According to Mauboussin (2011) from the Harvard Business Review suggests that many people including CEO’s
appear to have a false sense of what shareholder value creation actually means.
CEO’s need to understand the main principles of shareholder value and the reasons
why they are so important when judging difficult trade-offs, learn about the
relationship between financial performance of the company and also are able to
communicate clearly and act appropriately when expectation gaps open.
However, Sanghoe
(2014) noted that the obsession with shareholder value could sometimes
compromise a company’s innovation and strategic direction in favour of
immediate profits. Recent examples of this include the decisions made by
Blockbuster as they lost the opportunity to innovate and transition to go
digital, thus leading them to go into administration (Parson, 2014).
The owners of the
company are its shareholders and so the primary purpose of value-based
management is to achieve long-term shareholder wealth maximization (SWM). This
objective is superior in most commercial organisations that operate in
competitive markets. However, some companies put shareholder value in second or
third place behind other objectives. Is this right? Is growth in sales or
market share more worthy? I would disagree with this, as shareholders are the
owners of the company, who put their trust and investment and so would want to
be rewarded for this.
Source: Arnold (2013)
Figure 2. Three steps involved when creating shareholder value:
Source: Arnold (2013)
Alfred Rappaport
(1998) took the basic concept of discounting cash flows and developed a
simplified method of analysis. With respect to Figure 1, Rappaport’s seven key
factors that determine value are clearly shown. It is very
important that management teams understand and are fully committed to
creating shareholder value. With regards to Figure 2, Arnold (2013) has
identified three main steps when creating shareholder value. Firstly, the need
to create awareness and provide a genuine commitment to a shareholder wealth
maximising mission throughout the organisation is important. Secondly, it is
important to put in place techniques that help to measure whether the value is
being created at various organisational levels and also make sure that everyone
understands and respects the measures that have been adopted. Finally, it is
important to ensure that every aspect of management is suffused with the
shareholder value objective, from human resource management to research and
development and from the target setting to the allocation of resources (Arnold, 2013).
Why is shareholder value increasing?
There are many
reasons why shareholder value is gaining momentum. The first reason is due to
the fact that there is an increasing threat of takeover by teams of managers
searching for poorly managed businesses. This can create more value to
shareholders through strategic change, divestiture and shifting of executive
incentives. Global companies such as GE have the responsibility to provide the
best possible return to shareholders financially and through the impact on the
world today and in the years to come. As Trevor Schauenberg, Vice President, Investor Relations for GE
explains “Investors are increasingly interested in well-managed companies that
will create shareholder value over long periods of time, while contributing
positively to the society and the communities they operate in. With its portfolio of infrastructure solutions and reputation
of unyielding integrity, GE is able to respond to these investors and generate
value for them.” (GE, 2014).
However, problems
may occur with SWM. What managers wish to achieve may be different to the
owners i.e. shareholders. For example, managers may wish to achieve a bonus or
an increase in their salary, whereas shareholders would want a high return on
their investment through dividends. It is believed the owners of the business
would have the right to demand that director’s act in the best interest. This
would therefore lead to agency problems within the business.
Therefore to
summarise, shareholder value has been expressed through many different elements
as shown above. CEO’s should not neglect this, as shareholders are one of the
most important stakeholder groups in the business.
According to Mauboussin (2011) from the Harvard Business Review suggests that many people including CEO’s appear to have a false sense of what shareholder value creation actually means. CEO’s need to understand the main principles of shareholder value and the reasons why they are so important when judging difficult trade-offs, learn about the relationship between financial performance of the company and also are able to communicate clearly and act appropriately when expectation gaps open.
However, Sanghoe (2014) noted that the obsession with shareholder value could sometimes compromise a company’s innovation and strategic direction in favour of immediate profits. Recent examples of this include the decisions made by Blockbuster as they lost the opportunity to innovate and transition to go digital, thus leading them to go into administration (Parson, 2014).
The owners of the company are its shareholders and so the primary purpose of value-based management is to achieve long-term shareholder wealth maximization (SWM). This objective is superior in most commercial organisations that operate in competitive markets. However, some companies put shareholder value in second or third place behind other objectives. Is this right? Is growth in sales or market share more worthy? I would disagree with this, as shareholders are the owners of the company, who put their trust and investment and so would want to be rewarded for this.
Source: Arnold (2013)
Figure 2. Three steps involved when creating shareholder value:
Source: Arnold (2013)
Alfred Rappaport (1998) took the basic concept of discounting cash flows and developed a simplified method of analysis. With respect to Figure 1, Rappaport’s seven key factors that determine value are clearly shown.
Why is shareholder value increasing?
There are many reasons why shareholder value is gaining momentum. The first reason is due to the fact that there is an increasing threat of takeover by teams of managers searching for poorly managed businesses. This can create more value to shareholders through strategic change, divestiture and shifting of executive incentives. Global companies such as GE have the responsibility to provide the best possible return to shareholders financially and through the impact on the world today and in the years to come. As Trevor Schauenberg, Vice President, Investor Relations for GE explains “Investors are increasingly interested in well-managed companies that will create shareholder value over long periods of time, while contributing positively to the society and the communities they operate in. With its portfolio of infrastructure solutions and reputation of unyielding integrity, GE is able to respond to these investors and generate value for them.”
However, problems may occur with SWM. What managers wish to achieve may be different to the owners i.e. shareholders. For example, managers may wish to achieve a bonus or an increase in their salary, whereas shareholders would want a high return on their investment through dividends. It is believed the owners of the business would have the right to demand that director’s act in the best interest. This would therefore lead to agency problems within the business.
Therefore to summarise, shareholder value has been expressed through many different elements as shown above. CEO’s should not neglect this, as shareholders are one of the most important stakeholder groups in the business.
I would like to say that I also disagree with the fact that organizations don't follow the principle of shareholder value creation as their first objective. As you said shareholders are the true owners of companies and therefore the board of directors and managers should always act for the interest of their shareholders. I really liked the part that you have put pictures to show how shareholder value can be created. In general, the post is really good with so many information! Was a really good reading, good job Sana!
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