Creating and measuring shareholders value

International Accounting and Finance

Master Thesis – No 2001:8

Creating and Measuring Shareholder Value:

Applicability and Relevance in Selected Swedish Companies

Beatrice Nyiramahoro & Natalia Shooshina

Graduate Business School
School of Economics and Commercial Law
Göteborg University
ISSN 1403-851X
Printed by Elanders Novum AB

Preface
This thesis is a culmination of our study at Integrated Master Program-
Accounting and Finance. We finally carried out this project but it would have
been very difficult without the help and support of many people in our
surroundings.

We sincerely express our gratitude to our tutor, Jan Marton, for his advice,
guidance and support throughout this thesis writing.

We would like to thank our interviewees: Karl-Henrik Lindgren (Electrolux),
Marita Björk (SKF), Lotta Treschow (SEB), Fredrik Hjelm (Volvo Group), Bo
Gustavsson (Volvo Group), Hans Bertéus (Bilia), Staffan Salén
(Föreningssparbanken), Johan Karlsson (ABB), for their participation.

Our sincere thanks go to the Accounting and Finance program coordinator,
Professor Ulla Törnqvist and to all the Lecturers for their efforts in realization
of this program. We would like to thank Ann McKinnon for the support during
the whole master program.

Beatrice Nyiramahoro would like to thank her husband, Aaron Ndagijimana
and her son, Alan Ndagijimana for their patience, encouragement and moral
support.

We express our thanks to all who contributed in one way or another to the
realization of this work. Above all, we would like to thank each other for a
good teamwork.

Beatrice Nyiramahoro Natalia Shooshina

I

Abstract
To measure shareholder value creation has been the issue of discussion all
around the world. It has become crucial since the companies were increasingly
committing to creating shareholder value. Old traditional measures are
criticised for having low correlation with shareholder value creation. Therefore,
new valuation methods are needed to measure the shareholder value creation.
However, the changing process from the traditional methods to the new ones is
not easily welcomed. How then shareholder value creation is measured
nowadays is of crucial importance. In order to address this issue, the thesis
presents in a general way how shareholder value is created as a background to
the valuation methods being used for shareholder value creation measurement.
The empirical part of the study showed that although the companies in this
study have implemented many ways to create shareholder value, little effort is
being made to measure it since the majority of them are still using the
traditional accounting measures. The reasons for this may be conservatism and
lack of pressure from both the stock market and shareholders. Having noticed
this we then recommended the companies to use “value based methods” when
measuring shareholder value creation since they are more reliable.

Key words: Shareholder Value, Value Creation, Value Based Management,
Choice, Measures, Advantages and Shortcomings.

II

TABLE OF CONTENTS

INTRODUCTION .................................................................................................................. 1
1.1 BACKGROUND ................................................................................................................. 1
1.2 RESEARCH ISSUE ............................................................................................................. 3
1.3 OBJECTIVE OF THE STUDY ............................................................................................... 4
1.4 SCOPE AND LIMITATIONS................................................................................................. 5
1.5 CHAPTER LAYOUT ........................................................................................................... 6
2 RESEARCH METHOD...................................................................................................... 9
2.1 RESEARCH APPROACH ..................................................................................................... 9
2.2 POSITIVISTIC AND HERMENEUTIC PERSPECTIVE ............................................................... 9
2.3 QUANTITATIVE OR QUALITATIVE METHODS................................................................... 10
2.4 DATA COLLECTION ........................................................................................................ 11
2.4.1 Literature study ..................................................................................................... 11
2.4.2 Empirical data ....................................................................................................... 12
2.5 SAMPLE OF STUDY COMPANIES ...................................................................................... 15
2.6 RESEARCH EVALUATION................................................................................................ 18
2.6.1 Validity .................................................................................................................. 18
2.6.2 Reliability. ............................................................................................................. 19
2.7 SUMMARY ..................................................................................................................... 20
3 THEORETICAL FRAMEWORK .................................................................................. 21
3.1 CREATING SHAREHOLDER VALUE .................................................................................. 21
3.1.1 Introduction and History of shareholder value ..................................................... 21
3.1.2 What is shareholder value? ................................................................................... 22
3.1.3 Shareholder versus other stakeholders ................................................................. 24
3.1.4 Value drivers ......................................................................................................... 26
3.1.5 what is value creation?.......................................................................................... 27
3.1.6 Facts about shareholder value creation................................................................ 28
3.1.7 Ways to create shareholder value ......................................................................... 29
3.1.7.1 Excellence in operations................................................................................. 29
3.1.7.2 Getting the financial structure right................................................................ 30
3.1.7.3 Being focused ................................................................................................. 31
3.1.7.4 Credible earning growth ................................................................................. 31
3.1.7.5 Information ..................................................................................................... 32
3.1.7.6 Stock repurchase............................................................................................. 33
3.1.8 Shareholder value network.................................................................................... 34
3.1.9 Value Based Management ..................................................................................... 35
3.2 SHAREHOLDER VALUE CREATION – HOW TO MEASURE IT? ............................................ 38
3.2.1 Introduction. .......................................................................................................... 38
3.2.2 Old and traditional accounting measures – plusses and shortcomings. ............... 39
3.2.2.1 EPS – Earnings Per Share .............................................................................. 39
3.2.2.2 ROI: Return On Investment............................................................................ 40
3.2.2.3 ROE – Return On Equity................................................................................ 41
3.2.3 Recently developed measures – why are they better than the old? ....................... 43
3.2.3.1 TSR - Total Shareholder Return..................................................................... 43
3.2.3.2 EVA – Economic Value Added ..................................................................... 45
3.2.3.3 MVA – Market Value Added ......................................................................... 48

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3.2.3.4 CVA® – Cash Value Added .......................................................................... 50
3.2.3.5 CVA developed by the Boston Consulting group.......................................... 51
3.2.3.6 DCF – Discounted Cash Flow........................................................................ 52
3.2.3.7 CFROI® – Cash Flow Return On Investments.............................................. 53
3.2.3.8 Q ratios ........................................................................................................... 54
3.2.3.9 The comparison of the new measures ............................................................ 54
3.3 THE PARTICULARS OF THE APPLICATION OF THE SHAREHOLDER VALUE MEASURES IN
SWEDEN .............................................................................................................................. 58
4 EMPIRICAL STUDIES ................................................................................................... 61
4.1 CREATING SHAREHOLDER VALUE .................................................................................. 61
4.1.2 Reasons behind the choice of the ways used ......................................................... 64
4.1.3 Success of the ways to create shareholder value .................................................. 67
4.1.4 Shareholder value creation as key corporate objective ........................................ 68
4.1.5 Shareholder value creation in the long run .......................................................... 69
4.1.6 Value-based management ..................................................................................... 70
4.2 MEASURING SHAREHOLDER VALUE CREATION .............................................................. 72
4.2.1 Valuation Methods ................................................................................................ 72
4.2.2 Reasons behind the chosen methods. .................................................................... 75
4.2.3 The benefits of measuring the shareholders value creation.................................. 76
4.2.4 Development of measures that the companies use. ............................................... 77
4.2.5 Advantages and shortcomings of the chosen measures. ....................................... 78
4.2.6 The test of validity of the chosen measures ........................................................... 79
5 ANALYSIS........................................................................................................................ 81
5.1 THE SHAREHOLDER VALUE CREATION ........................................................................... 81
5.1.2 Reasons behind the choice of the ways used. ........................................................ 84
5.1.3 Successfulness of the ways to create shareholder value ....................................... 86
5.1.4 Shareholder value creation as a key corporate objective ..................................... 87
5.1.5 Shareholder value creation in the long run. ......................................................... 89
5.1.6 Value-based management ..................................................................................... 91
5.2 MEASURING SHAREHOLDER VALUE ............................................................................... 93
5.2.1 Analysis of valuation methods............................................................................... 93
5.2.2 Reasons behind the chosen methods ..................................................................... 98
5.2.3 The benefits of measuring shareholder value creation ......................................... 99
5.2.4 Development of the measures that the companies use ........................................ 100
5.2.5 Advantages and shortcomings of the chosen measures. ..................................... 100
5.2.6 Test of the validity of the chosen measures ......................................................... 101
5.3 A COMPARISON BETWEEN THE EMPIRICAL FINDINGS AND THEORETICAL FRAMEWORK 102
6 CONCLUSION AND REFLECTIONS ........................................................................ 105

REFERENCE ..................................................................................................................... 109

APPENDIX 1. ..................................................................................................................... 115

APPENDIX 2 ...................................................................................................................... 116

APPENDIX 3. ..................................................................................................................... 118

IV

Chapter 1 − Introduction

Introduction
This chapter deals with the background, research issue. The purpose and scope
of the thesis are also defined.

1.1 Background
One of the most frequently used terms in business today is Shareholder value.
The "equity culture" wildfire is spreading rapidly from the US to the rest of the
world (Thakor et al, 2000). It is seen as crucial all over the world. In Sweden
the new measurement systems of shareholder value creation were introduced in
the last decade and have been slowly introduced in various companies. Indeed,
some of the leading companies like SCA and SKF have made the creation of
shareholder value one of their key corporate objectives.

In the other parts of Europe this idea had spread earlier and rapidly. In
Germany, for example, Veba’s – one of the industrial giants – CEO closed
divisions that date back to Veba’s beginning, fired long-time managers, and
laid off thousand of workers – all in the name of investors. That CEO worried
about shareholder value. “Satisfying the shareholders is the best way to make
sure that other stakeholders are served as well. It does no good when all the
jobs are in the sick companies”—said that CEO (Eitemann at al, 2000).

What is shareholder value and why should the financial managers care about it?
If shareholders believe that the corporation is underperforming, they can try to
replace the board in the next election. If they succeed, the new board will
appoint a new management team. But the vote on a new board is quite
expensive and rarely successful so the shareholder will simply sell their shares
(Brealey and Myers, 2000).

Moreover shareholders are the owners of the corporation and the board of
directors are their representative and elected by them. The objective function of
the corporation is to maximize the shareholder value. Managers in most of the
developed world must focus on building shareholder value (Copeland et al,
2000).

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Creating and measuring shareholder value by Beatrice Nyiramahoro and Natalia Shooshina

If the managers and director don’t maximize value, there is always the threat of
a hostile takeover. The further a company’s stock price falls, due to the wrong-
headed policy, the easier it is for another company or group of investors to buy
up a majority of the shares.

Large institutional investors are increasingly influencing corporate policies.
They are creating a heightened awareness of the role of compensation-based
incentives in focusing executive efforts on creating shareholder value.
Companies are rewarding senior executives with shares and with options on
these shares. Thus, share price is now critical for most senior executives
(Thakor et al, 2000).

Most executives today understand that the need to create shareholder value is
paramount and the world’s most competitive management teams are
responding to the pressure to create value by embracing new metrics and new
models for managing their companies (Copeland et al, 2000)

Traditionally a variety of measures were used to show how much value was
created. Some of them are earning per share (EPS), Return on Investment
(ROI) and Return on Equity, EVA (economic value added). Moreover a variety
of consulting firms have been creating their own measures and recommending
them to their clients.

In today’s Globalized world characterized by accelerated competition
companies must stimulate profitable growth, measure value creation and
continually learn from success and setbacks. The only companies that can
acquire new capital, grow and remain profitable are those that create value.
Active shareholders are putting more pressure on corporate management to
measure and communicate how they are creating value and shareholders find
anything other than value-creating companies unacceptable (Anelda, 2000).

Scott (1998) expressed that there is no doubt that nowadays the principal goal
of management is the enhancement of shareholder value and this means

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maximizing the returns generated to those people who have an ownership stake
in the business.

This idea of creating shareholder value comes as an imperative to many
companies and leads them to get actively involved in that process. Companies
create shareholder value through a set of strategies, depending on what they
believe would create more value.

1.2 Research Issue
When managers consider alternative strategies, those expected to develop the
greatest sustainable competitive advantage will be those that will also create the
greatest value for shareholders (Rappaport, 1998).

Companies can choose excellence in operations that is closely related to the
profitability. They can get their financial structure right, which is closest to free
cash flow among the fundamental drivers. They can also choose to be focused
and this is linked most closely to profitability. Those are areas of comparative
advantage. They can also create value through credible earnings growth, which
matches the fundamental driver growth and many other ways are in place to
create shareholder value (Dalborg 1999).

The research issue arises from this variety of different ways to create value.
There is always scope for creating value in companies and they avail
themselves of value-creating advice. The strategies are put in practice within
the framework of that scope. We then find it worthwhile to investigate how
strategies are handled in practice in some selected Swedish companies.
However, it is not enough to have strategies in place, there is need for some
indicators to ensure whether value had been created. Thus the companies need
to measure and make sure that they are being successful in creating value for
shareholder. “What gets measured gets done” this was a famous statement by
Percy Barnevik’s (Dalborg, 1999). That statement underlines the importance of
measurement.

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The idea of measuring value creation is not new. Most attempts to measure
value creation have been based on numbers derived from historical
performance. Research shows that many traditional accounting measures used
have shortcomings (Pappaport, 1998). They have a fairly low correlation with
shareholder value creation for example return on equity (ROE), and return on
the capital employed (ROCE), return on the investment (ROI). That low
correlation of ROE can be partly explained by the distortions introduced by
non-cash nature of these measures, their use of historical asset values, the
effects of deferrals etc. (Dalborg, 1999).

There is also a set of inventions and innovations that are designed to overcome
the limitations of the traditional accounting framework, as seen from a 21st
century perspective. This flow of new inventions to improved performance
measurement hitting world business today, created in us, the curiosity also to
investigate the measurement process used nowadays within the companies;
whether they are still using those traditional measures or whether they have
modified them or formulated their own.

Indeed, based on what is discussed above the research issue for this study is
therefore formulated as follows:

How do companies measure shareholder value creation?

In order to better answer the research issue, creating shareholder value will be
studied in general as background to the research issue. The research issue will
cover the different valuation methods used by companies to measure
shareholder value creation and also the advantages and shortcomings of those
methods whenever identified.

1.3 Objective of the study
The purpose is to conduct an analytical study of different methods used by
companies to measure shareholder value creation. The study also aims to give a
general picture of how shareholder value is created as a background to
measuring shareholder value. Furthermore all that will be done will be based
on an empirical study.

4


1.4 Scope and limitations
Creating and measuring shareholder value can be studied from different
perspectives. When studied from the shareholder or other stakeholder
perspective, the research is mostly based on the information collected from the
shareholder or stakeholders. When it is the stock market perspective, the
information used in the study is collected mainly from the stock market. If the
study is based on the company perspective then the information used will
mainly be collected from the company. Every perspective is very important to
investigate. However due to the time limit and the scope of the problem we are
obliged to make some limitations.

In our study we are tackling this research issue from the point of view of the
company. We chose this point of view since it is actually the company that is
putting in place different strategies and using the measures for shareholder
value creation. We therefore believe that our research problem would be well
answered if we used the company perspective. We have then conducted
interviews only in the companies. Even though we are considering this problem
on that point of view, in our work we may when it is judged very imminent
refer to some secondary data from the consulting companies but this may only
occur occasionally.

We also limited our study to Swedish companies since we want to explore what
is being done in Sweden and given that the new metrics for measuring
shareholder value creation have reached Sweden in the mid of last decade, we
want to know what has happened so far. Moreover, we are collecting our
empirical data from the headquarters since we want to capture the information
on the group level and for most of the Swedish companies the headquarters are
situated in Sweden. That makes it very accessible to us given the time limit of
our thesis.

Our study is also limited to 7 companies that we believe are in position to
provide information that can be used to better answer the research issue. Thus
not all Swedish companies will be included in our study. Those companies in
our study are large and able to provide information we need, they are

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international, create shareholder value and they are listed companies. More
about the choice of companies is included in the methodology part.

Many factors can affect shareholder value such as the environment surrounding
the firm, weaker business climate, political situation, and currency fluctuations.
We are not going to cover the above factors in our study since the background
information will be covered in general and it is not the main focus of our
research. However they are discussed partially only when our sample
companies consider them to be crucial factors affecting their operations.

1.5 Chapter layout
Chapter 1 covers the research issues. It includes the background information
and the research discussion. The purpose of the study and the scope and
limitation are also discussed in this chapter.

Chapter 2 is methodological discussion. It includes the description of the
research approach, conceptual framework, and qualitative or quantitative, types
and how we collected the data, and finally the research evaluation. The purpose
of this chapter is to give a clear picture of how we carried out our study.

Chapter 3 explains the shareholder value concepts and related concepts. The
Stakeholder in the shareholder value corporation is covered, and the different
views on shareholder value creation. This chapter also discusses different ways
or strategies for creating shareholder value. It also covers the value-based
management. The purpose of this study is to give the reader a better
understanding of shareholder value creation. It focuses on describing both
traditional and recent methods used to measure value creation. It encompasses
their definitions, how they function and their possible shortcomings and
advantages. The aim of this chapter is to provide the information that will help
the reader understand different existing measures of shareholder value creation.

Chapter 4 includes the results. It gives general information on strategies for
creating shareholder value and the reason why they are chosen. It also describes

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the identified measures used for value creation, why they are used and their
possible shortcomings on the basis of the point of view of the companies.

Chapter 5 covers the analysis and the interpretation of the results. The analysis
links the theoretical framework to the results that is linking what the theoretical
part proposes to what actually takes place in practice. It covers general analysis
of the shareholder value creation in order to give a background to the analysis
of the measurement of shareholder value creation.

Chapter 6 covers main conclusions that are drawn from the study. It also
includes our comments and recommendations to companies included in our
study as well suggestions for further studies

Chapter 7 includes the list of references and appendix.

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Creating and measuring shareholders value

Chapter 2 − Research method

2 Research method
This part covers the process through which our research was carried out. It
describes and discusses different methodological issues used in the thesis.

2.1 Research approach
In the process of answering our research issue we used different approaches.
We used an explorative approach. We went through the literature to document
the shareholder value related issues in order to get basis information about the
research issue. We also used a descriptive approach during the theoretical part
where we give a general view on the existing ways of creating shareholder
value and the existing methods of valuing shareholder value creation. Our
thesis has also a prescriptive part where we explain what ought to be done in
this area of creating and measuring shareholder value. We believe these
approaches are best for our study since they allow us to better document
ourselves, describe and prescribe furthermore, all these are vital in answering
our research issue.

2.2 Positivistic and hermeneutic perspective
A scientific problem can be approached either under a positivistic or
hermeneutic conceptual framework. In the positivist position there is a mind-
independent that can be described with objective language. Statements are only
meaningful if they are synthetic and represent contingents or empirical truths or
analytic that represent formal truth. The meaning of a statement is delivered
from the method of its verification (Ryan et al, 1992). Moreover, Ericksson and
Weiedersheim (1999) state that in the positivistic approach the empirical
research is the most important part; the scientific value has to be verified with
empirical data.

Hermeneutics study is the interpretive understanding or meaning with special
attention to context and original purpose. It takes the position that nothing can
be interpreted free of some perspective so the first priority is to capture the
perspective and elucidate the context of the people being studied and the
researcher own perspective must be made explicit (Patton, 1990). The
hermeneutic approach is that which has strong emphasis on the overall view

9


and it assumes that all actions, social names and values have a human
foundation (Ericksson and Weiedersheim, 1999).

Positivistic framework is the best for our study since we collected the empirical
data from the companies and we draw conclusions on the basis of them. Thus
the empirical data have a great importance in our study. Moreover the empirical
data are collected on the company perspective towards the measuring
shareholder value and creation of shareholder value as a background, which
then contribute in excluding our personal view and societal norms from our
study. This has great importance for our study since it shows how the creation
and the measuring of shareholder value is and not how it seems to be.

2.3 Quantitative or qualitative methods
Two methods may be used in the research, those are quantitative methods and
qualitative methods. In the quantitative study the focus of the research is
quantity and its goals are predictions, control, description, confirmation,
hypothesis testing. Its associate phrases are experimental, empirical, and
statistical. The sample in the study may be large, random, and even
representative. The data collection is done through inanimate instruments such
as scales, tests, surveys, questionnaires, and computers. The mode of analysis is
deductive by statistical methods and the findings may be precise, narrow or
reductionist (Merriam, 1998).

In contrast, the qualitative study usually involves the field work that is that
researcher must physically go to the people, institutions in order to observe
behaviour in its natural setting, however as exceptions some qualitative study
can be undertaken using documents alone. The focus of the research is the
quality, which may be defined as nature and essence. Its associate phrase may
be naturalistic, grounded and subjective. The sample may be small, non-
random, purposeful or theoretical. The goals of qualitative study are usually
understanding, description, discovery, meanings and hypotheses generating.
Concerning data collection the researcher is the primary instrument, and can
use interviews, observations and documents. The model of analysis is inductive

10


by the researcher and the findings are comprehensive, holistic, expansive, and
richly descriptive (Merriam, 1998).

Even though our research is mainly qualitative, in conducting our study both
qualitative and quantitative techniques were used. The qualitative techniques
are more used than quantitative ones in collecting, processing, and analysing
the information that we gathered. This depends on the nature of our study,
which is qualitative and the kind of information needed. A combination of both
techniques is advantageous for this thesis since it allows us to identify,
understand and tackle in a deeper way the research issue. It also contributes to
the relevance of our study.

2.4 Data collection
“Research is simply gathering the information you need to answer a question
and thereby help you to solve a problem” (Booth et al, 1995). In order to carry
out our research project, we needed to collect the data. Since getting the data
was one of the important parts of our work, we had to determine which kind of
data would help us to better answer our research issue. We decided to use
literature study and empirical data so that we would be able to have a balanced
picture of what took place and also of what is currently going on in our
research areas. The discussion below describes each type of information and
discusses in detail what we actually did with each type of data.

