How valuable is ‘Shareholder Value’?
- 5 January 2012
Capturing the sentiment, Forbes suggests ‘shareholder value' a key business concept of the last two decades may be the dumbest idea in the world. This is Forbes contributor Stephen Denning considering a book released last year by Roger L Martin, dean of the Rotman school of management at the Universtiry of Toronto, who suggests that company boards may have massively lost their way.
Denning writes: "CEOs and their top managers have massive incentives to focus most of their attentions on the expectations market, rather than the real job of running the company producing real products and services."
Get those products and services to customers, Denning and Martin believe and an improved share price will follow – something they argue hasn't been happening much in the last few decades.
Denning continues: "The 'real market'", Martin explains, "…is the world in which factories are built, products are designed and produced, real products and services are bought and sold, revenues are earned, expenses are paid, and real dollars of profit show up on the bottom line. That is the world that executives control-at least to some extent.
"The expectations market is the world in which shares in companies are traded between investors-in other words, the stock market. In this market, investors assess the real market activities of a company today and, on the basis of that assessment, form expectations as to how the company is likely to perform in the future. The consensus view of all investors and potential investors as to expectations of future performance shapes the stock price of the company."
But counter-intuitively, this then helps investors. For example the three exceptions to this world of managing expectations and shareholder value are Johnson & Johnson, Proctor & Gamble and Apple, three firms which generally have very happy shareholders.
And the thinking appears to be catching on.
John Plender writing on FT.com suggests: "The practice of rewarding executives increasingly with equity is imposing a far greater focus on short-term measures of performance. Academic evidence in the US has, for example, shown that a high proportion of chief financial officers admit to a willingness to sacrifice economic value to meet short-term earnings targets. The current record profit margins and exceptionally high unemployment reflect that ruthless focus".
He also suggests that boards are also to keen to embrace M&A activity "partly because stock options and rewards for failure give managers a huge incentive to bet the ranch".
Here the Telegraph business comment is very cynical about UK retail businesses' attempts to meet stock market demands with year on year retail sales figures when, the paper argues, it is profit that matters especially in this climate.
And the paper offers this advice to potential investors. "Given the City's obsession with like-for-like sales, who could blame the chief executive of a troubled retailer for sacrificing a bit of profit margin to deliver the like-for-like sales increase the City's scribblers crave?
"But profit margins should be at the forefront of investors' minds this year, given that many retailers were forced to discount heavily ahead of Christmas in a last-ditch attempt to attract shoppers into their stores. Look for any clues in the chief executive's statement, or analysts (particularly those working for the retailer's own advisers) nudging down profit forecasts following the update."
However some bloggers for example Ruth B, an academic who lectures and writes about, among other things, corporate strategy and remuneration, thinks the arguments including those of Roger Martin require some refining.
She writes: "In my own book, Corporate Financial Strategy, I address head-on the issue of different stakeholders, and point out the problems inherent in running an organisation to prioritise all of their different needs. I conclude chapter 1 as follows:
● Stakeholder management is an important part of long-term shareholder value creation.
● Although accounting results are not necessarily an indicator of shareholder value, companies spend much time and effort on ensuring that the accounting results look good, sometimes to the detriment of value.
I don't disagree with the Martin ideas and the Forbes article. But it's lazy thinking to misapply a perfectly useful concept and then damn it for being wrong."
This could be one of the debates of the year 2012.
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