Objective of the research
- 1. Objective of the Research The study also aims to give a general picture of how shareholder value is created as a background to measuring shareholder value. Direct factors includes 1. Capital budgeting (dividend policy, capital structure, weighted average cost of capital, required rate of return); 2. Corporate governance (agency theory); 3. Market environment (industry regulations); 4. Business ethics and corporate social responsibility (accountability, earnings quality, stakeholder theory); 5. Shareholder’s return measurement (TSR, EVA, Cash return on investment); 6. Innovations as return driver (R&D investments, intangibles) Many indirect factors can affect shareholder value such as the environment surrounding the firm, weaker business climate, political situation, and currency fluctuations. Which are seldom studied in previous work. Research problems: 1)what happens to product/service outcomes and/or profit and/or the environment when shareholder value becomes the primary corporate goal? How much cash should firms give back to their shareholders ? should corporations pay their sharholders through dividends or by repurchasing their shares, which is the least costly form of payout from tax perspective? Which of the financial characteristics of a firm its management should concentrate on, when maximizing the wealth of the shareholders?? Who benefits from corporate commitment to shareholders? Impact of the dividend policy on shareholders value? The effect of acquisitions and offshoring on the sharholder value? How should sharholder value be measured?
- 2. Research methodology: Secondary research—authoritative sources---sebi,bse,nse,cmie and ministry of statistics, project management offices,Indian industrial groth---specific companies Most people today would say corporations have but one proper purpose: maximizing their shareholders’ wealth as measured by stock price. Other goals--serving customers, building great products, providing good jobs—are viewed as legitimate business ends only to the extent they increase “shareholder value.” Indeed, there is good reason to suspect that focusing on “shareholder value” may in fact be a mistake for most business firms. This is because there is no single shareholder value—different shareholders have different needs and interests depending on their investing time frame, degrees of diversification and interests in other assets, and perspectives on corporate ethics and social responsibility. Shareholder value ideology focuses on the interests of only a narrow subgroup of shareholders, those who are most short-sighted, opportunistic, willing to impose external costs, and indifferent to ethics and others’ welfare. As a result shareholder value thinking can lead managers to focus myopically on short-term earnings reports at the expense of long-term performance; discourage investment and innovation; harm employees, customers, and communities; and lure companies into reckless and socially irresponsible behaviors. This ultimately harms most shareholders themselves—along with employees, customers, and communities. 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. 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
- 3. 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). Creating and measuring shareholder value by Beatrice Nyiramahoro and Natalia Shooshina 2 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 wrongheaded 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
- 4. 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 Chapter 1 − Introduction 3 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. 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. Why is creating shareholder value suddenly becoming a credo in corporate boardrooms? There are many reasons for this renewed emphasis on measuring and managing shareholder value, prominent among which are the following: l Capital markets are becoming increasingly global. Investors can readily shift investments
- 5. to higher yielding, often foreign, opportunities. l Corporate governance is shifting, with owners now demanding accountability from corporate executives. Manifestations of the increased assertiveness of shareholders include the necessity for executives to justify their compensation levels, and well-publicized lists of underperforming companies and overpaid executives. l Executives are concerned with self-preservation. Well-publicized hostile takeovers have served notice to all levels of management that weak financial performance is unacceptable and may precipitate a fight for corporate control. This potential loss of control has motivated many executives to better understand the importance of measuring and managing shareholder expectations. There is also considerable dissatisfaction with existing accounting-based earnings and return measures. Evidence is mounting that accounting measures such as earnings per share (EPS) and profit or growth in earnings do not take into account the cost of the investment required to run the business. Similarly, return-based measures, such as return on assets, often motivate managers to make short-term dysfunctional decisions that encourage underinvestment. Furthermore, neither earnings nor return measures appear to correlate well with actual market values of companies. II. SCOPE This Statement compares and contrasts various measures that claim to quantify management’s shareholder-value-creation abilities and describes the issues and challenges faced in order to implement an operating paradigm resulting from these measures—value-based management (hereafter referred to as VBM1). This Statement applies to all firms, private and public, large and small, whose managers are interested in creating value for their shareholders/ owners. It will help management accountants and others to: l understand the fundamental concepts of shareholder-value creation; l link value creation to shareholder-wealth maximization; l unravel financial and operational drivers that can lead to improved performance and thereby improve shareholder-value creation; l understand the differences among a variety of measures that assess management performance within the context of shareholder-value creation and wealth maximization; l appreciate the organizational and management accounting challenges in implementing VBM to
- 6. improve shareholder-value creation; and l broaden shareholder and management awareness of the importance of shareholder-value creation. Value based Methods 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