Why shareholder value is still relevant

US excesses obscure the fact that there is far more to value than just the share price

SHARAD APTE and COLIN SMITH

The implosions in the United States of companies such as Enron and WorldCom have caused some people to question the shareholder value movement that swept the US and Europe over the past decade.

Focusing on shareholder value and aligning the interests of top management with shareholders via stock options has led in part to fraud and massive management excesses.

This has made many shareholders question the intrinsic link between the actions and decision-making of executives who run companies and the long-term returns of shareholders who provide capital. Stock options, which supposedly align senior executives' interests with those of shareholders, were considered the best tool to ensure that executives took a long-term view.

However, some executives focused on manipulating short-term returns to enrich themselves at the expense of the shareholders.

Has the emphasis on getting management to ``act like owners'' paradoxically led to the erosion of shareholder wealth? Is the shareholder value approach relevant to Asian corporations given recent excesses in the US?

Critics of shareholder value link it with three primary evils:

- Executives fixated with daily share prices and short-term results. In extreme cases, it allegedly leads to questionable accounting practices to shore-up results and support share prices. In some instances executives have replaced a focus on the fundamentals of strategy and business operations with financial engineering. When it unravels, those who pay the price are employees, customers, suppliers and ultimately (and ironically) shareholders.

- Senior executive salary inflation. The globalisation of CEO compensation has been a factor, as has the scarcity of high performers, but a big contributor is the use of options packages not directly linked to the longer-term performance of the company, or lacking explicit performance hurdles.

- A focus on the wrong measures. Companies that claim to focus on shareholder value are often fixated on a single number _ the share price. Management ignores the importance of performance measures relating to developing staff, customers and markets. The focus is on what the market wants to hear _ ``costs slashed!'' ``Revenues up this quarter!'' _ instead of on the things that truly drive long-term shareholder value.

During the US market boom in the late 1990s, management had trouble staying stay focused on the things that drove long-term shareholder value. It is even harder when the executives have a vested interest in maximising short-term measures _ which is exactly the case for many companies with option-based reward systems.

The challenge for shareholders and potential investors, whether they are large or small, is to identify companies that have robust processes and procedures that are followed in good times and bad. Sticking to those processes will create long-term shareholder value. Some signs of companies that have robust shareholder value processes include the following:

- Even in an uncertain environment, a continued focus on long-term shareholder value creation when setting strategy _ that is, evaluating alternative strategies on the basis of their long-term cash flow generating potential.

- Clear communication to investors about their strategic trade-off of short-term earnings outcomes versus longer term value objectives.

- The ability to convert strategic objectives into meaningful operating and performance measures for senior and middle managers.

- Rewarding executives with equity in a form that they cannot immediately cash-out _ effectively making them long-term, aligned shareholders.

For every Enron and WorldCom there is a GE or Coca-Cola, companies that generate substantial value for their shareholders. The ultimate test of management and the strategies that they pursue is whether it creates economic value for shareholders.

Investors must learn to separate those companies that espouse shareholder value approaches and those that actually follow shareholder principles. In today's challenging markets, the concept of shareholder value is more relevant than ever.

- Sharad Apte is a director of L.E.K. Consulting's Bangkok office. He can be reached at sapte@lek.com. Colin Smith is a director of L.E.K.'s Melbourne office, e-mail csmith@lek.com.

Back to index page