial securities .............................................................. 113 2.3.7.2. Implications of the liquidity effect .......................................................... 114 2.3.7.3. Liquidity increasing measures............................................................... 117 2.3.7.3.1. Organizational form of a company ................................................... 117 2.3.7.3.2. Public placement ............................................................................. 119 2.3.7.3.3. Liquidity increasing measures after placement ................................ 123 2.3.7.3.4. Corporate borrowing ........................................................................ 124 2.3.7.4. Implications for the researched companies........................................... 125 2.3.8. Risk management ......................................................................................... 125 2.3.8.1. Shareholder value variable risk............................................................. 125 2.3.8.1.1. Some basic considerations of investors ........................................... 125 2.3.8.1.2. Risk measurement........................................................................... 127 2.3.8.1.2.1 Capital Asset Pricing Model (CAPM).......................................... 127 2.3.8.1.2.2 Arbitrage Pricing Theory (APT) .................................................. 131 2.3.8.2. Managing risk to increase shareholder value........................................ 132 2.3.8.2.1. Diversification