2.4.1 Literature study
By literature study we mean the information that had been collected by other
researchers for various purposes and are available to be referred to. The sources
for our gathering of the literature study are various documents; in our case there
were annual reports, books, articles, databases and Internet search engines.
Literature survey was done on the above-mentioned literature materials. The
literature study was to help to get baseline information on what was known
about shareholder value creation and measurement. Annual reports from
different companies were also reviewed in order to provide information on
what is being done by the company. All these secondary data that we gathered
helped us to get a better understanding of the subject and the problem and it

11


also gave us the basic foundations for conducting this study on measuring
shareholder value creation for the companies.

2.4.2 Empirical data
Empirical data stand for the information that is collected by the researcher from
the fieldwork. As mentioned in the qualitative study there are different way that
can be used to collect the data. Among those ways we used the interviews for
collecting our empirical data. The discussion that follows in interviews covers
the reason why we chose to use interviews, how we selected the interviewees,
the structure of the interview, the formulation of interview questions and the
form of the interview.

We chose to use the interviews because of the nature of our study and we were
convinced that interviews are best way we could use to get information, which
was reliable, detailed and up to date that was needed for our study. This idea is
backed by Merriam (1998) who mentioned that in qualitative studies
interviewing is a major source of qualitative data needed for understanding the
phenomenon under study. We also judge interviews to be the best way for us to
use the following explanations from them given by Dalphnem (2000) who said
that an interview is a controlled interaction, which uses verbal exchange as the
main method of asking the questions and it has a direction and a shape. It is
designed for a specific purpose and gives the opportunities to the interviewer to
explore the reasons for a person’s responses. Questions, which were not
understood, can be rephrased, and being given encouragement can help
reluctant or anxious interviewees.

Before discussing how we selected our interviewees we would like to make
clear that the companies in our study sample are organized differently and
conduct different business in their own way that made it impossible for us to
predetermine the same department in all companies where we were to conduct
the interviews. Thus, our interviews were not conducted in the same
department but all of them were conducted at the headquarters. In selecting our
interviewees we contacted the headquarters since we were interested in the
information on the group level not on subsidiary level. We proceeded in this
way. We first sent e- mails to the contact persons in the companies. That e-mail

12


explained what our research issue is about, our purpose, the kind of information
we wanted from the company and we asked the contact person to direct us to
the appropriate person meaning the person who works or is in charge of what
we want to know on the group level. The contact person directed us to the
person he or she believed was the right one.

We then proceeded in contacting the right persons by sending them e-mail
messages explaining further our research issue. This was made again since we
were aware of the problem that might arise from getting the wrong person if we
let the companies choose for us whom to talk with. Thus we wanted to be very
sure that the interviewees were the right people. Fortunately, in all the cases
this was the right person to talk with. Later on, after the confirmation, we then
phoned them to book the date and time for the interviews.

Our interviewees were of different characteristics since they worked in
different departments and their tasks were not exactly similar this helped us to
reap a rich content of information. It is also important to mention that our
interviewees had some similarity. All of them work, deal or are in charge of
information for creating and measuring shareholder value. Before, we
conducted the interviews, we kept in contact with our interviewees in order to
deal with some problems, which would arise such as change of schedule or
change of position in the company. On the basis of the above information and
on how the interviewees responded during the interview we believe that we
talked to the right people in the companies.

Concerning the structure of the interview Anderson et al (1998) discussed that
research interviews generally focus on collecting data or information that is
essential for a larger task of learning about or deciding about, something and
such research takes many forms. Merriam (1998) wrote that the types of
interview used depend on the amount of structure desired. There are highly
structured/-standardized interviews whereby the wording of the questions and
the order of questions are predetermined and these interviews are like an oral
form of written survey. There are also the semi-structured interviews whereby a
mix of more or less structured questions are used. The last one is the

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Unstructured / Informal interviews whereby the questions are open-ended
questions and it is flexible and exploratory and it is more like a conversation.

We used semi-structured interviews where a mix of more and less structured
questions were used. We are convinced that this was a good structure fitting our
study since there were some areas in our study where we wanted all
interviewees to give their point of view and it was necessary to have the same
part for all interviewees. This constitutes then standardized parts of the
interview where the questions were the same for all the interviewees. We also
left the interview open by a flexible part of the questions where the questions
were to be answered following the information available to the interviewees
and also depending on the kind of business the companies ran.

In regard to the formulation of questions, Merriam (1988) pointed out that the
questions are the heart of interviewing and to collect meaningful data one must
ask good questions. Following the importance of the questions in the interview,
we made a list of questions. These questions were based on our research issue
and purpose. We also took into considerations previous research done on this
area, thus our questions are good and balanced.

Our questions could be categorized as the kinds of questions identified by
Patton (1980), there are some knowledge questions which aim at finding out
what is believed to be factual information to the research issue. There are some
opinion value questions which aims at what people think, feeling questions,
which help to understand the emotional response of people and their
experiences and thoughts; finally there are also experience/ behavior questions
whereby description of experience, behavior, actions, and activities that would
be observed are elicited. Having these different types of questions in our
interview contributed to collecting a good, variety, quality information that was
necessary for our research issue. We also needed facts, points of view and
descriptive information and using different types of questions helped us to get
as much information as we could.

Concerning the form of interview, the most common form of interview is
person-to-person interview encounter in which one person elicits information

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from another (Merriam, 1998). In conducting our interviews five interviews
were person-to-person interviews and two of our interviews were done on the
telephone. The reason for one of the interviews, which was done on the
telephone, was the location of the office that dealt with the information we
needed and the reason for the other interview on the phone was the wish and
desire of the interviewee.

In conducting our interview we established a good, dynamic relationship with
the interviewees by letting them express themselves and they were open. In
case there was difficulty to understand the question we came in and made it
clear for them so that it could help them to give us more information about our
questions and at the same time we avoided influencing their answers. In some
cases we also asked for immediate clarifications in case their responses were
not clear to us and we also avoided the unnecessary interruptions of the
conversation. We had also the responsibility of guiding the interview and
making sure that its direction was not out of the area.

Our interview data was recorded by taking notes during the interviews, thus our
interviews were not taped and that gave us an advantage since the interviewees
were open and expressed their ideas freely. After the interview we synthesized
the information written as soon as it was possible to make sure that we were not
missing out some information. In some cases following agreement with
interviewees we sent back what we wrote down to the interviewees for them to
check if there was no misunderstanding or for them to add what they felt was
missing in the written information. The dynamic relationship was maintained
throughout the interview and by the end of the interview; both the interviewees
and we felt that we had participated in a worthwhile activity. All interviewees
agreed for further clarifications on e-mail or telephone if necessary.

2.5 Sample of study companies
In our study we could not include all the Swedish companies in our study
because of the practicability and the time limit. We then had the task of
choosing the companies that should be included in our study. In order to narrow

15


down our sample we set eligible criteria that companies must fulfill to be
included. Those criteria were the following:

• More than one shareholder own them. In this case, there is a motivation
to create shareholder value.

• They are Swedish companies since they will be easily reached and the
study aim was to know how the situation is in Sweden.

• They are listed companies, the reason for this is that it is much more
possible to measure shareholder value creation.

• They are creating directly or indirectly shareholder value since this study
could be best done in the companies admitting that they are creating
shareholder value.

• They have a history stretching back more than 30 years and in case the
company may be a result of a new merger, then, at least one of the
companies should satisfy that criteria. The reason for this criterion is that
the companies with long histories are believed to be more stable and
could manage to face the future challenges than those that are recently
established.

• Finally, those companies are large and operate in international
environments since such companies are believed to disclose more
information than others.

We did not limit ourselves to specific industries since measuring shareholder
value creation, which is the research issue of the study, does not depend on the
industry that is even the reason why the companies in the study are not
categorized. After setting these criteria, we then used a nonprobability sampling
method, which is the convenience sampling to the companies that were
fulfilling them. According to Fink and Kosecoff (1998) the convenience
sampling is a nonprobability sampling whereby one selects everyone who

16


meets the criteria for the study, who are willing to complete all questions and
are available when they are needed. This means that we took a list of Swedish
companies that fulfilled the criteria and we sent them e-mails explaining what
we intended to investigate and asking them if they were interested in
participating in our study; the companies that answered positively were all
included in our study. These are then the following seven companies: Volvo
group, ABB, SKF, Electrolux, SEB, Föreningssparbanken, Bilia.

Description of companies
We are giving in this section a short description of all the companies included
in our study to help and give the reader general idea of the companies in case
he or she may not know the companies.

Electrolux AB.
It is the leading white-goods company in Europe and the third largest in the
USA. The Group is also the second largest producer of the floor-care products
and garden equipment.

ABB
ABB was established in 1883 and nowadays is one of the largest energy and
automation companies, which consists of several segments. Those segments are
automation; power distribution; power transmission; building technologies; oil,
gas petrochemicals and financial services. It is the Swedish-Swiss company
that operates all over the world.

Volvo AB.
It is a one of the leading truck producers in the world: which consists of the
following segments: trucks, buses, construction equipment, marine and
industrial power systems, aero equipment and financial services.

SKF:
It was founded in 1907. It is the world largest manufacturer of roller bearings,
which operates in the 22 countries. It consists of the following divisions:
industrial division, automotive division, electrical division, service division,

17


seals division and steel division. It has around 41 000 employees and operates
in more than 150 countries.

Bilia
Bilia was established in 1967 and nowadays it is one of the leading car
companies in services, sales and supplementary services.

SEB
SEB was established in middle of 19th century as a private bank in Stockholm.
The innovative forces and far-sighted investment during the 150 years have
transformed the bank into the market leader in several fields of business. It has
developed into a European financial group for primarily companies and
financially active private individuals. The group is represented in some 20
countries around the world has 21500 employees.

Föreningssparbanken
Föreningssparbanken is a result of a merger between föreningsbanken and
sparbanken in 1997. However its history goes back to 1820 with the
establishment of sparbanken. Nowadays it is one of the largest Nordic bank
groups in the region.

2.6 Research evaluation
2.6.1 Validity
Ryan et al (1992) explained that the internal validity is determined by how
much control has been achieved in the study and they defined the external
validity as the extent to which the result of a study can be generalized to other
settings and samples. Merriam (1998) added that internal validity deals with the
question of how one’s findings match the reality.

To be able to reach a high level of validity we concentrated much attention on
the literature review and the definition of our research issue. The formulation of
the interview questions was also done with much attention so that they would
cover the subject under study. In addition we had a discussion with our tutor on
the questions. We also explained clearly our research issue to the interviewees

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so that they could get a good understanding of our study. This helped them to
also get prepared and allowed us to get the right information from them. We
also used these strategies to insure the internal validity. We used multiple
sources and multiple methods to confirm the emerging sources. The validity of
our study is also increased by the relationship between the result of our
research and the primary data since our analysis and interpretation is mostly
based on the information we got from the interviews. We are also using the
peer examination whereby we ask our colleagues to comment on our findings
and we also took into consideration their comments and we contacted, when it
was needed, the interviewees several times in the process of the work on the
topic of the study.

2.6.2 Reliability
According to Ragin (1994) reliability concerns how much randomness there is
in a particular measure. It refers to the extent to which studies can be replicated.
In other words, for example, if the same study could be repeated would it give
the same result? In our study, the main source of our empirical data collections
is the interview and in the interview people give their points of view which may
be different from person to person, then a certain degree of reliability of our
study may be lost. That is because in case this study was repeated, it may not
give exactly the same result since people would have changed their view or the
circumstances in which they work would have changed. Moreover, in our study
seven companies are included and by the time the study is repeated they might
have changed the strategy or have restructured themselves. All these factors
would affect the reliability of our work. Despite these factors that are likely to
influence our study, we are sure that our study has a considerable degree of
validity since to insure the reliability in our study we explained very well the
assumptions behind the theories and the theoretical framework of reference
were written based on reliable and objective sources. By setting good questions
and using multiple sources and methods we also increased the reliability of our
study.

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2.7 Summary
The methodological part indicates that our study is done under the positivist
perspective. The explorative, descriptive and prescriptive approaches are used
in different parts of our work. In the study the qualitative methods are used but
some quantitative elements can be identified. The literature review data is
collected in different documents and Internet sites while we collect our
empirical data through the interviews. The sample of our study includes seven
Swedish companies. The notion of validity and reliability of our study are also
discussed in this chapter.

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Chapter 3 − Theoretical framework

3 Theoretical framework
The theoretical framework includes two parts. The first parts give the general
information about the concepts; theories and perspectives on the shareholder
value creation in order to create a background for the second part that describes
the present methods used to measure shareholder value creation.

3.1 Creating shareholder value
3.1.1 Introduction and History of shareholder value
The theories on shareholder value have a history stretching back to 1950s and
1960s and their intellectual roots are in the pathbreaking work of some
economists of that time and a number of them have been honored with the
Nobel prize for economics. Shareholder value started to take on a life of its
own as a result of work done on what become known as the Capital Asset
Pricing Model (CAPM) which argues that the returns both received and
expected by investors are related to the risk incurred by owning particular
financial assets. As it is commonly understood, the higher the risk the greater
the return should be. The main insight of the CAPM model which is central to
the shareholder view of the world is that there is a risk- weighted discount
factor which allows one to assess the value today and tomorrow’s
developments, profits and cash flows. Not only the discount rate is delivered
from the observation of the capital market but it also defines what the
opportunity cost of the equity to an investor in the market is. It also states that
what the company has to earn in order to justify the use of capital resources tied
up in the business. During the late 1970s and 1980s the work in applying some
insight of CAPM to the corporate sector began (Black et al, 1998).

Shareholder value was accredited considerable appraisal following a
publication of Creating Shareholder Value in 1986 by Rappaport. In almost
every industry, companies started considering the commitment to shareholder
value. This implied a change in the management process; The CEO’S began to
direct their focus on creating shareholder value.

Interest in shareholders received a further appraisal with the 1990 publication
of Valuation by Tom Copeland and other publications from the Mc Kinsey

21


Group. In this book they show that the application of Shareholder value
principal to company is feasible and highly desirable and that it yields
substantial benefits not only to shareholders but also to other stakeholders
(Black et al, 1998).

3.1.2 What is shareholder value?
Value.
Value is an impressive term whose analysis is more art than science. Value has
a variety of meaning and people can have very different views on what the
value of a company is at any given point in time, they may even disagree on
today’s value or on the future value. Even though the past value appears to be
objective, the present and the future value becomes non-observable because of
different value judgments. However, value can be quantified on the basis of a
number of factors. Quality of information, perception control, time horizon,
uncertainty and tolerance for risk are all factors that create the individual’s
perspective on the value of a particular company at any given time. What the
investors expect to happen to the company’s cash flow is the largest
determinant of value. Value is a subjective statement of beliefs about the future
and represents a perception (that is one of many possible perceptions) about the
company’s prospects (Knight, 1998).

According to Black et al (1998) value has existed as a concept as long as
humanity has conducted trade and accumulated capital and wealth. It has been
the consistence measurement used by those with freedom of choice to trade,
invest and preserve capital.

Shareholder value defined
“The total economic value of an entity such as a company or a business unit is
the sum of the value of its debt and its equity. This value of the business is
named the corporate value while the value of the equity portion is named
shareholder value” (Rappaport 1998) In the form of equation:
“Corporate value = Debt + Shareholder value”.
This formula rearranged in order to compute shareholder value
gives:“Shareholder value = corporate value – debt”. In this formula the debt

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portion stands for the market value of debt, unfounded pension liabilities and
also the market value of other claims such as preferred stock.

The corporate value is the value of the total firm or business unit. It includes
three following components:
• The present value of cash flow from operations during the forecast
period.
• “Residual value”, which represents the value of the business attributable
to the period beyond the forecast period.
• The current value of marketable securities and other investments that can
be converted to cash and are not essential to operating business.
(Rappaport, 1998).

It is not only Rappaport who defined shareholder value but many other Authors
have also defined shareholder value such as Black et al (1998) who defined
shareholder value as being the difference between the corporate value and debt
whereby the corporate value is the sum of the future or free cash flows
discounted at the WACC. The free cash flows themselves are made up of the
individual cash flows for each year of the growth duration or competitive
advantage period or the residual value. Thus, cash flow is named free in the
sense that it could be distributed to shareholders.

The Ernst and Young1 attempted to define shareholder value as being the sum
of discounted value of all cash flow from the company to the owner, including
what is distributed when the company is sold or dissolved.

Serven (1999) commented that what matters most to shareholders is what
happens to the price of their stock and then he defines shareholder value as
being the market value of a common stock. Scott (1998) wrote that shareholder
value is another term for the total value of equity of a firm or its “market
capitalisation”. He added that the market capitalisation of a publicly traded firm
is highly transparent and it is the number of shares listed on the market
multiplied by the average price per share. Even though different authors give

1
From the class notes given while studying in Ernst and Young office

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these definitions, the key element of most of the definitions seem to cover the
Rappaport definition of shareholder value.

3.1.3 Shareholder versus other stakeholders
Normally in the shareholder value management model the primary goal of the
company is to maximize value for the shareholder. The opponents of this model
argue that this model does not take into account other stakeholders of the
companies. They therefore argue that the stakeholder model in which the
ultimate goal of the company is to satisfy all stakeholders would be best. Many
researchers who studied the shareholder value model have confirmed that other
stakeholders are included in the shareholder value model.

Rappaport (1998) wrote that a growing number of domestic and global
companies demonstrated that shareholder value orientation builds more
attractive companies not only for investors, but for employees, customers, and
also other stakeholders. He mentioned that there are powerful market incentives
that lead value-maximizing managers to make decisions consistant with social
desirable outcomes namely work place safety. He argued that the managements
governed by shareholder interests would invest in technology, training, or
reengineered workplaces that reduce safety cost. He criticized the stockholder
model saying that it may be used by the managers to justify the uneconomic
diversification or overinvesting in a declining core business since these moves
are likely to be endorsed by constituencies other than shareholders. He explains
then a view that would be an alternative to stakeholder model at the same time
as being consistent with shareholder interests. This view recognizes that to
continue to serve all stakeholder companies one must be competitive if they are
to survive. Furthermore the company’s long-term destiny depends on the
financial relationship with each stakeholder who has an interest in the
company. To satisfy the financial claims of those stakeholders, the management
must generate cash flow by operating its business efficiently. Then this
emphasis on long-term cash flow is actually the essence of the shareholder
value approach. In fact a value creating company benefits not only its
shareholders but also the value of other stakeholders claims and indeed all
stakeholders are vulnerable when the management fails to create shareholder

24


value. According to him, self-interest dictates that shareholder and other
stakeholders engage actively in a partnership of value creation.

Dalborg (1998) discussed further this issue and made it clear that the
shareholders are the residual claimers on a company cash flow since they do
not have claim to the company’s cash flow until the other direct stakeholders
have been compensated. He goes on to say that in the company’s income,
statement other stakeholders are paid first before dividends to shareholders are
considered. He added that in the long run also shareholder oriented
management benefits all stakeholders. Value cannot be created for shareholders
unless the interests of employees are met, such as an attractive working
environment. Therefore, fulfilling the goal of value creation is the ultimate test
of how a company meets the interests of employees, customers and
shareholders. He argues that creating value for employees, in the form of self-
fulfillment, remuneration, personal development, etc., are necessary
prerequisites for the provision of competitive products for customers. To create
value for shareholders, value for both the employees and customers must be
created. He then demonstrated this relationship in the following figure:

Shareholder value

Customer
Value for
value
employees

Figure 1: The shareholder value triangular (Dalborg, 1999)

25


He also stated that while a company managed by shareholder concentrate on its
objective it cannot afford to ignore other stakeholders. That is because the
employees would leave if they are under rewarded or mistreated, customers
will leave if they are not satisfied. Furthermore, suppliers have to be kept
happy.

3.1.4 Value drivers
It is helpful to identify and use value drivers in decision-making and corporate
objective for value maximization. Value drivers are the operating factors with
the greatest influence on the operating and financial results and they also
incorporate the entire decision- making dynamic. Value drivers helps make the
strategy real at all level of specificity that is meaningful and actionable. Value
drivers include aspects of the operating decisions and are used to understand
non-financial operating measures. Value drivers occur in all parts of the
company (Knight, 1998).

Value drivers are in fact at the root of value creation. Rappaport (1998)
explained that value audit permits the managers to monitor the overall value
creation and value drivers analysis is a very critical step in searching for
strategic initiatives with highest value- creation leverage. He made it clear that
the shareholder value analysis helps management to determine the areas of
business which need to be managed most; otherwise it is not easy to set priority
since many factors can influence the value of a business. Petty and Martin
(2001) recognized that if one wants to manage for shareholder value, the first
and foremost thing is to identify just what drives shareholder value in the
capital market. A key issue that frequently arises in this regard involves
whether share value reflects a firm's quarterly earnings or encompasses the
future cash flow generating potential for the firm.

Dalborg (1999) identified three fundamental drivers of value creation. These
are profitability, growth, and free cash flow. According to him, normally the
value of a company is determined by its current profitability, expectation for
profit growth and he added also that free cash flow could be considered to be a
determinant of value in certain situations.

26


According to Rappaport (1998) there are seven critical value drivers in
determining the value of any business: sales growth, operating profit margin,
incremental fixed capital investment, incremental working capital investment,
cash tax rate, cost of capital and value growth duration. However, he mentioned
that for the operating decisions these factors are broad and in order to be useful
there is a need to determine the micro value drivers that influence the above 7-
macro value drivers. This means that the manager needs to set micro value
drivers at the business unit level. It is seen to be very crucial since it presents a
variety of advantages. It allows focusing on the activities that maximize the
value, that have significant value impact that are most easily controlled by
management. It also helps to eliminate cost in activities that provide marginal
or no potential for creating value.

3.1.5 What is value creation?
According to Copeland et al (2000) value is created in the real market by
earning a return on the investment greater than the opportunity cost of capital.
Thus the more you invest at a return above the cost of capital the more value
you create. That means that growth creates more value as long as the return on
the capital exceeds the cost of capital. They go on to mention that one should
select the strategies that maximize the present value of expected cash flows or
economic profits. The returns that shareholders earn depend primarily on
changes in the expectations more than actual performance of the company.

