Jack Welch, former chairman of General Electric, once said, “Managing an organization for both the short term and the long term is very difficult to do. Very few companies are able to do it.” Govinderajan argues that long run criteria contribute to organizational effectiveness rather than short term criteria whereas Rappaport suggests that shareholder value analysis addresses both and maximises both. There is, nevertheless, a considerable body of evidence which suggests otherwise and that a concern with shareholder value added and returns to shareholders leads to a short term focus and lack of regard for the longer term. Indeed some managerial actions taken to boost short term valuations, such as downsizing and outsourcing can be argued to actually reduce long term value.
Market Value Added (MVA), can be a useful tool in the hands of management. It is calculated as the market value of the firm less the total capital that has been invested in the firm. Whereas many traditional metrics are single period measures of performance (e.g., accounting earnings, return on investment), MVA represents a long-term performance measure. Second, whereas many performance metrics are backward looking, reporting what has been done, MVA incorporates a forward-looking market measure. MVA can also be shown to equal the present value of all future economic value added (EVA) and therefore represents a measure consistent with VBM.
Most of the firms are facing issues of rapidly changing markets, globalisation, hyper-competition, rising customer competition and implications of the information revolution. With the economic downturn staring them in the face, companies are looking at reducing costs, and trying to increase their turnover by taking tactical decisions that do not create value for shareholders. They are becoming obsessed with short-term performance measures and are ending up retrenching people rather than renewing and training them for a time when the opportunity arises. Though choices for a company could be maximising shareholders or maximising profitability, the strategies could be very different. As for maximising profitability, the strategy would be generally short-term, looking into cost-cutting to produce quick improvements which would give results in the short run but have an impact on the company's long-term competitiveness whereas for shareholder value growth, the focus would be on newer growth opportunities and building competitive advantages. Short-term strategies generally have a negative impact on creation of economic value. Companies’ strategy , when run by finance, it risks becoming part of the budget cycle, and therefore overly focused on costs and short-term earnings.
How far might strategy’s concern with long-term as well as short-term success be met by a complementary focus on stakeholder value?
Typically, shareholders are considered to be only one of a number of important constituencies or "stakeholders" competing for a preference in management's evaluation of key decisions. These stakeholders are usually specified to include customers, employees, suppliers (including creditors), and the wider community. A question that arises is if these two values should be viewed as substitutes or as complements?
Value Based Management, in its most basic form, provides a single objective function for management; maximize Market Value Added (MVA). While many other measures such as market share, employee satisfaction, and product quality may be important to the firm’s long-run success, these other measures can simply be viewed as value drivers toward this single-valued objective function.
On the other hand, A.G. Puxty states that: “companies are no longer the instruments of shareholders alone but exist within society and so therefore have responsibilities to that society, and that there is therefore a shift towards the greater accountability of companies to all participants”.
While the shareholder is still the focus of many companies, other stakeholders cannot be ignored. The long-term wealth of the firm can only be maximized if each stakeholder is considered in the value creation process. If employees, for example, are not taken care of, they can simply leave the firm.
All strategic choices that increase value for both stakeholders and shareholders are, of course, highly desirable and should fuel the growth of any business unit. On the other hand, options that reduce both values are clearly to be avoided or reversed immediately. For example, McDonald’s rapid withdrawal of its recent fifty-five cent hamburger campaign, which alienated franchisees without creating much new customer loyalty or demand, was a costly but necessary decision to avoid further damage to shareholder value.
Enhancing stakeholder benefits is important for long-term shareholder wealth. Providing additional, non-shareholder, stakeholder benefits, when they are relatively low, significantly enhances total shareholder wealth. In contrast, once stakeholder benefits are relatively high, further increases no longer increase long-term shareholder wealth. However, because stakeholder theory lacks direction on how management is to make trade-offs among competing stakeholders, it can be thought as incomplete as a management strategy. Value-based management, in contrast, provides the manager a solution to these competing interests since it requires only a single-valued objective function. On the other hand, VBM, is really no more than a means to keep score since it does not provide guidance on how to achieve the goal of value creation.
Managers, often face choices that involve real tradeoffs between stakeholder and shareholder value. These choices need to be made on the basis of their expected impact on shareholder value alone. If a proposal to increase customers or customer value will reduce shareholder value, then it should be rejected. For instance, we commonly find that clients offer product features or delivery options that customers appreciate but for which they will not, in fact, pay.
Nevertheless, the shareholder is the central stakeholder. Placing the shareholder at the focal point of business activity is simply recognizing the fact that firms that do not satisfy shareholder requirements increase their risk of capital flight, higher interest rates, pressure from the board of directors, takeovers, and lower productivity. Organizations that create long-term shareholder value simultaneously create relatively greater value for all stakeholders. Thus, value-creating organizations appear to operate with the following objective function in mind: Maximize shareholder wealth subject to satisfying remaining stakeholder requirements.
I believe that a company’s success ultimately depends on its ability to build and nurture relationships with constituents that are essential to their business: consumers, customers, suppliers, partners, government authorities, communities, employees and share owners. This will enable them to achieve their objectives of creating economic value added by improving economic profit.
BIBLIOGRAPHY
- “Value-Based Management: Developing a Systematic Approach to Creating Shareholder Value”, James A. Knight (1998), McGraw-Hill
- “How “Shareholder Value” Let Shareholders Down”, Ken Favaro.
- “The quest for value: A guide for senior managers”, Stewart G B (1991), Harper Collins.
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“The social & organizational context of management accounting”, Puxty A G (1993), Academic Press
- “Value-based management : context and application”, G Arnold - M Davies (2000), Wiley
- “Valuation: Measuring and Managing the Value of Companies”, T Copeland, T Koller, J Murrin 1995, Wiley
- “Creating shareholder value : a guide for managers and investors”, A Rappaport (1998), Free Press
