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  • Maximising Shareholder ValueAchieving clarity in decision-making

    Technical Report

  • Maximising Shareholder Value 1

    Contents

    Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

    1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31.1 Context conformance and performance . . . . . . . . . . . . . . . . 31.2 What is value-based management (VBM)? . . . . . . . . . . . . . . . 31.3 Shareholder value and the cost of capital. . . . . . . . . . . . . . . . . 5

    Sir Brian Pitman . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

    2 Creating Shareholder Value Strategy . . . . . . . . . . . . . . . . . . . . . . 7David Kappler . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

    3 Measuring Shareholder Value The Metrics . . . . . . . . . . . . . . . . . . 103.1 Shareholder value analysis (SVA) . . . . . . . . . . . . . . . . . . . . . . . . 103.2 Economic profit (EP). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113.3 Cash flow return on investment (CFROI) . . . . . . . . . . . . . . . . . 133.4 Total business returns (TBR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143.5 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

    Steve Marshall . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

    4 Managing For Shareholder Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164.1 Governance and ownership. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164.2 Remuneration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

    Jeremy Roche. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16John Barbour . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

    4.3 Culture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194.4 Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

    Charles Tilley . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214.5 Stakeholders . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

    5 Drawbacks of Value-Based Management (VBM) . . . . . . . . . . . . . . 22

    6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

    7 Bibliography. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

  • Since then, all kinds of companies havebeen publicly proclaiming theircommitment to increasing long-termvalue for their shareholders. One lookat the statements of directors or chiefexecutives in annual reports canconfirm this.

    To a certain extent this is old news. Wehave heard such pronouncementsbefore. The aim of publicly listedcompanies has always been to increasethe value of shareholders investment.

    But headlines such as, Value is the acidtest of good governance, Is goodgovernance good value? or Returningvalue by governance, all taken fromthe Financial Times in the last fewmonths, show the influence thataccounting scandals and the marketdownturn of the early 2000s have hadon corporate discourse.

    The debate is now focused on theinterplay between corporategovernance and company success. Theycross at a point where what matters iswhether and how a company hascreated value for its owners. Corporategovernance, defined as the system bywhich the owners of the corporationensure that it pursues, does not deviatefrom and only allocates resources to itsdefined purpose (LSE and RSM RobsonRhodes, 2004), has become anubiquitous topic here in Europe andeven more so in the US.

    Although CIMA believes this ispraiseworthy, there is a danger thatcompanies will assume that, oncecorporate governance has been sortedout, they will know how to manage forshareholder value. The truth is, many donot. These companies will carry onmuch like before, only under increasedscrutiny from both investors and thepublic. In fact, many executives seevalue creation as more of a corporaterallying cry rather than the goal ofserious strategic planning (Armour andMankins, 2001).

    This briefing is an attempt to drawattention to the context, tools,techniques and philosophy of managingfor shareholder value, or value-basedmanagement (VBM) as it is sometimesknown. It is not meant to beprescriptive. Like other managementconcepts, managing for value has beenadapted by companies to suit theircircumstances. There can be no one-size fits all model.

    In CIMAs Official Terminology, VBM isdefined as a managerial process whicheffectively links strategy, measurementand operational processes to the end ofcreating shareholder value.

    It is generally understood to consist ofthree key elements: creating value, ie, ways to actually

    increase or generate maximum futurevalue;

    measuring value; and managing for value, ie, governance,

    management, organisation, culture,communication.(www.valuebasedmanagement.net)

    We aim to outline the main features ofstrategic planning and decision-making,as well as how the chosen strategiescan be delivered via integratedperformance management systems andchanges to organisational culture andstructure.

    The briefing is divided into threesections corresponding to the mainVBM components: strategy for value creation; metrics for value measurement;

    and management encompassing

    governance, remuneration, culture,structure and stakeholderrelationships.

    It also provides insights from seniorfinance professionals with directexperience of managing for value and abrief discussion of some of the keybarriers and drawbacks of attemptingto implement VBM programmes.

    As this is a briefing from CIMA, it isprimarily aimed at those working infinance. Finance professionals andaccountants in business should play akey role in VBM implementation. Fewother professionals will have the samecommercial awareness coupled with abroad understanding of both thefinancial issues and the business as awhole.

    However, the overview of VBM shouldalso prove a useful introduction foranyone keen to gain a basicunderstanding of the subject.

    Maximising Shareholder Value2

    Preface

    After the market exuberance of the dot com bubble inthe late 1990s, the sobering up period that followed thebust brought with it a renewed interest in the concept ofshareholder value.

  • 1.1 Context conformance and performanceWhen corporate scandals started to hitthe headlines in the US and, morerecently Europe, the legislatorsresponse was swift and efficient. Amid aflurry of reviews, consultations anddebates about business ethics, a wholenew raft of legislation was introducedin an attempt to restore faith in capitalmarkets.

    On both sides of the Atlantic, much ofthis effort was focused on regulatoryand corporate governance issues. Thiswas hardly surprising, considering thenature and magnitude of the problems.Whats more, it is unlikely that thefocus on corporate governance andregulation is going to wane in comingmonths, despite the inevitable industrybacklash. The reforms continue and, formany, the effects of Sarbanes-Oxley inthe US and the new Combined Code inthe UK are starting to be felt.

    There is a danger, however, that thisadmittedly laudable attempt toimprove the way in which companiesare regulated and governed will detractfrom the basics of value creation. Goodcorporate governance may be anecessary prerequisite but will not byitself lead to superior performance which is, after all, what investors wantand expect in return for their money.

    At the beginning of 2004, theInternational Federation of Accountants(IFAC), in partnership with CIMA,published a report entitled, Enterprisegovernance getting the balanceright. It argued for a more holistic wayof looking at companies.

    Enterprise governance is defined as:

    the set of responsibilities and practicesexercised by the board and effectivemanagement with the goal of providingstrategic direction, ensuring thatobjectives are achieved, ascertainingthat the risks are managedappropriately and verifying that theorganisations resources are usedresponsibly.(Information Systems Audit and ControlFoundation, 2001).

    It has two dimensions conformanceand performance which need to bekept in balance. Too much emphasis onone, as the current focus on governancerisks doing, may detract from valuecreation.

    This briefing complements theEnterprise governance report byacting as a reminder not to overlookthe performance side of the enterprisegovernance framework. It covers thephilosophy and practice of managingfor long-term value.

    1.2 What is value-basedmanagement (VBM)?Defining VBM is not easy. There is, onthe one hand, a broad context ofgenerating value for shareholders thatis at the heart of the market economy.But there is also a more specificconcept that narrows VBM into amanagement approach, or even aphilosophy, characterised mainly by themetrics used to measure performance.

    In terms of the former- in the Anglo-Saxon context, the maximisation ofshareholder value has been widelyaccepted as a principal, if not the only,bona fide corporate aim.The concept ofenlightened shareholder value hasbeen enshrined in the recent UKCompany Law Review. The Reviewexplicitly rejected the notion ofpluralism where a company isrequired to serve a range of interestswider than just those of itsshareholders as being unlikely tocommand wide support.

    The Company Law Steering Group citedthe generation of maximum value forshareholders as the ultimate objectivefor compa