Dalborg (1999) pointed out that value is created when the returns to
shareholder, in dividend and share-price increases, exceed the risk adjusted rate
of return required in the stock market (the cost of equity). He said that the total
shareholder return must be higher than the cost of equity to truly create value.
Hogan et al (1999) state that in a competitive environment, shareholder value is
created when a company invests in projects that earn a return in excess of the
cost of capital.

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3.1.6 Facts about shareholder value creation
Shareholder value creation is seen as vital in many organisations. Before stating
describing different ways to create shareholder value, it is important to first
capture the following ideas about shareholder value creation. Knight (1997)
said that higher profitability does not guarantee value creation for shareholders
in a company. That is because creating value for shareholder operates under
three rules, which are the slippery slope of value creation: the first rule is that
the level of profitability has nothing to do with value creation. When it comes
to creating value for shareholders, companies that are very profitable have no
advantage over companies that are less profitable. Second rule, all management
teams start on a level playing field for creating value. Last rule is that different
companies face different challenges in creating value. Companies are
handicapped based on the results to date. Clarke (2000) added that what it is
important is that a company adhering to shareholder value principles
concentrates on cash flow rather than profits.

Petty and Martin (2001) state that value creation involves much more than
merely monitoring firm performance. Value is created where managers are
actively engaged in the process of identifying good investment opportunities
and taking steps to capture their value potential. Value creation requires
management to be effective at identifying, naturing and harvesting investment
opportunities. In addition to this a capital–market focused measurement and
reward system that ties employee-level performance to owners rewards will
promote the establishment of a continued cycle of value creation that benefits
everyone.

To be able to develop an effective strategy for increasing shareholder value,
there is a need to first, understand the factors that determine shareholder Value,
then assess by what means managers may create an environment where
increased shareholder value is made possible (Michael et al, 2000).

Concerning creating shareholder value in the future, it is becoming increasingly
more difficult to create value in the future since investors will realize no matter
how good is getting in creating value and they will price the stock accordingly.
By increasing the stock price, investors are giving managers credits for

28


performance to date, but they are also increasing the degree of difficulty in
creating future value. “What have you done for me lately?” is what the
shareholders are asking. Even though operating returns may have improved but
investors gave credit for that by increasing the value of the company and yet
they still want to know what is going to be done to create more value in the
future. Companies face challenges in creating shareholder value such as
increased complexity, greater uncertainty and risk, time compression,
conflicting priorities. Managers are being required to make the complex simple,
to reduce uncertainty and risk, to speed decisions making and to balance
conflicting priorities. Companies have been trying to face these considerable
challenges through different ways such as capturing the business strategy in
performance measures, paying management for value creating performance and
focusing managers on the business strategy (Knight, 1998).

3.1.7 Ways to create shareholder value
Different ways are identified in which companies create shareholder value.
Dalborg (1999) identified general four cornerstones in creating value for
shareholders. Those are excellence in operations, getting the financial structure
right, being focused, and credible earning growth. He believed that being
successful in creating shareholder value, the company needs to be well
positioned in both the four areas. Furthermore, other ways to create shareholder
value are also identified under this section.

3.1.7.1 Excellence in operations
Dalborg (1999) states that excellence in operations means running the current
business to produce maximum sustainable profitable growth from the current
assets base. Operating efficiency presents a great importance for value creation
since it contributes to the overall profitability and also when growth initiatives
are being considered operating efficiency is also a prerequisite.

He explained that one key to achieving excellence in operations is to decide an
outlay that promotes current and future revenue-generation capabilities while
simultaneously enhancing cost efficiency, which is a difficult balancing act.
This is because cost- cutting is never ending since new technologies oblige
improvement continuously. Thus, the culture of change must be introduced as a

29


norm rather than an exception. Excellence in operation is closely related to
profitability since with that profitability is maximized within the scope of a
given product area and geographical markets (Dalborg, 1999).

3.1.7.2 Getting the financial structure right
Dalborg (1999) based the discussion of getting the financial structure right on
the cost of equity; it is seen as important because it is used as a discount factor
in the calculation of value. A company’s cost of equity is equal to the expected
rate of return that investors require to purchase the company’s stock. Although
the cost of equity is not discernible from the market data, the information is
needed to manage risk capital in the interest of shareholders.

Under the assumption that markets are efficient, a company that aims at
maximizing shareholder value should pursue investments that are in line with
company’s strategy and have a risk adjusted rate of return that exceeds the cost
of equity. Thus to make right investment decisions the company need to know
its cost of equity, it is also important to know that the cost of equity varies with
a company’s risk level and debt structure. The risk level of a company needs to
be carefully chosen since it is an important determinant of the cost of equity.
Managing the level of risk capital is also important because companies get into
problems when equity is too low. The solvency ratio must be kept appropriately
high in relation to the risk in operations and expansion plans for the near future,
and not higher than that (Dalborg, 1999).

According to Dalborg (1999) a company should keep the structure of equity as
simple as possible in order to provide maximum value for shareholders. The
structure of equity capital should not, in a company that maximizes value, be an
obstacle to a takeover, instead a high share price should provide such an
obstacle. He also added that getting the financial structure right is closely
related to free cash flow since it deals with issues of capital, risk, and
dividends, the important point being to manage the company’s capital in the
interest of shareholders.

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3.1.7.3 Being focused
Dalborg (1999) states that focus has become one of the building blocks in
valuing the shares since investors are becoming increasingly aware that all
customers need for different products cannot be met by one company. In order
to maximize value, companies need to be focused. Therefore, they need to have
clear strategy on where to concentrate efforts. This must be effectively
communicated to the companies’ staffs and then adequate mechanisms for
follow up can be subsequently achieved. Companies can enter areas where they
have competitive advantage and downsize, divest, or close operations that do
not have the potential to create value, this has to start at the group strategic
level and it must be understood and accepted by the successive layers of the
hierarchy. Being focussed is linked most closely to the profitability since to
better manage a company one needs to focus on its areas of profitability
otherwise profits would deteriorate.

In addition to the above ideas of Dalborg, other authors had also some views on
this issue. Van and Linde (1998) stated that cutting back on investment (and
divert capital from) activities and lines of business which are uneconomic
meaning that they do not generate returns in excess of the required cost of
equity can also create value. Zook and Allen (2000) added that profitable core
could be an extremely durable engine for profitable and value creation driving a
company for many decades.

3.1.7.4 Credible earning growth
Growth adds new assets that provide for future profits; therefore a company’s
growth prospectus is very important in creating shareholder value. Innovations
that provide new rather than improved products are one of the explanations
why companies achieve spectacular results in creating shareholder value. The
market rewards investments for growth when expansion plans looks as if they
will create value. Except for some exceptions, generally business with higher
P/E ratios will expand faster than other businesses and companies that aim at
value creation should direct their resources towards growth areas. Growth can
be achieved through merger and acquisition and also it can be an organic
growth meaning that it is the growth generated by the company itself. Credible

31


earning growth matches the fundamental driver growth since the growth
prospect has to involve sustainable profitable growth not just growth per se
(Dalborg, 1999).

According to Doorley and Donovan (1999) if a company does aspire to a high
level of achievement, it must grow and companies with a near-fanatical focus
on the growth outperform all others. Companies with high growth rates are
mostly likely to have high returns to shareholders and companies with low
growth rates are likely to realize low returns. However, he said that not every
business could generate value by growing all the times. He also indicated that
there can be value destroying growth. Therefore, before committing to
developing a specific business, it is important for the company to determine
whether or not its returns exceed the cost of capital. Rappaport (1998)
discussed that Shareholder value creation in external growth such as merger
and acquisition depends not on the pre-merger market valuation of the target
company but on the actual acquisition price the acquiring company pays
compared with the selling company’s cash- flow contribution to the combined
company. Zook and Allen (2000) discussed the potential series on growth and
shareholder value creation and found out that sustainable revenue and net
income growth is the only reliable way to create shareholder value.

3.1.7.5 Information
Investors’ expectations play a big role in determining the value of a company.
Furthermore, the way companies present the information or the degree of
disclosure of information can also create the value. Van and Linde (1998) state
that it is important to tell investors about the strategies being followed and what
is actually being done in the company. Directors must ensure that all interested
parties are fully informed of any material matter affecting the company’s
business, with openness and substance over form being their guideline”. By
“Any material matter” the author means one, which affects shareholders’
expectations, and the market prices that are based on those expectations.
Failure to properly inform shareholders can be severe since investor confidence
is difficult to regain.

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According to Clarke (2000) giving out information will benefit individual
shareholders as well as the company. He then suggested that management
should report both why their strategies are expected to lead to the creation of
value over the long term and their own view over actual performance. It will
also facilitate the stock Exchange in allocating scarce capital resources. Knight
(1997) states that information controls value since value is based on
expectations of the future and what investors expect to happen to the
company’s cash flow is the largest determinant of value. He went on to mention
that information is the most single factor in determining value and that
information about the past is objective while information about the future is
subjective.

3.1.7.6 Stock repurchase
Rappaport (1998) pointed out that one of the guiding principals of shareholder
value management is to return cash to the shareholders and when the value
creating investments are not available, share repurchase becomes a
considerable supplement to the dividend in returning cash to shareholders.
Companies may repurchase their shares as a signal to the market that their
stock is being undervalued since average stock prices respond positively to the
announcement of share repurchases and premium tender-offer share repurchase
are most appropriate for reducing significant market undervaluation.
Furthermore when the market undervalues company’s shares, a share
repurchase transfers wealth from the exiting shareholder to continuing
shareholders. Then, in this case management objectives to maximise long-term
value for continuing shareholders, are put in action. The continuing
shareholders will thus get a return, which is greater than the required rate of
return if the exiting shareholders sell at that undervalued price.

The companies may carry out stock repurchase since it is a more tax efficient
means for distributing cash to shareholders. In most cases, taxes are lower on
capital gains than on ordinary income. However this tax efficiency idea does
not apply to some institutional investors such as pension funds with no tax
status. Companies also use stock repurchase since it enables them to increase
leverage and move towards a more desirable capital structure. Here, the
management must first make sure that this would be the least costly way of

33


increasing leverage. The author then argued that a share repurchase is a good
idea if it is at the right price ( Rappaport, 1998). Ehrbar (1998) had a discussion
on share repurchase and said that the basic building blocks of financial strategy
are the mix of debt and equity and the method that is used to distribute the cash
to the shareholder – dividend or share repurchase. He added that Companies
have far more flexibility when they choose the share repurchases because they
can carry more debt on their balance sheet. The other positive money for the
shareholders is that they pay taxes only on the portion that constitutes the
taxable gain.
3.1.8 Shareholder value network

Shareholder Shareholder returns
CORPORATE value added • Dividends
OBJECTIVE (SVA) • Capital Gains

VALUATION Cash flow from Discount Debt
operations Rate
COMPONENTS

Value growth Sales Growth Working Capital Cost of
VALUE Duration Operating Profit Investment Capital
DRIVERS Margin Fixed Capital
Income Tax Rate Investment

MANAGEMENT
Operating Investment Financing
DECISIONS

Figure 6: shareholder value network, Rappaport (1998).

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The above figure represents the relationship between the corporate objective of
creating shareholder value and the value drivers or basic valuation parameters.

The value growth duration, operating and investment value drivers determine
the valuation component which is Cash flow from operation. The valuation
component: discount rate is in its turn determined by an estimate of cost of
capital. To obtain shareholder value from the valuation component: debt is
deducted from the corporate value. Finally in its turn shareholder value added
serves as a foundation for providing shareholder returns from dividends and
capital gains.

3.1.9 Value Based Management
Knight (1998) defined the value-based management as a way of focusing
managers on the company’s strategy to achieve a better alignment and create
value. He goes on to say that managing for value means using the right
combination of capital and other resources to generate cash flow from the
business. This is an ongoing process of investing and operating decision
making that includes focus on the value creation. In the value based
management the focus on value is introduced into each of the three decisions
making areas: objectives, alternatives, and information. These help improve the
quality of the decision and create value. Managing for value means imposing
on the existing businesses the same type of discipline applied to new project
approval. Value based management companies focus on the value oriented
decision-making in the four key management processes of planning, budgeting,
compensation, and management reporting. When all of them are focused on the
value they reinforce the value mind-set.

Value Based Management (VBM) is also an integrative process designed to
improve strategic and operation decision-making throughout an organization by
focusing on the key drivers of the corporate value. Value management in the
strategic planning process should be conducted in the context of a value
creation target set by the center. Concepts, Principles, Practices of value-based
decisions are translated into the language of the business. The overriding role is
to make everyone in the company understand how they can create value
through their individual actions and decisions. The business managers can

35


develop alternatives, which can be compared to their potential value creation
(Copeland et al, 2000).

Value based management means operating the company to create shareholder
wealth and also take specific actions across the corporation to increase returns
to shareholder. To take specific actions across the corporation to increase
returns to shareholder-who after all, are the owners of the corporation and
providers of its capital lifeblood. The thorough value based management
approach increases the firm's future cash flow net of investment, with measures
and tools specifically suited to that challenge. Management process and
systems encourage the managers and other employees to behave in a way that
maximizes the value of organization. They include the planning, target setting,
and performance evaluation, incentives system, which every company needs in
its running business ( Copeland et al, 2000).

Choosing the right VBM approach should be as much about how the method
aligns with management's reason for adopting VBM as any argument of
superiority of one method over another. So having a clear understanding at the
outset of what you want to accomplish is absolutely essential. Successful VBM
programs have certain common attributes: first, top management support-
genuine commitment not simply taking involvement. Second, links to
compensation. Third, investment of time and money in educating the firm's
workforce about how the program works. Last, simplicity valued over
complexity. And they also stated that it should be clear that not all firms derive
the same benefits from implementing VBM (Petty and Martin, 2001).

Launching of the VBM program generally requires transforming the
organizations at all levels. The most fundamental change will come at the top.
There are many important corporate decisions which must be adopted from the
value perspective, such as corporate shape; portfolio planning and resources
allocation; mergers, acquisitions; financial policies such as leverage, rights
issues and dividends. Equally important are empowerment and the move to the
smaller corporate centers. The role these centers play in setting the framework,
processes and measures should encourage the whole company to deliver the
value (Monneri and Neil, 2000).

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The method by which such VBM is implemented will be different in each
company. However, common for all those companies is that it has to be based
on adopting existing measurements processes and measures. These processes –
strategic planning, target setting, and annual budgeting – and the measures used
can be employed as direct behavior in the organization. The purpose of the
management here is to translate the goal of value creation into the practical
tools that can refocus and motivate the behavior within the different businesses.
Fundamentals of aligning processes decision tools with the value creation are
the development of the appropriate set of the internal measures (Monneri and
Neil, 2000).

Value based management could be claimed to be evolutional in terms of its
break with past management accounting bases of performance measurement.
There are numerous different VBM techniques, including residual-income type
approaches, such as economic profit and EVA, 'shareholder value added'
approaches, and 'cash flow return on investment' (CFROI). The key advantage
of applying VBM techniques is that it can affect the behaviour of an
organisation. Critical to the successful adoption of VBM techniques is actually
changing the behaviour of employees so that VBM can be used as a strategic
tool and, if accepted throughout the organisation, such a change can be
beneficial in terms of providing both a common language and common
objectives (Cooper et al, 1999).

In a well-functioning VBM organization, the management processes, such as
planning and performance management, provide decision makers at all levels
with the right information and incentives to make value-creating decisions. It
operates in all levels of the organization. Line managers and supervisors can
have targets and performance that are in line with particular circumstances to
the overall business strategy (Petty and Martin, 2000). Some research was done
and came up with conclusions that that VBM adopters decreased their new
investments, increased the dispositions of the assets; increased their payout to
the shareholder through the share repurchases and utilized their assets more
intensively. All these responses are consistent with the shareholder value
creation, because the dispositions of the non-productive assets, returning cash

37


flow to the firm’s stockholders (dispensing free cash- flow) through the share
repurchase, and the greater use of the existing assets are all ways to increase the
SHV (Shareholder value) (Petty and Martin, 2000).

3.2 Shareholder value creation – how to measure it?
How can we define whether the firm raised the shareholder value in a particular
time period or not? There are real “wars” between different famous authors as
well as different consulting companies whereby every company defends its
own indicators and tries to find the minuses in the others. It is possible to divide
them into accounting based measures, such as ROI; ROE, EPS; and economic
based measures such as economic profit. Some of them are considered to be
better than others. The main idea of all these measures is to help the managers
to make value-created decisions and orient all employees towards value
creation (Copeland et al, 2000).

3.2.1 Introduction
Which measures are preferable? The McKinsey consultants - Copeland et al,
2000- state that the economic-based measures are preferable to accounting-
based because it is easier to understand the value drivers, and second, the cash
flow is what drives share price performance.
One of the most famous authors of shareholder value theory, Rappaport,
considers that only DCF (Discount Cash Flow) can give an objective view of
the company’s performance and shareholder value increase (Rappaport, 1998).
However most of the authors agree with the following statement: it is possible
to talk about the shareholders value creation when and only when the company
earns the rate of return on new investments higher than the rate investors could
expect to earn by investing in the alternative, equally risky securities.

It is possible to build the following framework for the metrics in order to better
understand different aspects of the firm’s performance.

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Value drivers Financial indicators Intrinsic value Share price performance
Market share ROIC DCF TRS
Cost per unit Growth (revenues, Real option MVA
Value of R&D ⇒ EBIT) ⇒ valuation ⇒
Projects Economic profit

Figure 1: Comprehensive Value metrics Framework, Copeland at al. (2000)

Each class of measures can have the following role in the management’s
performance:
• The company can set targets concerning the terms of market value of the
company or TRS;
• It can evaluate different strategies of BU (Business Units) or entire
companies in terms of intrinsic value (DCF);
• Intrinsic value can be translated into short- and medium term financial
targets for operating and strategy value drivers;
• Performance can be compared with targets, and managers’ rewards
(compensation and other) can depend on financial measures and value
drivers (Copeland et al, 2000).

3.2.2 Old and traditional accounting measures – plusses and
shortcomings.
3.2.2.1 EPS – Earnings Per Share
Since division of earnings of the company computes the earnings per share by
the number of outstanding shares, we will concentrate on the numerator, i.e.
earnings. According to Rappaport (1998), the Earnings fail to reflect the real
picture of the company performance because of the following reasons. At first,
it depends a lot on accounting principles such as various methods of
depreciation, pooling interest versus purchase method for mergers and
acquisitions. Secondly, it ignores time value of money since it does not take
into account that a dollar of cash value received today is worth more than a
dollar tomorrow. Thirdly investment requirement is excluded since the
relationship between the change in economic value and earnings is obscured
and investments in working capital are excluded from the earnings calculation.
When the business grows, the increase in accounts payable and inventories is

39


inevitable. Another problem is that the earnings (and actually other accounting
measures) don’t include the opportunity cost of equity. Lastly is the fact
accounting earnings don’t reflect the firm’s financial policy, for example,
whether it is a unlevered or levered firm (Rappaport, 1998).

3.2.2.2 ROI: Return On Investment.
ROI is one of the most popular measures the companies use in their financial
reports as one of the key measures of success, and it remains one of the main
measures of the division performance. The computation of ROI is expressed
under the following formulas:

ROI = Net income / book value of assets
Or ROI = Net income + Interest (1 – tax rate)/ Book value of assets

The increase in ROI is no guarantee of shareholder value creation despite its
being one of the most popular measures. It is considered that shareholder value
is created if ROI is bigger than WACC. But as Rappaport mentioned, it is the
same as “comparing oranges with apples” (Rappaport, 1998).

What are problems with this measure? ROI is an accrual accounting return and
cost of capital is an economic return demanded by investors. At first, ROI is the
single period measurement and it does not consider the events beyond the
current period. Computing an average ROI for several periods would reduce
but does not solve this problem. Second, the numerator and denumerator are
affected by the accounting allocation. Rappaport compares the ROI with the
discounted cash flow return (or economic one-year return on investments):
DCF return = CF + (PV1-PV0)/ PV 0
Where PV0 is the present value at the beginning of the year,
PV1 is the present value at the end the year
When the numerator is the economic income, the numerator in ROI indicator is
the accounting income. The present value of the cash flow received one year
from now excludes the present value of the current year’s cash flow which has
already been received in the formula of DCF return (it can be also called the
Internal rate of return).

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There are several misstatements of ROI over DCF – most often there are
overstatements
• Length of the project life: the longer the project life, the greater
overstatement since net income includes the capital expenditures, which
can be very big; and investments in working capital, where CF excludes
this, moreover, time factor is not taken into account.
• Capitalization policy: the smaller the fraction of total investments
capitalized on the books the greater the overstatement will be.
• The rate in which the depreciation has been put on the books.
Depreciation procedures faster than straight-line will result in higher
ROIs.
• The lag between investment outlays and the recoupment of these outlays
from cash inflows. The greater the lag, the greater the overstatement
(Rappaport, 1998).

It is important to emphasize that capitalization and depreciation policies are
strictly accounting matters and do not affect the company’s cash flow and
economic rate of return. Research and development expenses, a form of capital
investments, are expensed at the current period; so the comparing ROI of, for
example, drug and some industrial companies can be misleading because the
exclusion of R&D investments from the ROI base increases ROI.

Other additional shortcomings of ROI are that the economic rate of return
depends solely on the prospective cash flow, when ROI depends not only on
prospective investments and cash flow but also on underpreciated investments
of the post period. Moreover ROI is criticized because it neglects the residual
value of the company or business unit (the residual value is the present value of
cash flow which is to be received at the post planning period). The other
limitation of ROI is noticed in using it for the financial planning and control
since it involves the sometimes counter economic effect of changes in financial
policy on ROI.

3.2.2.3 ROE – Return On Equity
ROE= Net income / Book value of shareholders’ equity

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The ROE has the shareholders’ equity as the denominator; and it is more
popular at the corporate level, whereas ROI is more popular for the measuring
of the division’s performance. One of the reasons for such a preference is that
ROE is a measure of primary concern to investors.
Since ROE is similar to ROI, it has all the same disadvantages as ROI. The
specialty of ROI is that it is very sensitive to the leverage. ROE will increase as
more than optimal debt is issued and the value decreases, so the ROE and
shareholder value criterion is in conflict here.

