Shareholder Value - A Cause or A Cliche

21 Sept, 2002 

Shareholder value as a concept has been much bandied about in the press and in the corporate world. Depending upon whether one is a CEO or a shareholder and whether you are an interested party, each may well be labouring under different illusions and interpretations, as to what precisely constitutes shareholder value.

The recent rash of corporate scandals in the U.S., from Enron to Tycos, certainly highlight the fact that shareholder value is the first casualty that is either diminished or damaged and often irretrievably; whenever a public company is found to have behaved less than responsibly in its conduct and disclosure. Every reputable CEO worth his salt, harbours ambitions that he should be regarded well and leave his company after his stint, as a most honourable and noteworthy person for his distinctive contribution. But sometimes even well nurtured reputations and name and fame cultivated carefully, can be dented by a few indiscretions while in office or on leaving it. The skeletons in the cupboards can rattle unexpectedly and noisily. Percy Barnewick was revered as rectitude itself personified. It was only after his departure that his multi-million dollars pension arrangements came under scrutiny and he was hounded and humiliated by a bunch of disgruntled shareholders, led by the redoubtable Ebner of Switzerland.

Jack Welch, ex-Chief of General Electric (GE), another giant in the U.S. corporate scene, did the second best thing. As soon as there were innuendoes about his severance pay package, he quickly renounced many of the perks that he was legitimately entitled to and his successor Jeff Immelt applauded him in a rare spirit of successor-camaraderie.

All these are instances to illustrate that shareholder value creation is in itself an arduous and often a thankless task because the CEO of a MNC struggles and juggles with different high pressure alternatives and calls before he is able to produce that superior performance, for which he can rightly expect to be rewarded generously by the shareholders and applauded by the corporate community.

Often blurred accountabilities become critical issues. Is the CEO formally accountable only to the chairman of a corporation or does he also need to be cognisant of the wishes of the majority shareholders; who normally worm their way into a strong, dominant position within the boards of directors of many companies and in terms of their decision-making framework, within organisations?

It is in this context that the visit to Dubai of Dr. Erik Stern, the managing director of Stern Stewart Europe might provide an interesting opportunity for the corporate chieftains to compare notes on the much-talked about concept of Economic Valued Added (EVA). Dr. Stern has written for a number of publications including the FT, Sunday Times and the Global Investor and has frequently appeared on the television, be it Sky Business News or Bloomberg. Economic Value Added itself may be a well-worn financial performance measure. But its merits, arguably, are that "it comes closer than any other, to capture the true economic profit of an enterprise".

Simply put, EVA is nothing more than net operating profit of a company less an appropriate charge for the cost of capital that is either allocated to it or raised for investing in a particular enterprise. How much or how little a company has achieved in terms of its profitability need to be computed over and above the cost of money that the shareholders and the lenders put into this enterprise vis-a-vis what they might have received in other investment opportunities or on securities of comparable risk. This is what is regarded as the economic profit or loss.

EVA scores over conventional measures of financial profits or losses (inclusive of dividend payout or bonus shares and the like). It is its ability to precisely determine whether a particularly risky venture (all ventures are inherently risky and the scale and measure of that risk is important) can consistently produce a superior return to its shareholders, when compared to the opportunity cost of capital. Rather than needlessly complicating the matter, EVA can be simplified or made simplistic by clarifying that an investor puts his money for a particular type of activity and expects a certain net profitability to accrue to him either as a single owner or proportionately as a shareholder. If the enterprise's managers do not generate adequate surpluses to justify that minimum expected return, then they are either obviously not managing the enterprise well or the opportunity itself is a warped one or the shareholder may be unrealistic to continue to expect superior returns.

All management is charged with optimising the opportunities available to it and thereby creating wealth for their shareholders. The key component is the cost of capital. Typically this cost can be arrived at by deriving it directly or benchmarking one against the other within the industry over a period of time. Some corporates may look at what the risk-free return is and then build up a certain spread on top of that for justifiably rewarding the shareholder for risking his capital. Risk-free return is done with reference to U.S. treasuries or a country's sovereign debt paper interest rates.

EVA is also a useful concept to measure a CEO's and senior management's performance and thereafter calculate the option plans or bonuses and performance rewards that can be linked to EVA, especially if the performance is achieved consistently year after year. The management's tasks will include careful monitoring, on an ongoing basis, the effectiveness of the asset deployment and the income generation that can be honed further.

Although some of the recent corporate scandals have had more to do with non-disclosure or lack of transparency or deliberate stashing away of risks, assets and liabilities through a veil of SPVs and in some cases, by not booking costs or losses and deferring them or not recognising the impairment to the value of certain assets, none of this is new to this new Millennium. Even in this region, in the early 1980s, some of the banks went under and the shareholders were extremely annoyed and agitated with the auditors, who ducked responsibility. In any other part of the world, they would have been held accountable and ordered to pay compensation as many of them are insured for this purpose. In this region, it included a couple of the Big 5 auditors, who only a few months prior to the event, had chosen to sign-off on financial statements of companies that collapsed under the weight of their own wrong doings. Barely a few weeks earlier, the auditors had walked away with their fees for the annual audit exercise.

Shareholder activism therefore, requires a wholesome and vigorous body of informed shareholders who need to be given exposure, education and support. It is in this context that the governmental and regulatory authorities would be well advised to establish an investment training institute, not just for the investment managers but also for the hapless shareholders through mandatory seminars, so that they can become informed investors. There ought to be experienced analysts who can help out by critically analysing and simplifying financial statements received by shareholders and offer needed advice. Just like medical attention in public health services, the health of the capital markets is in public interest. Informed shareholders will no longer respond to emotions and knee-jerk reactions in the market place or vote with their feet by dumping the stocks, the moment they feel uncomfortable with them. Just as you ought to have experienced and skilled managers and outstanding CEOs, in the market place, you also need informed investors and sensible shareholders to make for a vibrant corporate scene. The stakeholders need to be provided with the tools and measures (such as EVA), so that they can measure the performance of the boards of directors and management that they have put in place. The senior management can legitimately expect to be compensated and their superior performances recognised in a measured manner.

Whether EVA or other tools, what is needed is a simple mechanism by which certain benchmarks can be established and then corporations within that particular activity are compared for what their peers have been able to. In a sense, this is the ultimate challenge before capital markets. In this regard, all live in a glass house, and therefore, no one should cast stones or pretend to be holier than thou; not even some of the egos that strut around and speak as if they were evangelists. It is better to engage in a system of building blocks for a more credible and durable enterprise than revel in mutual mudslinging.

(The author (sureshk@emiratesbank.ae) is a General Manager in Emirates Bank Group. The views expressed in this article are not necessarily shared by the Bank.)

Back

Top