The different accounting practice and operating results can be misleading. If we
want to increase ROE, we can do the following: increase the leverage (and
decrease the denominator), increase assets turnover, or improve the profit
margin. Of course, it is good when the company increases its ROE by the
improving of the operations by the higher turnover or by a larger margin. One
of the examples, except the different accounting practice, is the stock
repurchase, which lowers the equity.

The accounting changes and the stock repurchases decrease the usefulness of
other accounting-based metrics, such as dividend yield, price/earnings and
market/book value. Market-to-book measures can be also misleading because
of too optimistic or too pessimistic views of some companies, or because of the
shrinkage of the book value. Price/ earnings ratio is also not too much reliable
because the company’s management can manipulate with the earnings.
Another problem of the ROI and ROE is that it is impossible to compare the
returns for the knowledge company with that of an Industrial Company. The
industrial company invests a lot in the fixed assets, while the knowledge
company spends a lot on training, research, information but a small percentage
is capitalized. (Rappaport, 1998).

Ehlbar (1998) also criticizes these measures, but he discusses them from the
CEO’s point of view, particularly, the rationale of connection of the CEO or
CFO’s bonuses to these indicators. If the bonus depends on ROI or ROE or
ROA (ROA= net income/total assets), the manager can take the project, which
can destroy value but increase accounting earnings. Once again the author
mentions (without any references to the previous author) the stock repurchase,

42


which increase ROE. So if for example, the ROA (or ROI) target is 25%, the
manager will reject any project that will bring less ROA, even if it returns more
than the cost of capital and creates the shareholder value. Or the head of the
division whose target returns are 5% will accept an investment, and it does not
matter whether it covers the cost of the capital or not. (Ehlbar, 1998).

Bennet Stewart III writes about the same things discussed above concerning the
returns (ROE, ROI, ROA) but he divides the disadvantages into two types: the
accounting and financial disadvantages. Accounting distortions deal mostly
with the different costing methods (LIFO, FIFO etc) while the financial
distortions deal mostly with proportion of debt and equity. If the management’s
task is the particular ROE, The manager can accept the bad project, which is
financed by the debt, and reject the good one if it is financed by the equity
(Stewart, 1991).

3.2.3 Recently developed measures – why are they better than the
old?
3.2.3.1 TSR - Total Shareholders Return
These measures are supported by the Boston Consulting Group (BCG). (In case
one is interested on how TSR is calculated see Appendix 3- A3.1)

The CFO Magazine wrote about this measure: “ The TSR measure allows the
managers to make the appropriate trade-off among profitability, growth and
FCF (Free Cash Flow), and measure a unit’s contribution to the overall
company’s capital gain and the dividend yield of the overall market (in this
case it is Standard and Poor’s 500) or to peer group to determine if the value
was created by the management”. The calculation of this and other measures is
possible to see in the Appendix. The Boston Consulting Group lists the
following advantages of this measure such as that TSR is a final primary goal
of investors; that TSR gives early warning signals; that it is a comprehensive
ratio; that it is hard to manipulate this ratio and the last is that it enables
competitive comparisons (BCG Study report, 2000).

This measure is helpful in the comparing of the companies’ performance, of
one share versus another; or against the market index or some other peer

43


groups. However, the focus on relative performance insulates managers from
the macroeconomic factors, which are beyond their control. It creates a high
hurdle, since, by definition half of companies in a given market will under-
perform the average (Monneri, 1998).

Another disadvantage noticed by Monneri is that TSR can be measured only for
traded companies and only after the fact – not forward-looking (Monneri,
1998).

Koller and Dobbs (1998) consider also that despite TSR having many merits, it
also has several disadvantages. As they state any performance measure must
incorporate a company’s share price performance. However, it has to do more
than simply record how much the stock goes up or down. It should provide how
and why the management creates value. And there are several shortcomings to
the TSR.

Share prices are driven by many factors other than management performance.
During the period of one to three years over which TSR is usually measured for
the purpose of evaluating performance, much of the movement in a company’s
share price will be driven by the market as a whole or by the industry it
operates in. If the performance is measured on the basis of TSR alone,
managers can be rewarded or penalized for events outside their control (Koller
and Dobbs, 1998).

Moreover, the share prices in the short term are driven more by differences
between actual performance and market expectations and by changes in this
expectations, than by the level of performance per se. Companies that
consistently meet the high performance expectations but don’t exceed them
have difficulty delivering high TSR. The market may believe that management
is doing an outstanding job, but its approval has already been factored at the
share price (Koller and Dobbs, 1998).

TSR assumes that the shareholders will reinvest their dividends but the
shareholders in any company cannot reinvest their dividends; only to extent
that another group of shareholders sells their shares. For example, we can take

44


two companies, with the same risk factor, the same total return and market
capitalization. If one company’s total return is higher than the cost of capital
and the company pays no dividends, the shareholders will benefit more. Or,
vice versa, if the company pays large dividends but its rate of return is lower
than its cost of capital, the shareholders will benefit also; because in this case
the company destroys less value (Ehrbar, 1998).

3.2.3.2 EVA – Economic Value Added
Enter EVA, a performance measurement concept introduced to the corporate
arena in the 1920s, by the General Motors Corporation, and then forgotten,
until Stern Stewart Company, New York- based consulting firm, reintroduced it
in the 80’s as a replacement for the traditional measure of value creation. Stern
Stewart now trademarks the approach (Shaked et al, 1997).

EVA® is an acronym for economic value added; it is a measure of the
corporate performance that differs from most others by including a charge
against the profit for the cost of all capital the company employs. The
proponents of EVA claim that EVA is the framework for a complete financial
management and incentives compensate system that can guide every decision a
company makes, from the board room to the operation floor.
EVA = NOPAT – C% (TC),
In the formula, NOPAT is net operating profit after taxes, C% is the percentage
of cost of capital; and TC is total capital (see Appendix 3- A3.2) (Ehrbar,
1998).

Ehbar (1998) claims that EVA framework provides the “new lens through
which the managers view a corporation”. The capital charge, for example,
causes the management to consider the effects that their decisions have on the
balance sheet as well as income statements; and gives them a basis for
weighting trade-off between the two.

What then does constitute the wealth creation game? The TSR seems like the
logical answer but total return does not really tell whether the one company
does better than another one. The reason is that of a company’s required rate of
return, or the cost of the capital, rises with the riskiness of business.

45


Why EVA is more preferable? As Ehrbar explained in his book about EVA, the
formula includes a lot of adjustments to eliminate accounting anomalies.

The adjustments to NOPAT are necessary to make in order to calculate EVA.
The first step of calculating EVA is to decide which adjustments are necessary
to make to the GAAP accounts. The various types of adjustments can be made:
the timing of expense and revenue recognition, inflation, foreign currency
translation, inventory valuation, bad debt recognition, intangible assets
adjustments, taxes, pensions, post retirement expenses, goodwill, strategic
investments.

However, the major adjustments which are necessary to make are the
following: Research and development, Strategic investments, Accounting for
acquisitions, Expense recognition, Depreciation, Restructuring charges, Taxes,
Balance sheet adjustments.

In fact, before a company decides which adjustments to make, it has to consider
the following factors. At first, it is necessary to see whether an adjustment is
material. By material is meant that the numbers involved are significant to the
levels of decision-making. Material also means that the change in accounting
could alter decisions in ways that alter shareholder value. If an adjustment
doesn’t alter decision, it is not worth doing (Ehrbar, 1998).

EVA bonus system.
Another issue, which was raised, is the bonus system. How people do their job
depends on how to treat them and how to pay them. Whether the usual bonus
systems, which are tied to ROA, ROE or other accounting measures, are good?
Research has shown that the vast majority of the companies base their bonus
payment to top corporate managers on achieving targeted level of earnings,
earnings per share, operating profit, ROE, ROA. But such measures are as bad
as earnings, since both the numerator and denominator are distorted by
accounting anomalies. A division’s head, whose ROA for example is 25%, will
turn down every proposed investment that promises anything less even if they
return more than the cost of capital and would add to shareholder wealth.

46


However, the head of division where the ROA is 5% will accept any
investment (Ehrbar, 1998).

A critical factor in converting EVA measurement into corporate success is to
make it the basis for the incentive compensation plan that encourages managers
to think as owners and act like owners. Under such plan managers are rewarded
for the value creation instead of the “budget making” (Shaked et al, 1997).

However a far better incentive is to pay managers for the improving EVA
regardless of what they can earn. A properly constructed bonus plan can
effectively turn the managers into the owners of the individual units under their
control, they can become more entrepreneurial; operate with a renewed sense of
urgency.

The different levels of management require the different compensation mix.
Moreover, the each manager’s bonus should be based on the specific EVA that
he or she can affect. Senior executives – the CEO and other key decision-
makers – have a direct responsibility to shareholders. These executives should
receive their bonuses tied to TSR, stock options to incentives the future
performance and compensation linked to company-wide measures like EVA
(see the exhibit #1) (Ehrbar, 1998).

Exhibit №1. The compensation pyramid.

TSR

Stock options

EVA and CVA

Activity measures

Source: Shaked et al, 1997

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Second-level managers, usually, key-division managers, play the more
important role in the value creation, despite the fact that they have little direct
shareholder value’s responsibility. Middle and upper-middle level managers are
generally responsible for a given level of the capital and have some profit and
loss responsibility. To encourage cooperation between the units and to avoid
conflicts it is better to tie the portion of their compensation to the company-
wide EVA or CVA.

When establishing EVA or CVA objectives, it is necessary to pay attention to
the EVA/CVA improvements, regardless of their absolute level. It is actually
their improvements that have an effect on creating value above the price paid
by shareholders.

Certain managers are responsible only for a subset of the factors needed to
calculate the EVA/CVA. For these managers, relevant activity measures should
be used. For example, for inventory managers the objective can be the
inventory turnover. So the business unit manager, with the planned unit EVA,
will have the incentive to minimize the cost of capital and to set the goals so as
to induce an inventory manager to avoid excessive inventories (Ehrbar, 1998).

3.2.3.3 MVA – Market Value Added
MVA= market value – total capital
The total value in this formula is the market value of debt and equity. The total
capital here is the total assets from the balance sheet, which are adjusted
according to the EVA concept (Weissenrieder, 1998).

Dobbs and Koller (1998) consider this measure to be complementary to TSR. If
TSR measures the performance against the expectations of financial markets
and change in these expectations; MVA, on the other hand, measures the
financial markets’ view of future performance relative to the capital invested in
the business; and therefore; assesses the expectations about the absolute level
of the performance.

Ehrbar (1998) claims that MVA reflects well how management has positioned
the company for the long term, because the market value incorporates the

48


present value of expected long-term pay-off. MVA is automatically risk–
adjusted because the market values of a company incorporate investor’s
judgment about risk as well as performance. That is why the MVA can serve
for the comparing of performance of companies from the different industries

From the point of assessing the performance of the current management, the
change in MVA over the period of one year or five years is more important
than the absolute level of MVA. An increase in MVA means that the
company’s market value grew by more than any additional funds raised or
retained from the earnings. On the other hand, a decrease in MVA means that
shareholder wealth has been eroded (Ehrbar, 1998).

Changes in MVA can be caused by several factors. First, it is that all stocks
tend to rise and fall with the overall market. However, it is necessary to notice
here that companies also are beaten by the winds affecting their particular
industries.
The most important factor driving MVA is the management strategy. Actually,
what determines a company’s fate is not industry but the rightness of its
strategy and excellence with which managers execute their strategies (Ehrbar,
1998).

It is useful to keep in mind that stock prices are based on expectation since that
value of stocks depends on the profit that investors expect companies to
produce in the future. Past profits matter only because they are important
factors driving expectations about the future performance. The cash that
investors expect to get out of it, defines the value of the project or of the
company, not what had already gone into it (Ehrbar, 1998).

A company’s market value is the present value of future profit discounted to
the company’s cost of capital today. If a company earns exactly the cost of
capital; and no more or no less, its market value added is supposed to then be
zero. If expected returns exceed the cost of capital, the company’s stocks will
be sold at a premium and MVA will be positive; the management has then
created wealth by convincing investors that it will produce profits that exceed

49


the cost of capital. If expected returns account to less than the cost of capital,
management will destroy the wealth and MVA will be negative (Ehrbar 1998).

While the goal of every company should be to create as much MVA as
possible, MVA by itself is useless as a guide to day-to-day decision-making.
First, it is because the change in the overall level of stock market can
overwhelm the contribution of the management actions in the short run.
Second, MVA can be calculated only for publicly traded companies, i.e. for the
companies, which have the market price. Third, MVA can be calculated on the
consolidated level, not for business unit, division. As a result, managers have to
focus only on some internal performance measures that are closely linked to
MVA. According to Ehrbar, it is far better is to manage the increase on EVA
since according to the creators of EVA theory, it is the most correlated with
MVA (Ehrbar 1998).

Other consultants consider MVA a supplementary measure to the total
shareholder return (TRS). Neither MVA nor TRS can be the only measure for
the comparison of the companies. TRS measures the performance against the
market expectations and changes in these expectations. MVA on the other hand
measures the financial market’s view of future performance relative to the
capital invested in the business and therefore assesses the expectations on the
absolute level (Dobbs and Koller, 1998).

3.2.3.4 CVA® – Cash Value Added
Cash Value added is a Net Present Value that periodizes the Net present Value
calculation and classifies the investment in two categories: Strategic and Non-
Strategic investments. Strategic Investments are those, whose objectives are the
ones made to create new value for shareholders, such as expansion; while non-
strategic investments are the ones made to maintain the value strategic
investments create. Strategic investments – e.g. investments in new products,
in new markets – are followed by several non-strategic investments. A strategic
investment can be a tangible or an intangible asset. What is believed to be a
value creating cash outlay can be defined as a Strategic investment
(Weissenrieder, 1997).

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Strategic investments are the capital base in the CVA® model because the
shareholder’s financial requirements should be derived from a company’s
venture, not the material assets. That means that all other investments with
purpose of maintaining the original value of firm must be considered as “costs”

What actually is CVA®? Cash value added is defined by the difference
between operating cash flow (OCF) and operating cash flow demand (OCFD).
Operating cash flow is EBIT, working capital movement and strategic
investments. Working capital movement here is calculated using the following
formula: ∆ (Receivables – liabilities+ stock + cash). Operating Cash Flow
Demand represents the cash flow needed to meet the investor’s financial
requirements on the company’s strategic investments i.e. the capital cost.
However, in the CVA® model, the capital cost is not a percentage term but a
cash term (Ottosson, Weissenrieder, 1997).

In order words it is a cash flow, equal amounts in real terms every year that are
discounted using the proper capital cost. The OCFD is a real annuity adjusted
for actual annual inflation, not average inflation. Simply, OCFD represents the
annual cash flow amount, growing by assumed rate of inflation that will yield
an IRR (Internal Rate of Return) equal to the WACC on the original investment
Concerning the calculation of the CVA® and its components see in the
Appendix 3- A3.3.

If the managers can evaluate whether the historic margins have been sufficient
or not; they can more easily understand whether their plans will bring value;
i.e. whether the planned investments are likely to have a CVA® index >1.

3.2.3.5 CVA developed by the Boston Consulting group
The CVA® of FWC AB by no means should be confused with the other CVA
– the CVA of Boston Consulting group because they are two absolutely
different measures, with different ways of calculation.

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CVA of the BCG is the cash value added as well but it is the absolute measure
of the operating performance contribution to value creation. The CVA measure
reflects operating cash flow minus a cost of capital charge against gross
operating assets employed (Stelter et al, 2000). For different ways of
calculating CVA see Appendix 3-A3.4

According to the consultants of BCG this measure (CVA or AVE – added
value on equity) is an accurate tool of the determining priority of value drivers
and assessing the value drivers’ tradeoffs. It is a useful indicator that allows
managers to balance the high level tradeoffs between improving profitability
versus growing the business. Its measurement is based in cash flow and original
cash investment, it avoids the key distortions that can cause measures such as
EVA® to give misleading trends to capital-intensive business (Stelter et al,
2000).

3.2.3.6 DCF – Discounted Cash Flow
Discounted cash flow – DCF – is the most accurate and at the same time most
complicated measure according to Graph №1. According to McKinsey
consultants, DCF approach is a more reliable picture of a company’s value than
an earnings-multiple approach. There are two competitive approaches
concerning the value of the firm:
• In the earnings-multiple approach companies are valued based on a
multiple of accounting earnings. In its extreme form the earnings-
multiple approach indicates that only this year’s or next year’s earnings
matter.
• In the DCF approach the value of business is the expected CF discounted
at a rate that reflects the riskiness of the cash flow (Copeland et al,
2000).

Another problem with earnings is that investors cannot buy a house or car from
earnings. Only the cash flow generated by the business can be used for
consumption or additional investments. The DCF approach is based on the
concept that an investment adds value if it generates a return on investment
above the return, that can be earned on investments for a similar risk. Another

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related measure to the DCF is the SVA – shareholder value added .The formula
of SVA is the following: (Rappaport, 1998).

SVA=Cumulative present value of cash flows +present value of liquidatio
at the end of the forecast period – current liquidation value.

The classification of measures is given below:

DCF
CVA
EVA
ROCE
ROE
EPS
EBITDA
Revenues

Graph №1. The complexity and accuracy of the different measures (Laitinen,
Leppanen 1999)

All metrics are classified following the grade of complexity and at the same
time, the grade of accuracy of the shareholder value measures. Authors made
the above graph № 1 where they shown all measures by the increase of the
complexity and accuracy (see Graph № 1).

3.2.3.7 CFROI® – Cash Flow Return On Investments
The CFROI® model is rooted to the DCF principles: more cash is preferred to
less; cash has a time value and less uncertainty is better. All valuation drivers in
the CFRI model are calibrated as “real” values. Regarding the discounting rate
component, the authors of the CFROI® model reject the CAPM and β
procedures for estimating the firm’s discount rate – or the cost of capital – on
the basis that they are rooted in a backward-looking estimate of a premium for
the general equity market over the rate-free (Madden, 1999).

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In Holt’s model a firm’s discount rate is determined by the market rate plus a
company specific rate differential as a function of the market size and leverage.
(See Appendix 3 for calculation details).

It is possible to say that value is created or the value creation is positive when
CFROI > DR (real discount rate), negative when CFROI < DR and zero when
CFROI = DR.
DR means Real Discount Rate.

3.2.3.8 Q ratios
One more answer to the question whether the value is created is the VROI –
Value Return on Investment – and Q ratio, based on the Nobel Prize – winning
economist James Tobin. (Concerning the calculation’s details of Q ratios see in
appendix 3-A3.7).

The “pre-strategy” view is simply to capitalize the existing free cash flow –
probably for the later available year. Then it is compared with the post-strategy
value, which includes the value of cash flow generated over the forecast period.
The decision rule is straightforward: if VROI is more than one, SHV has been
created, if less – the destruction of the SHV – since incremental value added is
smaller than the incremental value of the resource used (Black, 1999).

From the macro-economic point of view, a Q ratio of greater than one means
that the market values of the company’s assets are more than what they actually
cost, while a ratio of less reflects the opposite. A high value of Q means that
corporations have a good incentive to invest in new plant or equipment since
the market values each unit of investment as more than it is really worth. A low
value of Q reduces the incentive to invest but encourages acquisitions via the
stock market since investors are paying less for an asset on the financial market
than it would cost them to replace it on the goods market (Black, 1999).

3.2.3.9 The comparison of the new measures
Blair (1997) considers that there is no consensus on what should replace the old
measures. EVA’s advance has been assisted by its positioning as a tool not only
for investors but for the companies too. It’s hard to find many City analysts

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who are not familiar with the EVA idea. CFROI® of the Holt firm is also one
which has a London office hawking CFROI analysis to fund managers for 2-3
years.

EVA is definitely the market leader among the new metrics despite the fact that
the companies have not dropped the old apparatus of EPS and pie ratios nor
that they are going to because it is too engrained to be swept away. It is also
considered too useful. (Blair, 1997).

The most important issue is whether the new metrics have anything to tell to
the companies about how to run their business. If so, to what extent should the
managers assist analysts in providing the information that will enable EVA,
CFROI® and rest to be calculated? On the matter of companies generating new
metrics data for analysts and investors, there is a willingness to help, but
disinclination to publish the companies’ own calculations. As a financial
director of one of the Burmah Companies said, since the analysts are looking at
EVA, we need to as well. He states that in his experience EVA crops up with
analysis, if at all, too late (Blair, 1997).

A similar view held by a financial director of another company, who considers
that analysts and investors giving more prominence to EPS and traditional
measures. He said that his company does its own calculations as fast as they
understand these new metrics. They are ready to report pro forma CFROI® and
EVA if any institution asks, but there is not any sign of it (Blair, 1997).

Bichard (1994) considers that the appeal of CFROI and other metrics that focus
on cash is that they help managers get a clear picture of a business unit’s capital
efficiency. Unlike traditional accounting measures such as ROA, for example,
CFROI looks at the true cash amount invested; adjustments for inflation, where
significant are made. This helps managers to judge whether a unit’s ability to
create value can be enhanced through expansion, reduced capital allocation and
assorted efforts to boost profitability.

There is no magic formula that always captures the long-term impact of a
business strategy on shareholder wealth. BCG’s CFROI and EVA happen to be

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one of the most popular tools finance executives are reaching for. To ask
whether EVA is better than CFROI is hard to answer. There is trade-off to
each approach. CFROI is very accurate but complex, while EVA is easy to use
but less comprehensive (Nichols, 1998).

While the attractiveness of EVA comes from the seeming simplicity of its
application, the techniques bring substantial challenges if it is to be well used.
Unless the right factors and adjustments are to be taken into account when
applying EVA in order to reflect the unique identity of each company, it
becomes difficult to get an accurate picture of value. In case few adjustments
are taken into account, the picture can be distorted and when many adjustments
are then made, the process risks becoming too complicated to be used
(Bichard, 1994).

Bichard (1994) summarizes the pros and contras of EVA of Stern Stewart Co.,
CFROI and TSR of Boston consulting group as follows.

Boston Consulting Group’s CFROI/TSR -- Advantages and shortcomings.
• Data required by SEC for proxy reporting and used by investors.
• No biases regarding new and old businesses.
• Similar to IRR and NPV metrics used widely to assess incremental
project investments.
• It is necessary to consider that market sentiment also drives actual
shareholder returns.
• Required tailoring to eliminate unnecessary complexities.

Stern Stewart’s EVA/MVA – advantages and shortcomings
• Easy for line managers to grasp.
• Easy for companies to apply and use without ongoing consultant help.
• Packaged neatly with training tools and software for reporting, planning,
and compensation plan design.
• MVA ignores dividend and it is not used by investors.
• Can be biased against low-return start-up investments; can favor business
with heavily depreciated assets (Bichard, 1994).

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The other problem is that the companies and their business units have their own
special characteristics, so EVA may not always be an ideal measure to use.
Companies that are particularly sensitive to the availability of capital, might
chose to use a measure known as cash value added, alone or with the
conjunction to EVA.

The advantages of the DCF are that this model values the components of the
business that add up to the enterprise value, apart from this, it helps in
identifying and understanding the separate investments. Another advantage is
that it can be applied at the different levels of aggregation meaning to a
company as a whole and to the business units. It is also consistent with the
capital budgeting process.

The problems with the free cash flow, is that FCF, while it is a valid measure of
the company’s value when projected into the future, is useless as an indicator of
the current performance. Nichols (1998) gives his analysis of the new measures
in his work “Unlocking shareholder value”. There he explained the new
measures briefly and he wonders whether these measures can tell more than
merely the latest way the consultancy can make money? Only time can show
this. Gunn (2000) gives his comprehensive comparison table for the
comparison of the measures, one for old measures and one for new measures.

Table №1. Comparison of Traditional Valuation methods.
Requirement P/E EV/EBITDA ROI
Simple and easy to use Y Y Y
Applicable across borders and industries N N N
Correlated with total shareholder returns N N ?
Accounts for risk N N N
Accounts for incremental investments N N ?
Incorporates mean reversion N N N
Estimates change in value N N N

Source: Gunn, 2000

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Table №2. Comparison of Three Alternative Valuation methods.
Requirement EVA SVA CFROI
Simple and easy to use N ? N
Applicable across borders and industries N Y Y
Correlated with total shareholder returns N ? Y
Accounts for risk Y Y Y
Accounts for incremenatl investments N Y Y
Incorporates mean reversion N Y Y
Estimates change in value N Y Y
Source: Gunn, 2000
In the tables above “N” means No, “Y” means Yes and “?” means that it is
unknown whether this measure satisfies the criteria or not.

According to Gunn’s opinion, SVA, CFROI also have their own problems
despite the fact that CFROI is best for the share price forecasting and SVA is
the best model of the incremental business value. The problems with the SVA
are that it uses CAPM and users must tailor the model to each company. It can
be useful for the corporate forecasting, not for investing. The problems with
CFROI are the following: first, the market specific discount rate doesn’t make
allowance for industry factors or for the global companies to which this
discount rate should be applied. This model doesn’t work well in some
industries, for example, in property, leasing, and exploration, for which
estimating the project life is often difficult (Gunn, 2000).

3.3 The particularities of the application of the shareholder
value measures in Sweden
CVA® -- Cash Value added – was elaborated by the consultants of the FWC
AB (Sweden), and is used at SCA. Concerning other measures, Stern Stewart’s
EVAand MVA are usually the most discussed in Swedish articles we were able
to find. These articles usually outlined the problems and plusses of using EVA.
The article: “EVA – is it something for Sweden?” one of the earliest written
(March, 1996) that we used in our study, considered that EVA was better than
the other key ratios and CEOs recognized this and sometimes even employ it at
their departments of economics and finance but it was not used beyond this at
that time. European chief of Stern Stewart &Co, Erik Stern, considers that EVA
could be the base for the bonuses as well (Hedberg, 2001).

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Affärsvärlden in its article about the companies – value creators and destroyers
gave the following formula of cost of capital calculation, more precisely, the
calculation of its components:
• The market cost of debt is the rate of the long-term risk free 10-year-
Swedish state bonds;
• The risk-free premium is the same;
• Risk premium of the stock market is 6%;
• β is the actual beta of the stock for the last 4 years before the current
year.

The most usual problem the authors of the articles outline is the calculation of
the cost of capital, especially the risk premium for equity. The β, which is used
in the Stockholm Stock Exchange, is not proper for the companies, which have
international financing. For them it would be better to calculate β in relation to
the world index (Affärsvärlden, 1996).

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Chapter 4 − Empirical studies

4 Empirical studies
The first part of the empirical study covers in a general way how companies
create shareholder value. After giving this background information this chapter
will then focus on different methods companies use to measure shareholder
value creation.

4.1 Creating shareholder value
We investigated the creation of shareholder value by asking interviewees about
the methods their companies actually use to create shareholder value. We found
out that all companies have undertaken some actions in regard to this issue. The
ways they use them are varied. The more frequently used way concentrates on
the core business. All the interviewees said that their companies were active
using this way. All the interviewees admitted that they were creating much
value by concentrating on the core business than when they were concentrating
on many different business areas.

Being excellent in operation was also mentioned by the interviewees. Some of
them said that creating shareholder value is all about how one runs the whole
business. Then, in order to create value the company must be efficient and
excellent in all the operations. Moreover, by doing that, it may provide the
possibility for the company to be number one in the market. One interviewee,
who indicated that the company managed to be number one in the world in
their core business, confirmed this idea.

Companies create value through organic growth meaning that they want to
expand their business. Concerning this, one interviewee says that the company
has also a target of organic growth in Sweden or abroad, which they believe
contributes to creating shareholder value. Another interviewee made it clear
that in the company, they pursue profitable growth and they mostly concentrate
on both the organic growth and acquisitions. In another company, they usually
buy small companies with special capabilities that can strengthen their business
and those small companies are easier to integrate within the corporate. More
about growth, is noticed in a company that is involved in active divestments

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and acquisitions to the extent that this company had made a great number of
acquisitions, up to approximately 300 in the last 30 years.

According to the interviewees, having their capital structure right is necessary
in order to create value for shareholders. The capital structure must be right and
the objective is to have a capital structure that enables financial flexibility and
long-term stability and at the same time conduct operations using capital in an
efficient way.

Some companies have a clear-cut strategy to create shareholder value through
eliminating some businesses with poor profitability. They do it because they
have a policy, which states that every activity in the company should create
value. However, according to other interviewees some parts that are
underperfoming in the company are not directly eliminated, instead, they are
helped to perform well. They added that they couldn’t just sell a business
because it is underperfoming. In this company selling can only be done if it is a
strategic choice to keep up with competition.

Buying back shares was also identified as a way to create shareholder value.
One interviewee indicated that it increased the stock turnover. In one company,
the repurchase was made to finance the acquisition but the interviewee also felt
that the company’s shares were undervalued and it was good then to use the
buy back share system. Other interviewees in favour of this share repurchase
also shared the same point of view. Another reason of using share repurchase
for one company was to improve its debt/equity ratio. Other companies that
have not yet adopted this way, recognize that this is also an opportunity to
create shareholder value and the annual meeting voted for a possibility to use it,
but, they have not started to put it into action.

Some companies do create shareholder value through focusing on the new
areas that will increase the profit and volume in the long run. One company
focuses on service meaning high tech service to processing industry, trading,
electronic to customise the product and enter into partnership with other
companies that have successful competence and good service; in order to be
able to offer customers a better service.

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In line with creating shareholder value interviewees agreed that disclosing
information was also a considerable step in creating value and almost all of
them said that the companies give out enough information to the market. One
interviewee made it clear that giving enough information to the market will
influence the market to believe the good story and to believe in the future of the
company as well and this will certainly create value.

Some of the companies have in place a policy that by creating customer value,
they will create shareholder value. They consider that giving better service to
customers and satisfying their needs is also very important for the companies.
One interviewee explained that the company’s main business idea is to turn and
to develop the consumer market.

One interviewee indicated that the company also created shareholder value
through developing a brand name. He said that before subsidiaries had different
names and there was no name for the whole group, then the brand name for the
whole group was set. Some other interviewees indicated that strengthening
their brand name was as well very important. In regard to this issue, one
company creates value in the opposite way, it instead use a multi-brand strategy
and the philosophy behind that is that each brand has the responsibility and
authority to further develop and nurture its established market position based
on its own specific attributes and value offering and with due consideration
given to the role assigned by its parent company. Then, this strategy will create
value.

According to one interviewee the decision to created a separate company for
properties created shareholder value in the company. The company had many
properties then, they created that separate company to lend out what was not
being used by the company, the company had a very large amount of hidden
value.

Adopting the new business philosophy was identified by one interviewee as
vital for the company since much value for their shareholders was created after
adopting the philosophy which indicated what the company actually was and

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what the actual business it runs is. This way made it clear to market that the
company is actually more and performs other services than what the market
thinks the company was involved in. It also showed that the company earned
much more from these services. The market’s response after this action was
positive and this created value to the company as well as to the shareholders.

In regard to creating shareholder value most of interviewees identified
innovation as also being important. Some companies innovate in terms of
service. Concerning this in one company there is a speciality in service of what
they called happy deal. Technical innovation is given much attention in many
companies and more is being invested in it.

According to one interviewee to deliver increased shareholder value, the
company constantly challenged itself to do what is right, smarter, faster, and
cheaper. In doing that the company creates an exciting, competitive, fast –
paced environment for the employees, where there is a great opportunity and
rewards for innovation and success.

One interviewee indicates that the value is created for shareholders through
leading competence, long-term relationship and good objectives, which would
push them to create value. To reorganize the company was considered also by
one interviewee as creating value for shareholders. He indicateed the actions
have been taken to reorganise the company and the company became more
centralized. This facilitated, according to the interviewee, the taking of
decisions for the whole group. Finally, reducing cost was also mentioned by
one interviewee as being vital in creating shareholder value in the company.
The company has a philosophy of reducing cost whenever it is possible and this
contributes to less spending while more value is created.

4.1.2 Reasons behind the choice of the ways used
Not only ways to create shareholder value are interesting, the reasons behind
choosing these particular ways are important. In order to gather information on
this particular point we asked the interviewees why they chose these particular
ways not the others. In general terms the interviewees do acknowledge that
there are a variety of reasons behind the choice they made.

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Profitability was mentioned as one of the reasons. Interviewees argued that the
market concentrates much on looking at the profitability. Thus they chose the
methods that will help them to make their business more profitable. Another
interviewee added that they chose the strategies, which are very suitable for the
kind of the business they run and which will make much profit for the
company. The way that will increase profit will be favoured. To this point,
then, profitability was a reason behind concentrating on core business,
eliminating unprofitable business, adopting the new business philosophy and
even developing brand name.

Wanting to increase focus on the hidden value in the balance sheet was also
identified. The interviewee who said that the company has a lot of hidden
value, which in case there is a focus on, would be of great importance for the
company. Then this justified the fact that they chose to use the strategy that
would best show it to the market. This reason was behind the creation of a
separate company that the company used.

Wanting to do what they can better is also another identified reason. The
proponents of this reason argue that it is vital to run their businesses doing what
they can to perform well. Thus, they needed first to identify what they can do
best and concentrate on it. This reason was especially behind excellence of
operation.

One of the identified reasons was giving the customer a better service and good
trading environment. The company believe that this is also very important for
the success of its businesses given that they have a large number of customers.
Then, they focus on service – high tech service that is a new area to be able to
succeed.

Interviewees identified also offering a more added value product as another
justifying reason behind their choice. They want to offer a good, better and up
to date product, which will offer more value and make a difference. This
pushed them then to focus on electronic in their operations, thus, focusing on
new areas.

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According to one of the interviewees gaining something new in the company
and easier facilitated integration were the reasons why the company took a
strategy of buying small companies. The interviewees argued that the company
is very big and have a well-established culture. Then the policy is to buy small
companies that will be more easily integrated into the company’s culture.
Moreover, those small companies must have some contribution to add to the
company such as new techniques that are not already in place in the company.

Future target growth markets and suitable strategic positions were also
identified. This was behind buying companies especially in Baltic countries. To
be strong enough for the market and to continue to be first in the market was
another reason. The company wants to occupy a considerable place in the
market and be known in its market, therefore, it chooses the strategy, which
will help in a faster way to become strong in the market. This reason was
behind the actions that the company took to concentrate on being efficient in
operation and also to undertake many divestments and acquisitions.

Capital structure was another reason identified. Concerning this the company
is very concerned with having its capital structure right. Thus, the strategies
that it prioritises are those which will not affect its capital structure and which
will contribute instead to getting it right.

To get a bigger volume and to expand more were also mentioned as reasons
justifying the choice made. They mentioned this, since they believe that when
you buy and sell in bigger volume, this contributes in cutting costs and then
passing the savings to the customers. The product would be then much cheaper
as result of that. Interviewees argued that to expand more has a connection with
the growth need because it is assumed that bigger may be better. That bigger
companies may be more successful, survive and prosper. This reason was then
behind merger and acquisition as well as organic growth.

To have low costs and to maximize the shareholder value are also other reasons
identified. Some of the companies want to offer a very high service level at
very low cost. They also want to maintain a low cost position and look for

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activities that will enable them to create cost saving and value creating
opportunities. This would help them to reach their determination of value
creation for shareholders. One company wants high performance at low cost.

The ways that will be chosen are the ones suitable for the kind of business the
companies run meaning that they do not just choose the way, it has to be in
accordance with the business in place. This was also behind the choice of
excellence in operations.

4.1.3 Successfulness of the ways to create shareholder value
Under this subject the interviewees were asked to evaluate to which extent the
companies’ actions to create shareholder value had been successful. The
answers to this question differed substantially. Interviewees answered in three
different ways. Some said that they are successful, others said that it is very
hard to tell. Finally, the last part said that they cannot be sure in the short term
but in the long run they will be successful.

For those who argue that their ways are successful they said that they have
reached their target or they indicate that they are successful because the share
price has not fallen much. Moreover, they argue that their EVA is positive thus
their ways have been successful. One interviewee mentioned that the company
had even paid all its debts and has strong cash flows and claimed that all that is
a sign of successfulness of the ways the company use to create shareholder
value.

The interviewee, who said that it is very hard to tell, argued that the
successfulness could depend on different factors and on time. For example, the
system of selling a product where one earns a fee may be expensive because
the personnel become expensive with the bonus they need on that fee.
Therefore the interviewee said that the answer could not be known for sure.

The last part that said that they cannot be sure in the short run but that they will
be successful in the future argued that time is needed to be able to tell whether
a way used is successful or not. Then, they cannot confirm at the present time

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but in the future given the ways they are seeing the situation, they will be
surely successful.

4.1.4 Shareholder value creation as key corporate objective
In order to find out whether shareholder value creation is a vital objective in the
companies, we asked the interviewee the following question: Is shareholder
value creation an explicitly communicated key corporate objective? The
interviewees answered in different ways, following what the companies were
putting into action.

Among the 7 companies one, of them has shareholder value creation as an
explicitly communicated key corporate objective. Two companies have value
creation as an explicitly key corporate objective but they clearly mentioned that
value creation is for shareholders, employees, business partners and consumers.

For three companies shareholder value creation is not explicitly the key
corporate objective but it is an internal goal for the management and they
combine it with creating value for customers.
One company does not have creating value as an explicitly key corporate
objective but it does create value considering not only shareholders but also it
creates value on the same level for the other stakeholders such as employees,
customers and society. It uses instead the stakeholder model. The interviewee
expressed the view that a company cannot easily succeed by only putting much
focus on shareholders without looking at the other parts such as employees,
customers, and society.

Contrary to this above idea, in the company that has shareholder value creation
as an explicitly key corporate objective, the conflict between shareholder and
other stakeholders is not remarkable since when the company is doing well and
creating shareholder value, the employees benefit as well as the society. The
interviewee in that company said that shareholder and stakeholder fit together.
Even if a conflict may occur it is very minor in the sense that it may be hard for
the employees to balance everything since they know that in everything they
have to think about cost. Time may also be a problem.

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4.1.5 Shareholder value creation in the long run
The long-term creation of value is very important both for shareholder and for
the companies. We then asked the interviewees what the companies were
planning to do for the future value creation and we got the following replies.
Interviewees agreed that the creation of value in the long run is very important
for both companies and shareholders. We identified different points of view
towards the ways they plan to do it. One company plans to stick with its current
strategy since it is very suitable for the company and the company will also try
to fulfil the targets it has set, with that the company would create value in the
long run.

To deliver good results and credible earnings were also mentioned. The
company was to try in all its operations even in the future to be best and always
have the objective of delivering good results that will create value.

“Build a brand name and communicate it very openly”, the interviewee who
mentioned theses ideas said that the company was preparing to manage its
operations very well and build a brand name, which will be communicated to
the market very openly. Thus, this will create future value since the market will
be very well aware of the brand name of the company and the reputation
behind that name.

“To find out the need of the customers was also mentioned”, in the long run
perspective the company was to identify the need of the customers to offer the
customer up to date products that would satisfy their needs and the company
would even market to them what the customers may be not aware that they
need while they surely need it. According to another interviewee, using
resources as efficiently as possible was what the company was to do for future
value creation. The company was to continue working with capital structure
using the resources in economical ways. The company plans to increase sales
without increasing the assets employed in operations. Thus, the company could
continue to focus on growth and stay number one in the market.

Watch what happens in the market. The interviewees argue that it is very
important that they keep watching the evolution of the market, what is

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happening in the industry, the technological development and also what the
competitors are doing. All this would be done in order to stay competitive in
the market and be the market leader in the long run. Otherwise, the company
would not manage to stay in the market if it was not watching what is
happening there and adapt to it accordingly.

Be efficient in operations was also identified and the interviewee argued that
the company would be running its operation in a very efficient way. That
would be done by managing and conducting their operations in a way that will
create value. One interviewee said that in the long run they would focus on the
profitability and work with liquidity of share. In this company, buying back
shares that will translate to big turnover would be used as well as coming out
with the information about the surplus value. All these ways would create
shareholder value.

Moreover, according to one interviewee divestments and acquisitions will
create value for shareholder in the long run since the company would invest in
profitable acquisitions, which will in its turn add value to the rest of the
company and to the shareholders.

In relation to this issue in one company the interviewee said clearly that in the
company they do not give information about their future plans. For this
company, much of what is being planned for future value creation is not
disclosed.

4.1.6 Value-based management
It was important in this background study to have some investigation about
value-based management given the place it occupies in value creation where it
is used. We were very curious to know exactly how interviewees feel about this
new emerging term. Then, we ask the interviewees whether value based
management was used in their companies. Some of the interviewees knew little
about this term. However, other interviewees were very much aware of value-
based management.

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Three companies out of seven use value based management. One interviewee
mentioned that the company use value based management, thus, managing for
value is the organization’s principal objective for creating value for all the
stakeholders. The creation for value is the foundation of the corporate culture
and the basis for everyday business activities. Everyone of the business
managers knows the cost of capital for his or her business, the economic
yardstick for measuring the potential value of business strategy for allocation of
resources and assessing of performance.

The managers are challenged to maximize their free cash flow while at the
same time investing sufficient capital to position in the future. There is a
primary focus on the free cash flow generation in all employees and this policy
is fully incorporated in the enterprise planning and management. The starting
point is that the goals for value creation are set for the whole group and its
individual businesses. Those goals are in its turn translated into value driver
targets, which are then prioritized and broken down into specific actions
directly linked to increasing value. Finally these are communicated throughout
the organization. Everyone in the organization is a direct contributor to and a
beneficiary of value creation.

Value creation is a measure of performance in another company. That model
for value creation is used internally to measure performance by sector, product
line and region. They drive down costs, improve the rate of capital turnover,
and rationalize assets that don’t generate sufficient returns. Improvement of
value creation is driven by greater internal efficiency, which generates higher
margin. The company continued to implement value-based management at all
of its subsidiaries. The third company uses value-based management and it is
considered as a systematic approach to creating shareholder value.

The remaining companies do not use value-based management and
interviewees had some comments on this issue. They said that they have
instead goals and objectives that are adapted to each category of employees.
They also believe that not all the employees would understand the real term of
creating value even if it was communicated to them. They set a target for each

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business and have a very centralised system whereby each has to fulfil its
target. Another interviewee said that basing performance on value creation
would not be good since creating value depends on many factors. The
interviewee added that employees, in this case, may have worked hard, but,
might be judged negatively if at the end, value was not created.

4.2 Measuring shareholder value creation
4.2.1 Valuation Methods
After having the general information on how shareholder value is created, we
then investigated how the companies measure shareholder value creation. In
replying to this question, the interviewees explained how they measure
shareholder value creation by presenting the different valuations methods they
use.
Those methods are then identified in the table below and each horizontal
column stands for one company in the study, as mentioned earlier in the
method part, there are seven companies.

Used measures for shareholder value creation

Companies Measures used
Company 1 ROA, ROE, ROCE
Company 2 EVA, ROE, EBITDA
Company 3 DCF, ROE, EBITDA.
Company 4 ROI, EPS
Company 5 ROE, ROA (DU–PONT model)
Company 6 EVA, TVA
Company 7 ROE
Source: own
According to the replies we got from the interviewees most of the companies
use ROE – Return On Equity. Some of the companies use it with other methods
and it is not the only measure, which shows them the shareholder value
creation. However, some of companies consider it to be the main method for
shareholder value creation. One interviewee defined it as being a result for the
year as a percentage of the average of taxed shareholder equity at the opening

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of the year and the close of March, June, September and December
respectively, adjusted for Dividends paid during the year and any possible right
issue. Another interviewee said that ROE is calculated as the profit for the
period divided by average shareholder equity. Average shareholder equity is
adjusted for the new bonus issues, dividends, and minority interest.

Two companies out of seven included in our study use EBITDA – earnings
before interest, taxes, depreciation and amortization – It is used alongside other
methods. According to one interviewee, the company uses traditional measures
that indicate best the profitability, which is –operating profit/loss for the year in
relation to the net turnover – and according to the interviewee profitability is
vital in the company and recognized that for different levels of the company the
profitability is also different. Concerning the group level the company uses the
operating margin. The same interviewee said that profitability is most directly
connected to the shareholder value and that is the reason why the company
considers it to be important.

ROCE – return on the capital employed is used in one company alongside other
traditional methods. According to the interviewee it is calculated as operating
income plus interest expense in relation to the average capital employed.
Average capital employed is calculated as total assets less non-interest bearing
short-term provisions and liabilities and deferred tax liabilities.

ROCE= (Operating income + interest expense) / (Total assets – non-interest
bearing short-term liabilities – deferred tax liabilities)

According to one interviewee RONA – return on net assets – is also calculated
and it indicates shareholder value creation. This is calculated as net income
divided by the net assets. Net assets are calculated as total assets minus non-
interest bearing liabilities, interest bearing financial receivables, and provision.

RONA= Net income /(Total assets – non-interest bearing liabilities – interest
bearing financial liabilities –provision)

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One interviewee said that they use ROI – return on investments – to measure
shareholder value creation. In one company the whole group use Dupont model
whereby according to the interviewee, ROE and ROA included in that model
indicate shareholder value creation. Here ROA = profit margin x assets
turnover = operating profit/net turnover x net turnover/ total assets.

EPS – is used in one company the interviewee also said that the equity per
share is used and it is shareholder equity divided by the number of shares
outstanding. Shareholder equity is equity according to the balance sheet
adjusted for the equity portion of the difference between fair and book value of
financial instruments.

According to the replies from the interviewees, some companies in our study
do use the economic measures and they consider it to be the main measure for
shareholder value creation. In these two companies EVA is used. For one
company the aim of using EVA is also to improve the margin; reduce the
capital and create the profitability growth and then TVA (Total Value Added)
is operating income minus the cost of the capital in the currency the entity
operates in. The development for the concerns’ EVA numbers is correlated
with share price development over the long-term period. Company’s concern’s
bonus and option program is based on this model. However, this company does
not publish any figures of EVA in its annual report.

In the second company, where EVA is used, value creation is the measure of
performance within the group and the interviewee referred to the following
value creation model present in the annual report. This model is accompanied
with the figures in the annual report.

Value Creation Model
NET SALES
- Cost of goods sold
- Marketing and administarive costs
= Operating income, EBIT
- WACC x Net assets
Value creation/ destruction

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According to the information referred to by the interviewee present in the
annual report 2000 WACC is the weighted average cost of capital, and it is 14
% for years 2000 and 2001 in this company. The calculation of the cost of
capital is as follows: Re= market interest plus risk premium divided by tax
adjustment, approximately 0.7%. The market interest rate on the loan, and
debt/equity ratio is 0.5 or 50%. This company started to use EVA model since
1998 during all this time EVA was positive.

Concerning this issue of economic measure some interviewees in the
companies that still use the traditional measures as their main indicator for
shareholder value creation mentioned that for curiosity EVA or DCF are
calculated only on the top management level to get a picture of their
performance and the make it clear that these measures cannot be considered as
the measures that group use for measuring shareholder value creation.

4.2.2 Reasons behind the chosen methods
There are many measures that the companies can use, to then find out about the
reasons that pushed the companies to choose the particular methods that they
use to measure shareholder value creation, we asked the interviewees to
identify those reasons. It is also important to mention that in very few cases
specified in this report, some reasons present in the journals were also added.

Concerning Du-Pont model the interviewee mentioned that the reason why it is
used is that the company considers the model to be comprehensive, since it is
possible to break it down by components and identify which factors influence
ROA.

According to one interviewee the choice of EBITDA used in the company is
based on the fact that it can be applied deep down within the group, to different
units etc. The interviewee added that the company had been using it for a
longtime. Interviewees pointed out other reasons for using this accounting
measure among those reasons is that it is easy to communicate them to the
lower level. The interviewee said also that it is easier to communicate that
especially when compared to the Cash Flow that is considered to be difficult

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when it comes to communicating it to people without economic / finance
education within the company. One interviewee added that the company
concentrates on profitability, then, the measures chosen are those, which show
most the profitability.

One interviewee mentioned that they chose to use DCF because it would help
them to estimate what the company wants to achieve and according to him, it is
a useful tool in the investments’ measuring.

One of the reasons mentioned for using EVA is that it helps the company’s
management to see if every business unit is able to cover its cost of capital.
Moreover, as noted earlier, the company uses the bonus system based on EVA.

The most comprehensive information about the usage of EVA and its
implementation is that the company that has been using it for three years seems
to be satisfied with its choice. As it can be read in (Ekonomi&Styrning, №1,
2000, ) one person from this company ‘s top management did mention another
reason for using EVA and said that they wanted to choose the practical model
which gives the positive effect; which is relatively simple and compacts with
the language and the priorities of the company. The same person added that the
advantages are obvious. The company has got the simple measure for growth,
margin and capital. In the company it is possible to compare the return with the
real cost of the capital and try to reduce the capital part when necessary; all that
because they use EVA.

4.2.3 The benefits of measuring shareholder value creation
To know what the interviewees think about the benefits of measuring
shareholder value creation we asked them to give us their views on this issue.
Generally, all interviewees perceive that measuring shareholder value does
indeed provide some benefits.
The most common view on the benefit of measuring shareholder value creation
identified by interviewees is that it can raise the share price. They added that
this is an important step since by measuring it; they will be sure of the value
created. Furthermore, if this information is well communicated, it can also
create value.

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Another point of view on benefit mentioned by interviewees, is that measuring
shareholder value creation helps management make the right decisions. For
example they said that if the company measures shareholder value creation, this
will enable it to know whether the value is being created or not. On the basis of
that information, the management can take the decisions accordingly. They can
easily identify the activities that do not create value and eliminate them. They
added that it then is useful in taking the operating, investment as well as
financing management decisions.

One interviewee made it clear that this is especially important for the company
since it helps them to see which businesses should be developed more. These
are the businesses that give more cash flow and became more profitable. The
interviewee added that this also could be classified under the fact that it helps
in the management decisions.

Another interviewee said that measuring shareholder value creation helps them
to keep the optimal capital ratio on the level the group has set. It is by
measuring it, that they will be sure if they are keeping that level or not. They
will then know what to do in the next step.

It was also stated that measuring shareholder value creation contributes to
increasing the turnover of shares and liquidity of the shares. The interviewee
said that if the share price is increasing then people could sell them or buy them
at a greater speed. Once the company performs well the market should notice it
and increase the share price.

4.2.4 Development of measures that the companies use
Nowadays, some companies are developing their own performance indicators.
To get some ideas on whether the companies in our study had developed those
measures they use internally and if not what their views on this issue are, we
asked the interviewees. It was quite clear after the replies to the preceding
questions, that none of measures, which the companies use was developed
entirely internally. However, interviewees did mention that even though they

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did not develop the measures, they do set their own definitions of some the
components of these measures.

One interviewee mentioned for example that the firm did not develop the Du-
Pont model by itself but it had its own definitions of some existing terms
connected to that measure inside the company. Another company sometimes
uses the help of the consultants when it comes to defining WACC. However,
the measure the company uses that is DCF was also borrowed.

EVA was developed by Stern Stewart &Co. The authors of this method
recognize that there can be a lot of adjustments to the NOPAT. The
interviewees who said that their companies use EVA mentioned that they chose
to use the simplified methods, without a lot of adjustments.

Interviewees that use the accounting measures also did not develop these
measures internally but gave their own definitions of the main components
(numerator and denominator). All the interviewees mentioned that so far the
companies have not considered developing entirely their own measures.

4.2.5 Advantages and shortcomings of the chosen measures
In this section we present advantages and shortcomings of the measure used by
the companies from the point of view of the interviewees. We brought up this
issue to see what the users of these measures consider to be good and what they
feel is the weak part of these measures as well as some problems in the
application of those measures.

Concerning the traditional measures, the interviewee avoided making many
comments about the ineffectiveness of them but were much more concerned
about what the benefits are of using them. They mentioned for example, that
they are easy to communicate. One interviewee identified shortcomings and
advantages of the Du-Pont model. According to the interviewee it is difficult to
relate the real growth to the real value. Concerning the new measures,
interviewees said that their shortcomings are that people without financial
knowledge do not easily understand them and it is hard to communicate them
to the lower level employees. As for advantages, interviewees mentioned that it

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is possible to emphasize that for people in the administration these measures
are good since they create goals. Another advantage is that when the company
uses them, it becomes possible to convince the manager to reduce the stocks
and as a result the profit may go up. It was also added that they facilitate the
taking of decisions.

One company that uses EVA considers the advantages of EVA as being its
simplicity when many adjustments are not made and its shortcoming being
many adjustments that should be made. This company does not make many
adjustments; or use more superior models – because of their complexity.
Another EVA company recognizes that EVA may be a shortsighted model but
considers that this is not a big problem since there are other ways to eliminate
those shortcomings. EVA is also considered a good tool for the central
management since it makes it easier to see value. The DCF-user doesn’t see
any weakness in the DCF model, but mentioned the advantage of it as being
that the company can see whether it is going the right way or not.

4.2.6 The test of validity of the chosen measures
This section covers the interviewees’ replies on the testing of the validity of the
chosen performance measures in the companies in our study. It also raises the
issue whether companies are planning to change those indicators in case their
validity is questionable. It is interesting to notice that all the interviewees had
some views on this issue.

Concerning the testing of the validity of the chosen performance, all the
interviewees agreed that this is very important to do and that their companies
were in one way or another testing the validity of the measures. Some
companies made adjustments whenever necessary. However when it came to
whether the company could change the measures that are known to be no
longer valid or appropriate, we got slightly different ideas.

Some interviewees mentioned that the companies are not planning to change
the models they used since they are slightly modern. They consider that their
systems function very well and there are no reasons to make any changes. One
EVA Company added that some adjustments can be made but there are not

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going to be any significant movements to the other performance models.
Another company’s management said that their system the Du-Pont model –
contains the components for shareholder value creation gives them a “flexible
way to look at information and express it in different ways” and that it may not
change it but that there is always room for flexibility.

One reasons mentioned for not changing the traditional accounting measures
was the lack of the pressure from influential shareholders and the stock market.
It was also added that the stock market is quite conservative and it still wants to
use old measures. Consequently the companies prefer to keep the old methods.
Some interviewees mentioned that the business the companies operate in is
very conservative. Consequently the flexibility to change is very low.
Therefore, these companies are not planning to change in the near future.

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Chapter 5 − Analysis

5 Analysis
This chapter covers first the analysis of the information collected on creating
shareholder value and after analysing this background, the chapter focuses on
the analysis of measuring shareholder value creation.
5.1 The shareholder value creation
Most of the companies create shareholder value and have started to integrate
that in their daily ways of working. This may be the reason why for every
company we interviewed, there were a number of answers they gave us to
indicate that they are creating shareholder value. Moreover, all the companies
mentioned at least in the annual report that they create shareholder value.
However, all of them do not create shareholder value in the same way or to the
same degree. From what we found out, there are some ways, which seem
common to every company that were mentioned before any other ways. The
most used way concentrates on the core business, it is considered to be very
effective. The occurrence of this way may depend on the high competition
present in the market, which is forcing the companies to concentrate on what
they can do best and be able to offer good products, which can be competitive
in the market. It is also important to notice that the globalisation that is taking
place nowadays may be also another reason pushing companies to concentrate
on their core value.

The company cannot act in this way alone and to be able to create shareholder
value, it must combine it with other ways to ensure success. The interviewees
also shared this view and they mentioned several other ways they put in place
to create value. Being excellent was also mentioned by many interviewees, this
might due to the fact that many of the companies are actually very well known
companies that may be sure that the market does appreciate their operations
and they could then declare that being excellent is one of their ways. Organic
growth, which was mentioned, may also be justified by the ways the companies
are expanding and making a lot of acquisitions.

It is also interesting to see that most of the companies consider share
repurchase as a way to create shareholder value and some of them have already

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done it or are preparing to use it. However, it appears that from the
interviewees’ information, some of the companies did it for the purpose of
meeting their own needs such as the conditions other business partners put on
them. In this case share repurchase may not have been done for the primary
reason of creating shareholder value or because they felt that their shares were
undervalued as they claimed. Even though this cannot be ruled out, it may be
questioned. Moreover, whatever the motive behind it, the result of it is that
share repurchase created shareholder value.

One of the other reoccurring ways is eliminating some businesses with poor
profitability. This appeared to create some controversial ideas among the
interviewees. Some interviewees mentioned that it is good to use and this may
be due to the fact that they are from the companies that have creating value as
the explicitly key objective. Other interviewees stated that they could not just
dispose of a business because it is not profitable, they can instead try to
support it so that it can become profitable. Eliminating business with poor
profitability can get our support since we think it is a waste of resources as well
as time to continue to invest in activities that are not productive. They should
instead use those resources to invest in other activities that can create value or
to develop and expand the existing profitable activities.

It was unexpected that the idea of having a correct capital structure was not
directly mentioned by many companies, given its importance. Two
interviewees identified it. We feel that it should be the focus of each company
in its process of creating shareholder value. It is more likely that other
companies consider it, but they should not underestimate communicating and
revealing to the market the actions they are taking in regard to the capital
structure.

Disclosing enough information was seen as an important step in creating
shareholder value. Some of the interviewees shared the view that the
information they disclose can affect the price of their stock, that is the reason
why they disclose as much information as they can. This may be due to the fact
that these companies are large and disclose a lot of information. However, this
cannot exclude the fact that we found out that companies were not disclosing

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the information to the same extent. Some companies have made a considerable
effort to really give out a lot of information while others still have to make
effort to disclose a lot of information which we feel could create a lot of value
for shareholders in those respective companies.

Innovation is also one of the most common ways mentioned by the companies
concerning creating shareholder value. It thus seems that the pressure to
innovate is very much at work in the companies. Different actions to innovate
are being taken and a lot of investment in research and development is under
way. We found out that this is especially true and to a large extent in the
manufacturing companies than in the service companies even though the fact
that the service companies are also making some effort in this area cannot be
excluded. The manufacturing companies are time after time coming up with
new technological development and new products. All these are the fruit of
innovation, which is contributing to the creating of shareholder value.

If we turn towards developing a brand name as way to create shareholder value,
it appears that there were two points of view, which we also feel both create
value when taken from their context. The fist view stated that the company
decided to have one name and develop it instead of having different names for
each subsidiary. This may create value for this company since when all the
subsidiaries are known under one brand name and behind that brand name there
is a good reputation, this could attract more customers than if all the
subsidiaries had different names. The second view involves the case whereby
the company bought or acquired other companies that already had developed
and reputed brand names and preferred to keep the brand names of those
companies within the corporation. Each brand name has the responsibility and
authority to further develop and nurture its established market position. This
could be seen as a good way to create value since by doing that the company
would not only keep the customers of those acquired companies but it would
also reap an advantage of having many more customers who may hear about
that multi-brand strategy.

Concerning creating shareholder value, some companies adopted the strategy
that by creating customer value, they will then create shareholder value. They

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concentrate on the fact that giving better service to customers and satisfying
their needs will create value for customers and thus for shareholder value. This
view may be due to the fact that the companies favouring it, are much more
customer oriented than shareholder oriented. It seems as if everything they are
doing for the customer, they are trying to relate to the shareholders. However, a
more common way, which we feel may be in accordance with shareholder
value model, is the other way round. That is creating the value for shareholder
then the value of other stakeholder will be automatically created. More related
issues are going to be discussed later in this thesis.

Focusing on the new areas that will increase the profit and volume in the long
run was seen as creating value for shareholders. It can be seen as important for
companies to focus on the emerging new areas that are attracting many
customers, such as to focus on electronics, to further develop e-business, to
gain competitive advantages by combining technological expertise and know-
how or by creating joint activities. This adopted procedure also should be seen
as a way to invest for the future since it may help the company to keep up in
the future.

Reducing cost, that was also mentioned, may be considered a good way to
create shareholder value since the company would avoid any unnecessary
expenses while it offers good products and be better off without many
expenses. This may be the reason why many of the companies in our study are
reducing the cost through for example laying off many personnel. Companies
might be judging that they can still cope and at the same time offer better
services without a great number of personnel. Many jobs have been lost in that
process of reducing cost and while this may be negative for the personnel who
are losing their jobs, it seems that companies are getting better off with this
strategy. However, it cannot be ignored that many other driving forces may
push the company to lay off personnel, such as reduction in the market share,
losses etc.

5.1.2 Reasons behind the choice of the ways used
Before carrying out a certain way to create shareholder value the company does
make a choice since there exist many ways to create shareholder value. The

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companies in the study use many ways and different driving forces were
mentioned as to being behind those ways. Different reasons were mentioned
even when the way chosen was the same. Therefore, we looked into them
closely to try to get the reasons why that might be that case. One explanation
about that choice may be that the nature of decision-making process may be
different from company to company. We also found out that there is a
possibility to group these reasons.

Profitability is very important for quite a number of the companies. To have a
low cost and to maximize the shareholder value, the companies plan to use the
ways, which will be more profitable. The need to eliminate some businesses
with poor profitability and deliver good results are also other reasons. Theses
reasons appear to be cost oriented since they seem to be directed to the process
of lowering cost while increasing profit.

Wanting to increase focus on the hidden value in the balance sheet lead the
company to choosing the way, which would reveal that information in a
remarkable way. This was then behind the creation of a separate company and
giving out information. This reason appears to be value oriented since they
seem to show that the company has more value than what the market perceived.

Wanting to do what they can do better, Suitability for the kind of business they
run are the reasons that influenced the companies to concentrate their actions
on the core value. Gaining something new in the company and easier facilitated
integration led one of the companies to choose ways that will welcome new
ideas and intelligence. These reasons appear to be service oriented. This is
because it seems to have in common improving activities in order to offer
better services.

Offering a more added value product influenced the company to concentrate on
the ways that would allow the company to produce and offer up to date
products. This reason appears to be product oriented since it seems to centre on
the product. That means the state in which the product should be in once
delivered.

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Future target growth market, suitable strategic positions, to be strong enough
for the market and to continue to be the first in the market were also reasons
mentioned. To get a bigger volume and to expand more while developing a
brand name. These reasons appear to be market oriented. They actually seem to
cover the market issue, how to expand the market share, the position that can
be occupied in the market and the reputation in it.

Capital structure as well as giving the customer a better service and good
trading environment were mentioned as reasons for some companies and for
others they were identified as ways to create shareholder value. This may
indicate that some ways or reasons may be interpreted differently from
company to company depending on the scope the companies have.

However, how the reasons were determined in the companies seems to be
unclear. It would be better if the ways were chosen after the company had
identified its value drivers and chose ways that will maximize those value
drivers. However, the various reasons mentioned behind the ways were in most
of cases very different to the value drivers or they just included only one of the
value drivers that the companies had. It seems that the importance of value
drivers was not underlined when determining the reasons that stood behind the
ways. In some cases companies did not make it clear what their value drivers
were, which complicates the procedure of judging whether there may be any
link between their value drivers, and the reasons why the companies made such
choices. This may also partly explain why some considered ways in some
companies, were mentioned as being the reasons behind the ways in other
companies. In our view, the reasons behind the ways should at least have some
link with or even be the value drivers that the companies have in place. That is
because when the companies consider the value driver as the reasons behind
the ways used and choose the ways on the basis of those value drivers; the
companies may best meet the value drivers and would create much more value.

5.1.3 Successfulness of the ways to create shareholder value
The success of the ways to create shareholder value is judged differently in the
companies in the study. The results seem to show that the companies that said
that they were successful based their view on the financial situation of the

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company and the share price. This may be due to the good financial situation
the companies had that time. However, nobody from these companies wanted
to raise the questions of other factors in place that may influence the
successfulness. It seems that the companies were ready to continue with these
ways.

It may be suggested that the companies reluctant to state that their ways were
successful, took that position not only because their financial situation was not
good as well as the price of share that was not being stable but they also raised
the question of other influential factors to be considered in deciding whether a
certain way is successful for creating value.

The time factor was introduced, in the view that the interviewees cannot be
sure in the short run but that they will be successful in the future. However, this
may be subject of argument since some of the ways were introduced in the
companies some years ago in these very well established companies, if time
was the factor then the interviewees arguing for these ideas should have been
able to give an answer to this issue. We therefore sense that many other reasons
should have been behind this view such as the falling of the share price, the bad
condition of the financial situation, to mention but a few.

Even though the successfulness of the ways depends on different factors as
many of the interviewees proposed and that different people have different
views on what really shows success, we feel that it is very important to know
whether a way is meeting the expected results based on different aspects before
finance is invested in it, this would give room to change to another way that
may be successful. The complicated nature of judging success should not be
used as an excuse of not knowing the answer concerning the successfulness of
a certain way. We feel as many other authors did that this evaluation should be
based both on financial and non financial aspects, it would be then more
accurate.

5.1.4 Shareholder value creation as a key corporate objective
The shareholder value model indicates that shareholder value creation is the
explicitly communicated key corporate objective and it is used as the basis for

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valuation. The problem is to know whether companies consider this as a very
important step in their creation of value. The results seem to show that this
objective does not correlate with the majority of the companies in the study.
Although all the interviewees were able to identify various ways in which they
create value for shareholders, few companies implemented the shareholder
value model. That is one company out of the 7 companies did implement the
shareholder value model with the shareholder value creations as a key
corporate objective. This company argued that it was creating value in an
impeccable way. Other 2 companies had also value creation as an explicitly key
communicated objective but not only for shareholders but also for other
stakeholders. One possible reason for this could be that the companies do that
to avoid many complaints that would arise from other stakeholders.

Other companies use the stakeholder model which is the opposite of the
shareholder model, within this model shareholders are not the only important
stakeholders, they are considered on the same level as employees, society,
customers. The replies we got from the interviewees seem to exemplify the
conflict that the opponents to the shareholder model said existed. Some of the
interviewees seemed to be opponents of shareholder value model while others
seemed to be the proponents of it. The opponents of the shareholder model said
that the companies could hardly survive if their main objective was to create
shareholder value and they feel that shareholder value creation is not a good
measurement system to base on when it comes to valuation. This idea seems to
show that the companies have not yet welcomed this immerging issue of
shareholder value model, which seems indeed successful in the companies that
did use it. However, the proponents of this model mentioned clearly that by
creating shareholder value they also create value for other stakeholders. They
also mentioned that they do not experience the conflict between shareholder
and other stakeholders. We feel that this view could be supported since the
shareholders seem to be becoming increasingly important and could in many
cases influence considerably the companies’ decisions. Having creating their
value as a key objective would not only encourage shareholders but would also
create their value as well as the value of other stakeholders.

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When examining this issue some interviewees judged that shareholder value
creation is simply an internal goal. This answer could be seen from two points
of view. This answer could simply have been given to us because the
interviewee did not want to state openly that it is not their objective and
preferred to stay vague. Or it may be that the interviewee wanted also to state
that they create shareholder value but not to the degree of having it as their key
corporate objective. For these companies, it seems that they use neither of the
two models: shareholder or stakeholders model. However, their views seem to
direct to the stakeholder model since most of them criticised having this
shareholder value creation as an explicit key corporate objective. They said that
it would not produce good results for the companies. We feel that if the
objective of the company in regard to shareholders is very clear and openly
stated the company may reap more benefit and this would have some influence
in its value since the market would take into consideration that such a company
is doing its best in that area, given that it has shareholder value as its key
objective.

5.1.5 Shareholder value creation in the long run
Creating shareholder value in long run plays a very crucial role for
shareholders. They always want to know what the company plans to do
concerning their future value. Even though all interviewees agreed on this issue
and stated that their companies were also planning for the future, it seems that
for some companies little was being done to prepare for more future value
creation for shareholders. In some cases the future value creation was to
maintain the strategy, which is in place. Usually, shareholders expect in future
much more than the present ways, they then expect the company to have in
place many more plans and projects which would increase their value. If then
the company takes that opinion that it will only maintain its present ways, there
may be a risk that shareholders would tend to think that the company is doing
little or nothing when it comes to the future value creation.

Delivering good results and credible earnings were also mentioned as offering a
promising future for shareholders. Even though this way was mentioned as how
the company would create future shareholder value. We feel that this is instead
a result of the actions the companies would take. This would seem to indicate

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in this specific case that the notion of what to do to create shareholder value
might have not been very well communicated. Furthermore, the theoretical part
discusses that delivering good results meaning high profits is not a guarantee
for value creation.

Building a brand name and communicating it very openly would be beneficial
and help the companies to create future shareholder value since the brand name
contributes to differentiating the companies’ products from those of its
competitors. We feel that shareholder value may be created if the brand name is
promoted since this may exercise some psychological power over the
customers who may then favour the companies’ products. This would also
provide some market power for the company. However, it should not be
forgotten by the companies that the brand names might in some cases not be
received well in other cultures; the company should consider that, when it
comes to cross culture transfer of the brand name.

To find out the needs of the customers and to watch what is happening in the
market were also to be done for future value creation. It seems like this may
require a constant commitment and could involve costs of conducting inquiries.
It may also ask for patience but if the companies are determined to satisfy
expectations of high profile customers and not to disappoint them in the future,
they would then reap the benefits of it. The companies may be underlining
those ways since knowing what customers need, as well as their purchasing
power, may be used to determine the ways their products should be made
available to generate a competitive advantage in the future. We also feel that by
watching what is happening in the market would not only create value for
shareholders but would contribute to the technological development and the
survival of the firm in the future.

Use of resources as efficiently as possible was mentioned also as a way to
create shareholder value in the future. The company was to continue working
with capital structure using the resources in economical ways. The company
was also to produce good quality and bigger volume at low cost. We feel that
this would also create more shareholder value in the future. This is because the
company may reap the benefits of achieving economies of scale since by

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producing more in an efficient way, the company may achieve lower costs as
well as higher profit. This would also add value to its reputation.

It should be noted that divestments and acquisitions are also thought by some
interviewees as creating value. This may be due to the business environment,
which presents many numerous opportunities for assets acquisitions and
divestments. Once the company identifies and evaluates these opportunities and
succeeds in managing them well, this may create future shareholder value.
Furthermore, once divestment and acquisitions manage to add value, it may
then have some contribution in developing the brand name, which in turn
would create shareholder value in the future.

When we examined closely the responses given to us under the future
shareholder value creation, we noticed that the majority of them were
marketing related efforts that were planned to be done in the future. This may
underline the importance that the marketing activities occupy for the future of
the companies and the creation of shareholder value. This may be a sign that
companies are very much concerned about the increasing greater variety of
competition and are striving to develop as well as to expand their marketing
activities.

5.1.6 Value-based management
Value-based management implies that the value creation is at the centre of all
the activities, every activity should create value and that value creation is the
basis for performance evaluation. The interviewees who were aware of the
rationale behind value based management agreed on this.

It should be noticed that even though all the interviewees agreed that creating
value was important for the companies, only 3 companies use value based
management. This seems to indicate that the majority of the companies in the
study did not welcome the value based management issues. The companies in
the study using value-based management were mostly manufacturing
companies. However, it should be stated that there was one manufacturing in
our sample that did not use this value-based management at all. In some of the
users of the value-based management all aspects of value-based management

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are implemented from the top level down to the employee and value creation is
a measure of performance in those companies. Therefore, this would contribute
more to shareholder value creation.

Other interviewees who were also aware of the value-based management had
some views on it. They stated that basing valuation on value creation would be
simply not fair since an employee can always do his job well and at the end, the
reported result may indicate that the value was not created and this would come
as discouragement to the employee who is working hard. To the above ideas,
we suppose that they may not be an excuse not to use the value based
management since when value creation is the measure of performance then the
employees may be more concerned about the value they create than when the
value creation is not a measure of performance. The other interviewees’ idea
was that every employee would not understand the value creation. We felt that
this view may not be practical since every employee may well be able to
identify which activities in his job can create value. This has to do with
knowing what they are doing and having more training within their careers and
it should be not forgotten that this training is included in the implementation of
value-based management.

For the value-based management to be successful, all individuals at all
functions should have the ability to fully understand the concept behind the
VBM and then be able to put it into practice. This may be the reason why some
of the interviewees did not favor the VBM on the basis that not all the
employees would be able to go through that process and succeed. It should be
noted that the value based management was not rejected as a whole, some of its
ideas were supported by the same interviewees who work in the companies that
do not use value based management. They feel that some elements of it can
also work well in their organization. The key finding from these ideas may be
that some companies still have yet to fully grasp the ideas behind the value
based management and learn how it can produce good results when applied
fully in the companies. We feel that it may not be practical for a company that
is said to create shareholder value to completely ignore this issue since Value
Based Management is part of the sources that increase considerably
shareholder value.

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Under the value based management all the activities that do not create value are
eliminated or sold. This means that the companies would not invest in any
activities that do not create value. All the interviewees in the companies that
use value based management agreed on this line of reasoning. However, this
may raise a line of questioning. That is because some of these companies using
value based management said that their focus is to create value for
shareholders, customers, and other stakeholders. However, Rappaport (1998)
made it clear that within the companies that are committed to balancing the
interests of every stakeholder, there may be overinvesting in the declining core
business even though that core business is not creating value for shareholders.
In this case, for other stakeholders, this would mean for example more jobs for
employees, suppliers would benefit, larger taxes to the local community. On
the basis of all that, we feel that it may be hard to eliminate all activities that do
not create value in those companies using value-based management and are at
the same time committed to balancing the interest of all stakeholders.
Therefore, in order to avoid this conflicting issue the companies using value
based management should focus on creating value for shareholders, then, the
value of other stakeholders would be created during that process.

5.2 Measuring shareholder value
5.2.1 Analysis of valuation methods
Interviewees mentioned several methods the companies use to measure
shareholder value. First, we noticed that most of the methods were the
“traditional/old methods”, which are highly criticized because of their
ineffectiveness in measuring shareholder value creation. They use for example
ROE, ROA, RONA, ROI, and EPS – in other words most of the traditional
measures. Here, we should mention that for the companies that use the same
measure, the general formulas are the same but the calculation details are
different from one company to another. It should be noted that most of the
interviewees mentioned ROE and research has shown that this measure has a
very low correlation with shareholder value creation.

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Concerning the companies that use only those traditional methods, we feel that
this would put into question whether these companies can really claim to
measure shareholder value creation. Moreover, in one case it looked like the
interviewee was presenting different measures they use for the group but it
seemed that it was not that easy to identify the exact method they use to know
whether shareholder value has been created.

We feel that these shortcomings of the traditional methods should have been
identified and dealt with especially nowadays whereby the companies are
claiming to create shareholder value. It is good that the companies are
presenting different ways they use to create shareholder value but it may be
unacceptable to see the low commitment in regard to the measuring of
shareholder value creation. Measures used should be more reliable to better
measure the value that the companies claim to create.

It is interesting to see that some companies in the study use the new methods
such as EVA, TVA, DCF as their main indicator of shareholder value creation.
Some of these companies also calculate using the traditional methods. This fact
that some interviewees mentioned that they use these measures may be seen as
a strong indicator that some companies are determined to present more reliable
results concerning shareholder value creation. This may be also seen as a
positive effort as far as shareholders are concerned. In some cases, the EVA
results are even published in the annual reports. Concerning EVA, its
popularity may be easily understood. This measure helps to see whether a
firm’s profit covers its cost of capital or not; and it can be useful for the
business units’ estimation. Stern Stewart (2000) suggests making nearly 164
adjustments. We however think that it may be quite a labor-demanding process,
and companies usually do very few of them or do not do any (as one of the
interviewees who use EVA stated). More about EVA is that this method is easy
to manipulate and it distinguishes itself from others in that it takes into
consideration the cost of the capital. This may be the reason why the
interviewees from the company using EVA mentioned that they could easily
identify some business units that do not cover their cost of capital, and then
these business units are usually divested. Bonus systems connected to EVA
may also be quite attractive since they value managers by result of their job.

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An interesting point to note is that EVA may be easy to calculate if one does
not consider the complicated adjustments. EVA deals with the past NOPAT,
which has been earned already. The DCF deals with the forecasted cash flow,
which is supposed to be earned in the future. Here, it can be mentioned that
forecasts may not turn out to be true. Furthermore, the forecast of the perpetual
cash flow may also have mistakes since it does not reflect the macro economic
situation, the market peaks and recession, the situation within industry the
company operates in. Probably, here the so-called sensitivity analysis could be
helpful. This means that the cash flow from the optimistic, pessimistic and
most realistic ways of the business development could be considered. Even
though these two valuation methods present various disadvantages, we feel that
EVA, DCF are good measures of shareholder value creation especially if we
compare them to the traditional methods.

Even though the companies in our study do not use the methods mentioned
below, we feel that a discussion of them may give a hint to why the companies
may not use them or why they should be good to use. Concerning TSR and
MVA, both of them depend on the market movements. This may mean that the
firm’s management should not be responsible for the events outside its control,
such as macroeconomic events, market recession etc. If we take for example
the situation during the past year, the stock prices of most of the companies
decreased. Therefore, if company had MVA as a measure of the shareholder
value creation and periodically reported the indicators of MVA, there could
have occured some consequences. The shareholders looking at the results
would have sold their shares, and the situation would worsen. Moreover, the
CEO would be replaced; despite the fact that he or she might pursue a right
strategy that creates the value. In order to improve the MVA, a CEO could try
to manipulate the book value of the company (depreciation in order to decrease
the assets etc).

Concerning TSR, the problems may arise with treadmill, it is hard to reach and
maintain the proper speed of the growth and beat the expectations.
Furthermore, nothing is known about the current situation of the firm profit, CF
etc when using this measure. Even though it can be argued that if the share

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prices go up, the company is doing well, it is necessary sometimes to consider
the financial situation, and other factors. Concerning the decision-making we
feel that TSR and MVA may not be very good methods to use since they do not
relate to the current situation of the company.

CVA—cash value added is the name of two different measures elaborated by
two different companies. The first method of CVA calculation, direct, seems to
be quite clear. It is possible to see whether the cash flow is enough to cover not
only the capital charge but also the implicit investments. This may indicate
whether the investments made could be used better somewhere else, or whether
it is worth taking the project. It seems as if there may be a number of problems
in using this method. At first, the complexity arises while trying to predict the
economic life of the project and WACC. Another problem may be the
complexity of calculation since it may be necessary to create special programs
– software – to make calculations using this method. However, this method
may present some strength since once the calculations are done the companies
may be certain in part concerning answers whether to take a project or to reject
it.

It is also interesting to see that this method not only answers the question
whether the value was created but also answers the question of “How much?”
CVA® of FWC AB goes further, and tries to predict which Operating Cash
Flow is necessary to get if a firm wants to add value, or at least, not to destroy
it. That amount is equal to the minimal amount of cash flow necessary to
collect. CVA index is also quite demonstrative since it is easy to see whether
the firm performed well or badly. Furthermore, CVA® considers the inflation
which other valuation methods do not take into account. Perhaps this may be
the reason why this method is thought to be accurate and useful for the
companies despite its complexity. This method may be good to use when the
company are considering making big, strategic investments.

CFROI of the Boston Consulting group as well as CFROI® of Holt Value
associates answer the question of whether the value was created but do not
answer how much. It is interesting that CFROI® of Holt Value is mostly
created for the prediction of the share price and used mostly by investment

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bankers, stock exchange brokers, fund managers and analysts but not too much
by companies. We realize so far that this method has not become so popular.
Maybe, the companies may not win too much benefit from the implementation
of this method since it does not provide the information about the situation in
the company that the managers may use.

One interviewee mentioned that where he worked when they tried to use the
new methods, the result indicated that the company incurred losses and that
those methods were not working well in the companies consequently they
suspended the use of them. On this particular issue, we feel that it is really
difficult to know whether the root reason for this impact was the use of the new
measure or whether the company was doing actually badly at that time.
However, on the basis of the idea that the new methods are better in the
comparison to the old ones, the results shown by the new measures should be
more trustworthy than the result shown by the old ones. Therefore, we feel that
it would be good for the company to maintain the new measures.

The problem for most of these new measures which may be the cause that the
companies are not choosing them is that they are not easily understood by the
non-financial people: line managers etc, as well as for shareholders with non-
financial education.

The question is to know whether the companies still using only traditional
measures will also make efforts to change to new measures. Concerning this
issue some of the companies revealed that for their own curiosity, they use
these new measure only on the management level to see how far they are
performing but this is not communicated to the lower levels. Furthermore, they
made it clear that the group as whole use the traditional methods. This seems to
indicate that they indeed consider the new measures to be more effective than
the older ones. We may expect also that maybe step-by-step these new methods
could be used as group ‘s methods for measuring shareholder value creation.

It is interesting however that some of the interviewees said that they do not
exclude the possibility to turn to the more accurate measures such as DCF etc.
Maybe in future MVA, CVA of BCG, CVA® of FWC AB, DCF would also

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attract attention. As for CFROI they don’t show the real value creation, they
just answer the question whether the value was created or not. It seems like
time is needed for these companies to successfully implement new measures.
We feel that this issue should be more reflected in business press, and the new
indicators should be shown in the same line with ROE, ROI, EPS.

It is important to point out that the importance of combining financial and non-
financial measures that are published should not be ignored under this issue.
We feel that in the process of improving the shareholder value creation
measurement, the non-financial measures should be as well integrated step by
step. This would give much more reliable results. Moreover, this may increase
the confidence that shareholders have in the companies.

5.2.2 Reasons behind the chosen methods
A variety of reasons why the companies chose methods they use were given to
us. One of the reasons that were mentioned by many interviewees who are still
using traditional methods was that they are easy to calculate and to
communicate to low levels in the organization. Even though it is true that those
methods are easy to use, we felt that it should not have been the reason not to
use the new methods, which would be more appropriate especially when
companies claim to create shareholder value.

According to one interviewee profitability was also another important reason
since it is directly connected to the shareholder value creation. Therefore, the
company is using the methods that indicate most profitability. This argument
however comes as a contradiction to the idea of Knight (1997) who stated that
the level of profitability has nothing to do with value creation and when it
comes to creating value for shareholders, companies that are very profitable
have no advantage over companies that are less profitable. This is also
supported by Clarke (2000) who proposed that it is important that a company
adhering to shareholder value principles concentrates on cash flow rather than
profits. We therefore feel that even though it is good to have good profit, and
that the profitability is considered to be one of the value drivers, it should not
be used as an indicator since it may not be a good indicator of the shareholder
value creation.

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From the information we got, conservatism may be a reason why old measures
are preferred. Some interviewees indicated that their companies are in a
conservative business, which is not easily changed. The traditional measures
were used for a long-time. Even though these are facts they should not be used
as reasons to choose the measures that are no longer beneficial or accurate.

5.2.3 The benefits of measuring shareholder value creation
Measuring shareholder value presents a variety of benefits and the company
does reap those advantages. All the interviewees agreed with this statement.
One of the benefits mentioned was that this could raise the price of shares.
However, it may be questionable whether the companies that use only the
accounting measures to measure shareholder value creation are gaining this
benefit. It was shown already that the ROE or RONA or other accounting
returns do not reflect the real situation and even may be misleading. Therefore,
the price of shares may not be raised because of the fact that the companies
measure shareholder value creation while they are using methods that are less
trustworthy. In case, however, the company uses the new valuation methods to
measure shareholder value creation, it may reap that advantage even though
these new valuation methods are not 100% accurate.

To measure shareholder value creation helps the company to make the right
decisions about investment or divestments and it helps to see whether to take or
to reject the project. These were answers from the companies that implemented
EVA and DCF. This may be practical since the results of these measures can
contribute to the taking of right decisions. Even if it cannot be underestimated
that minor errors may occur in the project’s life forecasting or the cost of the
capital estimation, DCF is more reliable since it considers the cost of the capital
and EVA is reliable as well given that it considers the future situation such as
cash flow and risk. Concerning this advantage of measuring shareholder value
creation, if the traditional accounting methods for example ROA or ROE are
the basis for taking decisions good projects may be rejected, or the bad
projects, which destroy value, may get approval. Therefore, the above-
mentioned advantage may not profit the companies that still use the traditional
measures.

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5.2.4 Development of the measures that the companies use
All the companies in our study did not develop the valuation methods they use
internally; this may be due to the cost and time issues. The elaboration of the
new method of the performance measurement takes years and usually takes
place in the consulting companies. Other companies simply cannot elaborate
the measures themselves because it seems costly to them. Moreover, it may
take a very long time to fully integrate the new metrics internally in the
companies.

The new metrics are usually developed when there is a necessity, i.e. when the
company sees that the old management system does not work. Concerning the
companies in the sample this need is not present.

Even though the companies in the study did not develop any measure
internally, it is quite interesting that they do make their definitions of different
components of the measures within the companies. This would seem to indicate
that there is at least a certain degree of relating the measure to the companies’
specific conditions.

5.2.5 Advantages and shortcomings of the chosen measures
When discussing the accounting measures, some of the interviewees did not
want to point out the weaknesses of the traditional measures. This may seem to
indicate that they are still supporting them given that they were mentioning
mostly their advantages such as they are easy to use. Most of them were
concerned about the weakness of the new measures and they said these new
valuation methods are complex and are not easily understood by non-financial
people. Perhaps, this may be an indication that they have not welcomed yet the
ideas behind the new measures. However, one interviewee mentioned that the
traditional measures – the Du-Pont model in this case – does not relate to the
real value. This may suggest that there is at least some progress within the
company to consider the problems associated with accounting measures.
Concerning the advantages of the traditional measures, some interviewees
mentioned also that they help to create goals. This may be a very doubtful

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advantage since relying on the traditional measures might lead to wrong
decisions.

The disadvantage of the economic measures – EVA in this case – is if all
adjustments are not made, then, this measure may not be accurate. If one
considers this closely it may be very difficult to make all the necessary
adjustments. Concerning the advantage of EVA, it is mentioned that EVA is a
good tool for the management, and it helps to make decisions concerning the
different business units. It is interesting that the important factor here is the
simplicity of EVA, and we feel that this may facilitate the process. According
to one interviewee DCF does not have any disadvantages. However, we feel
that even though this is a very good indicator of shareholder value creation it
does as well present some weaknesses. Concerning the view that it helps to see
whether the company makes the right investment or not, we realize that this
opinion about DCF seems to be in line with the opinion mentioned in the
theoretical part.

5.2.6 Test of the validity of the chosen measures
All interviewees agreed that their companies do test the validity of the
indicators. We feel that this is a positive action since if done well it would keep
the actions of the companies up to date. However, what is questionable is that
the companies that use the traditional accounting measures that are known to be
ineffective are the same companies that agreed that they do test the validity of
the measures. They still use these traditional accounting measures because of
conservatism. Furthermore, some interviewees mentioned that the stock market
and most of influential shareholders still judge the companies using the old
methods. In regard to this issue the stock market and influential shareholders
put no pressure on the companies. The interviewees then argued that this
pushes them not to change to the new measure. Here, we feel that the necessity
of pressure for change would be effective.

The complexity of the new measures plays also some role. Almost all the
interviewees mentioned that they can (and do) understand EVA etc but they
cannot go to the floor manager and say to him that his department has to cover
the cost of capital since all the employees would not understand that term. We

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however feel that all these thoughts should not be a barrier to the company that
plans to present more reliable results. In addition to this the companies in the
study that have adopted the new measures seem not to have a problem with the
stock market, the shareholders or employees.

It is interesting to notice that even though some companies do not calculate or
use new measures, some consulting companies do it for them. Then we feel that
this might create unpleasant surprises for companies. For example, Stern
Stewart & Co. calculated EVA for almost all famous and big Swedish
companies. Some of the companies are included in this study. Even though it is
unknown how it calculated WACC, other components are easily obtainable
from the annual reports. The results it published seem to show that EVA’s
indicators were not always good for those companies in this study that do not
calculate it. We therefore feel that it would be better for the companies to use
the new measure since their results would be comparable to those of the
consulting companies and this would give more confidence to the shareholders.

5.3 A comparison between the empirical findings and
theoretical framework
In this study the theoretical part gives recommendations on how to create and
measure shareholder value while the empirical findings constitute what is
actually being done by the companies in regard to creating and measuring
shareholder value. Even though the analysis part picks up some of the
relationship between the theoretical part and the empirical part, we are bringing
up some of the key comparisons in this section since this would help to know
whether what is being done in practice has any connection with various
recommendations from the theoretical part.

When we consider the different ways to create shareholder value that the
companies use, they correspond with different ways recommended in the
theoretical part. However some minor differences can be identified. Theoretical
part proposes that in order to maximize shareholder value, no value creating
activities should be eliminated but this is not the case in some companies.

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The literature proposes that it is important to identify first the value drivers of a
company since they are at the root of the value creation. Then, those value
drivers would be based on making a choice of, which methods would maximize
shareholder value. However, some of the companies did not follow this
recommendation since they did not identify first the value drivers in their
corporation and then base their choice of the ways on them.

Shareholder value model proposes that having the shareholder value creation,
as the key corporate objective would be a very important step in the value
creation. One company uses this model and the rational behind this model
corresponds with what was being done in this company. However, the
shareholder model did not correspond with what was being done in many other
companies that have ignored this issue. Moreover, the theoretical part proposes
that there is actually no conflict between shareholders and other stakeholders in
the shareholder value creation model but this view is not shared by many of the
companies in the study. They still admit that the conflict does exist between
shareholders and other stakeholders; as a result they still follow the rationale
behind the stakeholder model.

When it comes to creating shareholder value in the long run, the theoretical part
recommends that shareholders expect much more in the future. Operating
returns may have improved as a result of the ways in place and investors give
credit for that by increasing the value of the company and yet they still want to
know what is going to be done to create more value in the future. Furthermore,
according to the theoretical part, future shareholder value creation is also
important. However, some companies seem to take it lightly and seldom inform
the shareholders what they are going to do in the future, to create more value.
Here, it is important to notice that some companies have followed this
recommendation very well and do much in this area.

Concerning value based management the literature proposes that it involves
developing a systematic approach to creating shareholder value. It has to do
with managing for value and it creates value that generates competitive
advantage for the company. This allows the company to create more value for
investors. Managing for value has been adopted by 3 companies out of 7 in the

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study. These companies that have adopted it, most of what they do in their
companies corresponds to the rationale behind value based management except
for a minor difference noticed in two companies. These two companies direct
the value creation to all stakeholders instead of indicating that it is directed to
shareholders. In the other companies that did not apply value-based
management what they do and their different views as well, are very far from
the rationale behind the value-based management.

Concerning measuring shareholder value the theoretical part discusses the
traditional method and shows their shortcoming and discourages their use. It
proposes to use the new methods, which are much more reliable. However,
most of the companies do still use the traditional methods and only very few
have started to use the new recommended methods.

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Chapter 6 − Conclusions and Reflections

6 Conclusion and Reflections
This chapter provides insights and concluding remarks on creating and
measuring shareholder value in selected companies by taking a closer look at
the analysis of theoretical framework and empirical study. It also presents some
possible recommendations. Finally, the chapter gives suggestions for future
research.

Shareholder value creation has gained much attention in many companies
situated across the globe. This has preoccupied the manager in relation to
choosing the strategies. The measuring of shareholder value creation has also
been considered and increasing critics of traditional accounting measures have
been published. Consulting firms are increasingly creating new metrics; and
there is a flood of the new measures thought to be measuring shareholder value
creation in a better way when compared to the old traditional measures.

The empirical study shows that the companies are aware of shareholder value
creation and the importance it has on their companies’ process of decision-
making and to the whole activities that the companies run. Companies
identified different related issues to shareholder value creation. The empirical
data focused on the measuring of shareholder value creation and the companies
identified a number of different measures and other related issues to measure
shareholder value creation.

On the basis of the empirical findings, we were able to answer the research
question by setting first the background information on shareholder value
creation. We were able to generally give companies information on creating
shareholder value. The shareholder value is created through many different
ways and we found out that companies do use a combination of many ways that
are applied differently from one company to another. The choice of using those
ways also varies from company to company even in the case where the same
way was chosen. It turned out to be that the reasons behind the choice made
were not necessarily the value drivers of the company. This seemed to depend
on the nature of decision-making that was different in companies.

105


Future value creation is being considered in some companies. It was interesting
to find out that most of the actions the companies were planning to take for
shareholder value creation were mostly marketing related issues. This seemed
to underline the importance of marketing activities in the companies and in the
future shareholder value creation.

In general companies in our study have not welcomed the ideas of having
shareholder value creation as their key corporate objective. They prefer to have
it as an internal management goal. This may be due to the fact that they believe
that there is conflict between shareholders and other stakeholders.

Value based management has mostly been welcomed by some manufacturing
companies in the study but it is not yet popular in other companies. The reasons
behind not using it, may be that basing performance evaluation on value
creation would not be fair to the employees and that value based management
is too complicated to be understood by every employee.

After setting the above background we were then able to answer the research
question on how the companies measure shareholder value creation. The survey
of companies we made showed that most of the companies do not measure
shareholder value creation in the appropriate way. We mean that most of the
companies use the accounting measures, which are criticised for not reflecting
the real value creation since they do not consider the cost of the capital, risk,
and are distorted with the accounting rules. Thus, they do not reflect the
shareholder value creation.

The reasons for still using these traditional measures are mostly conservatism;
lack of pressure from stock market, main shareholders and that everybody in
the company cannot easily understand them. Some of the companies made
steps forward by starting using the new methods to measure shareholder value
creation but, it will take quite a long time for most of the companies to shift to
the new metrics.

The shortcomings of the old accounting measures used in the companies were
not necessarily identified instead it seems that they were ignored. However, the

106

Chapter 6 − Conclusions and Reflections

advantages of those old measures are the ones that are considered. We found
out that the advantages that the new measures present, are not that much
considered, as they should be. The fact that they are complex seems to cover
their advantages.

It was also interesting to find out that companies recognized that they could
reap some benefits from measuring shareholder value creation, such as it that
can raise the price of their share; it can help in their management decision.
However, we believe that the company using the traditional measures may not
benefit from that since those measure are not reliable.

Concerning developing measures for shareholder value creation, companies are
not doing that, they are using the measures that are already established. This
may be due to the cost and time it involves. However, companies do make their
own definitions of the terms, which would be seen as trying to adapt to the
situations in the companies.

Having identified all that is discussed above, we would like to recommend to
companies not using value based management to start considering it since they
may create more value for shareholder value if they properly implement the
value based management issues.

We also feel that shareholder value creation should be the key corporate
objective for the companies claiming to create shareholder value because by
doing that, real commitment to that issue would be fully reached. The
stakeholder model would be replaced by the shareholder model since the
company or other stakeholder would not lose anything since the value of
shareholders cannot be created when other stakeholder are not satisfied and this
was the case in one company. However, on the other hand, the value of the
shareholder may be lost from using the stakeholder model.

We would therefore recommend the companies still using the old measures to
consider the following measures: EVA, CVA® of FWC AB, CVA of the
Boston consulting group, DCF, Q ratios. Even though there are no ideal
measures since every measure has its own shortcomings, we believe that these

107


above-mentioned measures are far better when compared to the traditional
ones. The companies are to choose among them following what they intend to
discover because some of these measures show only whether the company
created value, others show how much value was created or destroyed and other
metrics depend mostly on the company’s management. We also feel that the
companies should not ignore changing to the new measures since the
consulting companies are increasingly making calculations using those new
measures and publishing the results of different companies; even though these
companies may not be using those new metrics.

Suggestions for future research.
Creating and measuring shareholder value is a broad subject, we covered only
one perspective of the shareholder value creation and measurement. To conduct
our research we mainly looked at this problem from the companies’
perspective, it would be therefore interesting to look at this issue using an
expanded perspective such as shareholder, analyst, stock market and consulting
companies’ perspectives. It would be also interesting to make a deeper study on
how companies create shareholder value. Finally, making a comparative study
would be interesting since it would highlight the differences that exist between
companies that we did not cover in this study.

108

Chapter 7 − Reference

Reference
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Föreningssparbanken, www.foreningssparbanken.com, 2001-11-01

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114

Chapter 7 − Appendix

Appendix 1.
Interviewees.
Carl-Henrik Lindgren, Electrolux, chief accountant of Electrolux group,
Stockholm, personal interview.

Fredrik Hjelm, Group Controller and Bo Gustavsson, Head of Business
Control, Volvo group, Gothenburg, personal interview.

Hans Bertelius, Group Controller, Bilia AB, Gothenburg, personal interview.

Johan Karlsson, ABB, employee of the Value Services department, Stockholm,
interview by phone.

Lotta Treshow, SEB, Senior Vice President - Head of Investor Relations -
Group Treasury, Stockholm, personal interview.

Marita Björk, SKF, the chief of the investor relations department, Gothenburg,
interview by phone.

Staffan Salén, Chief for Investor Relation- Director of Information,
Föreningssparbanken, Stockholm, personal interview.

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Appendix 2
The interview questions
As an introduction we asked the interviewees to give a brief introduction to
their background information on the person we were interviewing such as
education, experience, the current position and task in the company.

Questions on creating shareholder value

1. Given that nowadays companies are creating shareholder value through
different strategies for example they sell and buy business, they
restructure themselves etc. Which methods or strategies do you use to
create shareholder value?

2. What are the possible reasons for choosing these particular strategies?

3. How successful are those ways or strategies to create shareholder value?

4. Is shareholder value creation an explicitly communicated key corporate
objective?

5. What can the company do to increase shareholder value in the long run
perspective?

6. Does the company apply the value-based management?

Questions on valuation method or on measuring process

1. On the corporate level how do you measure the shareholder value
creation; in other words which method or ways do you use to be able to
know whether the value had been created?

2. What are reasons behind choosing these particular measures?

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3. How will the company benefit from measuring shareholder value?

4. Did you develop this method internally in the companies?

5. What are your views about the strengths and weaknesses of this
performance measure you use to evaluate the creation of the shareholder
value?

6. Does the system regularly test the validity of the chosen performance
indicators as predictors of future financial performance and adjust the
indicators as necessary?

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Appendix 3.

A3.1 The calculation of TSR.
There are different steps that were suggested by the Value Based Management
Resource center (www.valuebasedmanagement.com):
• Begin with the one share of stock at the beginning of the period.
• Determine the number of additional shares that can be purchased this
month with the dividends and the cash equivalents distribution earned
each month.
• Add this amount of the share purchased to the to current share added.
• Multiply the number of shares owned by beginning month’s stock price
to get the “compound value” of stock.
• Total return equals the growth in stock price plus the effect of reinvested
dividends over the period being measured.

The formula of this measure is the following
Price gain + dividend
TSR =
Price at beginning of the period

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Table № 1. The TSR calculation.
Dec- Jan-94 Feb-94 Mar- Apr- May- June-
93 94 94 94 94
Beginning share 1.00 1.00 1.00 1.00 1.00 1.00 1.00
owned (a)
Dividend (b) 0.00 0.00 1.00 0.00 0.00 1.00
Cash equivalent 0 0 0 0 0 0
Distribut. (x)
Share price (c) 22.50 22.73 22.95 23.18 23.41 23.65 23.88
Additional share 0 0 0.043 0 0 0.044
purchased (d=
a*(b+x)/c)
Adjusted share 1.0 1.0 1.043 1.043 1.043 1.087
owned e=a+d
Compound value 22.50 22.73 22.95 24.18 24.42 24.67 25.95
(c*e)
TSR (monthly) 1% 1.0% 5.4% 1.0% 1.0% 5.2%
Source: http://www.valubasedmanagement.com/

A3.2 The calculation of the EVA components

EVA = NOPAT – C% (TC)
Where NOPAT is net operating profit after taxes, C% is the percentage of cost
of capital; and TC is total capital. (Ehrbar, 1998)

Table№ 2. The example of EVA calculation.
MSEK 1994 1995 1996 1997(budget)
Sales 234 258 305 420
Operating expenses - 200 -205 -243 -285
Tax 0 -3 -10 -28
--------------------------------------------------------------------------------------------------------
Operating profit 34 50 52 107
Financial requirement -45 -50 -60 -62
Source: Weissenrieder F., 1998

The financial requirements are calculated as the defined capital (adjusted the
balance sheet) multiplied with a suitable WACC:

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Table №3. The financial requirement calculation:
MSEK 1994 1995 1996 1997(budget)
Capital 375 417 500 520
WACC 12% 12% 12% 12%
---------------------------------------------------------------------------------------------------
Financial Requirement 45 50 60 62
Source: Weissenrieder F., 1998

A3.3 The calculation of CVA®

The calculation of OCFD has three steps:
• Identification of the initial outlay for each strategic investment still in use
in a strategic business unit.
• Estimation of each strategic investment’s economic life.
• Finding the amount of the nominal cash flow which each strategic
investment is to produce every period in order to give that strategic
investment a NPV of zero in a nominal calculation.

The table beneath shows the CVA® model in its basic form with one strategic
investment. The amount of strategic investment is $100 m. This strategic
investment can be R&D investment or an investment in advertising and
promotion brand. It is strategic decision by itself and what the investment
meant to do (create or maintain the value) that determines if it should be
considered to be a strategic investment. The initial investment in working
capital could be considered as a part of the strategic investments. The economic
life is estimated to be 11 years. The historic inflation is 3% and the same
inflation rate is assumed for the future. The pre-tax cost of capital (WACC) is
15%. The strategic investment has in this case been running for 7 years of those
11 years.

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Table №4. The CVA calculation.
M$ 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Sales 160 170 250 185 200 215 200
Costs -150 -155 - 220 -160 -170 -180 -155
Operating 10 15 30 25 30 35 45
surplus
WCM 0 -1 -6 5 -1 -1 1
Non-strat.
invest. –1 -3 -1 -3 -12 -4 -3
OCF 9 11 23 27 17 30 43
OCFD 17 18 18 19 19 20 20
CVA -8 -7 -5 8 -2 10 23
CVA index 0,53 0,64 1,29 1,42 0,88 1,51 2,11
Strat. inv. –100
Cash Flow 9 11 23 27 17 30 43
Source: Erik Ottosson, Fredrik Weissentireder, “Cash Value Added – a new
method for measuring financial performance”, 1996

Since the OCFD should be adjusted on inflation, the formula of the adjustment
is following:
Investment amount
OCFDyear1 =
(1+inflation)ⁿ
1 (r – inflation)
r-inflation (1+r)ⁿ
The total OCFD for a company equals the sum of the OCFDs on each
investment for any period in the past, present and future.

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When we know how all other components are known we can show the whole
CVA model (Weissenrieder, 1997).
Sales
- Costs_________________
= Operating surplus
+/- Working Capital Movement
- Non- strategic investments
= Operating Cash flow
- Operating cash flow demand
= Cash Value Added

NPV (Investments) = PV (OCF1..n) – Investments= PV (OCF1…n)- PV
(OCFD 1…n) = (OCF1-OCFD1) / (1+r) +….+ (OCFn – OCFDn) / (1+r)ⁿ

If the company wants to add value to its stockholders the NPV of CVA should
be positive.

Another dimension of CVA model is the CVA index. It is calculated as

PV (OCF1…n)
CVA (index) =
PV (OCFD1…n)

A CVA index above 1 indicates that the strategic investment produces
sufficient OCF. The CVA index can be split also into four value drivers (in
realtion to sales):
• The operating surplus margin
• The working capital movements
• The non-strategic investment margin and
• The OCFD margin.

A3.4 The calculation of CVA of the BCG.
There are two ways to calculate the CVA of BCG: direct and indirect. Direct
calculation:

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CVA= gross cash flow -economic depreciation-capital charge.
Indirect calculation:
CVA= (CFROI-cost of capital) x gross investment.
The components of the formulas are following:
Gross cash flow – economic depreciation
CFROI =
Gross investment
This CFROI-indicator shouldn’t be confused with CFROI® of Holt Value
Associates which will be explained later.
Economic depreciation is an amount, which has to be put aside annually to
finance future replacement investments. It is calculated using the following
formula:
Economic Depreciation = WACC / (1+WACC)ⁿ x Depreciable assets
Gross cash flow = adjusted profit+ interest expense+ depreciation
Gross investments = Net current assets+ historical initial cost (possibly adjusted
for inflation)

Example (BCG: New perspectives on the value creation): We have the
following data for the CVA calculation:

Gross cash flow 150
Economic depreciation 50
CFROI 10
Gross investments 1,000
Cost of capital 10%
Capital charge 100
Non depreciable assets 200
Asset life 10 years

Economic depreciation = 10% / ((1+10%)-1) x (1,000-200)= 50
CFROI= (150-50) /1,000 = 10%

The CVA (direct method) = 150-50-100=0
The CVA (indirect method) = (10%-10%)x 1,000=0

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A3.5 The calculation of the DCF.
There are several steps in DCF calculation:
• Reorganizing the accounting statements in order to get a greater
analytical insight and calculating FCF;
• Estimation of the cost of the capital;
• Forecasting performance;
• Forecasting the continuing value.

FCF = NOPLAT - net investments =
(NOPLAT + depreciation)-(Net investments + Depreciation)=
Gross cash flow - Gross investment

The next step of the DCF calculation is the estimation of the continuing value
but for this it is necessary to forecast the future performance of the company.
When it is done and the NOPLAT is known we can estimate the continuing
value. There are several formulas of the continuing value estimation but the
simple one is the
Continuing value = (FCFT+1) / WACC-g , where
FCFT+1 is the normalized level of FCF in the first year after the explicit
forecast period; g is the expected growth rate in NOPLAT in perpetuity.

Table №5. Cash projection for period of 5 years.

Year 1 2 3 4 5
NOPLAT 100 106 112 120 126
Net investment 50 53 56 60 63
Free cash flow 50 53 56 60 63
Sources: Copeland et al (2000), p.271

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When WACC is 11% and the growth rate for NOPLAT and FCF each period is
6% then if we are going to forecast for example, for 150 years we will get the
following result:
CV= 50/1,11 + 53/ 1,11 2 + 56/ 1,11 3 +…+50(1,06)/ 1,11ⁿ = 1000
Or if we use the growing free cash-flow perpetuity formula:
CV= 50 / (11% - 6%) = 1000
The explicit forecast period should be long enough so that business will have
reached the steady state of operations by the end of the period.

A3.6 The calculation of CFROI® of Holt Value Associates.
The calculation of the CFROI® is the following. Holt calculates the CFROI®
in two steps (Holt Value Associates®) At first, Holt measures the inflation –
adjusted gross cash flow available to all capital owners and compares that to
the inflation adjusted (current monetary unit) gross investment made by those
capital owners. In other words; gross cash flow is equal to Net Cash Receipts –
this term is used in the book of B. Madden about CFROI (Madden, 1999).

NCR=net income + depreciation expense+ interest payment-outflows=
=Gross CF

125


Step ONE: From Accounting to cash
Net income (Before extraordinary terms)
+/-Special Items (after tax)
+ Depreciation expenses
+ R&D expense £10
+Interest expense
+Minority interest Cash in
+Rental expense
+/-Holding gains (losses) Inflation Adjusted
Net income - FIFO profits Gross Cash Flow
= 10%
Book assets Inflation adjusted
Book assets + accumulated depreciation Gross Investment
+Inflation adjustments Cash flow
+Operating assets
+Capitalized R&D £100
+Goodwill
-Non-debt monetary Liabilities

Next, Holt converts the ratio of gross cash flow to gross investment into an
Internal Rate of Return (IRR) by recognizing the finite economic life of
depreciating assets and the residual value of non-depreciating assets such as
land and working capital. The process is identical to calculating the yield to
maturity of the bond. As a percent per year internal rate of return, the CFROI is
directly comparable to the shareholder return investors expect to receive, i.e.,
their cost of capital or discount rate.
Step two: From Cash Flow to economic return (IRR)
CFROI = 6%
$25 Non-depreciating assets
Inflation adjusted
Gross Cash Flow
$10

13 years Asset Life
$100
Inflation adjusted
Gross Investment

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A3.7 The VROI and Q ratios calculation.
The formula of VROI calculation is the following:
VROI=(Post-strategy value – pre-strategy value)/ Present value of projected
investment

Table №6. Example of VROI and Q ratios.
At Wacc of 15% year 0 year1 year 2 year 3 year4 year5 year6
Profit after tax (PAT) 16
Assets employed (nominal) 80
Cash flow 12 14 12 14 16 12
Discount factor 0.9 0.8 0.7 0.6 0.5 0.4
Present value 10.4 10.6 7.9 8.0 8.0 5.1
Present value (perpetuity method) 200.0
Present value of residual 84.6
Present value of cash flows 50.0
Total PV (post-strategy) 134.6
Assets employed inflation adjusted
(3% inflation assumed) 95.5
VROI calculation
Net investment 5.0 8.0 6.0 7.0 8.0 4.0
Discount factor 0.9 0.8 0.7 0.6 0.5 0.4
Present value 4.4 6.0 3.9 4.0 4.0 1.7
Total present value 24.0
Total PV (post-strategy) 134.6
Pre-Strategy value =year 0
(PAT/WACC) 106.7
Value increase post-pre-strategy 27.9
VROI=Value increase/PV investment 1.2
Q ratio= Total PV post-strategy/assets
(Inflation adj.) 1.409
Source: Black, 1999

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Creating and measuring shareholders value

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