Driving Shareholder ValueManaging for the New Millennium
Dr. Roger A. MorinGeorgia State University, Distinguished Professor of Finance
Chairman & CEO Utility Research International
FI 8360Lecture #2 Roadmap
Why Value Value Value and Capital Markets The Value Manager Valuation Frameworks: DCF
NPV, FTE, FCF, APV, etc.
Why Value Value?
Economic Value
n E(Ct)
Present Value = ------------- t=0 (1 + k)t
Future value corresponds to future and uncertain business cash flows, Ct. So we discount expected cash flows
Cash flow and Risk
Because business cash flows occur over many future periods, we locate them in time, then discount and add them all.
Timing
Because business cash flows are risky, investors demand a higher return: the discount rate, k, contains a risk premium.
Risk
Corporate Value
infinity
Value = Cash Flowt
t=0 (1 + Cost of Capital)t
Shareholder value analysis focuses on the factors that investor use to
value companies:
Cash Flows Long-Term Expected Performance Risk
What is VBM?
A Way of Thinking A Process for Planning and Execution A Set of Tools
So What is So Different?
Drivers of Value
Cash Flow
SustainabilityAsset Utilization
Growth
VALUE
old new
??newer
Investor Perspective
VBM Links All Management Decisions to the Maximization of Shareholder Value
Value-Based Management
StrategyFormulation
CorporateDevelopment
IncentiveCompensation
Financial Policies& Practices
PerformanceMeasures &Inf. systems
Employee & InvestorCommunications
VBM plays a significant role in each stage of the management process
Financial Policy Assessment
Business Planning
Resource Allocation
Performance Management
Portfolio Assessment
Evolution of VBM
Number Crunching Strategizing Integrating
Mid ‘80’s Mid ‘90’s 2000 -
RHS Balance Sheet• Finance• Raiders• Valuation Models• LBO’s• Divestitures• Junk Bond Mkt
LHS Balance Sheet • Internal Operations• Strategy Evaluation• Financial Approach to Strategic Planning
• Holistic, Integrated• Investor Perspective• Common Language• Shared Culture• Executive Compensation• Performance Evaluation
Benefits of VBM
Better Pay Better Decisions Better Morale Better Performance
What’s In It For Me?
Your stake in the company becomes more valuable
Opportunity to learn new skills Job creation
Challenge to Create Value
Curse of competition Curse of beating market expectations
Potential Rewards
1
0
0
Dell Computer Computer Industry S&P 5000%
50%
100%
150%
% T
SR
Figure 2-5 Measuring Dell Computer's PerformanceAnnual Total Shareholder Returns (1995-1999)
-15 -5 5 15 25 35 45
% Total Shareholder Return
0
10
20
30
40
50
60
70
80
No. of Companies
Figure 2-6 Total Shareholder Return (S&P 500)1995-1999
CitigroupWal-Mart
Gen'l ElectricHewlett-Packard
HoneywellUnion Carbide
Procter & GambleJohnson & Johnson
Amer. ExpressCoca-Cola
Merck & Co.United Technologie
IBMAlcoa
Dow Jones AverageMcDonald'sExxon Mobil
Du PontMorgan (J.P.)
CaterpillarChevron
Minnesota MiningDisneyAT&T
Eastman KodakSears Roebuck
Int'l PaperBoeing
Philip MorrisGen'l Motors
Goodyear Tire
Co
mp
any
$0 $5 $10 $15 $20
Thousands
Growth of $1,000 invested in 1990
Source: Value Line Survery for Windows 01/2000
Figure 2-7 Stock PerformanceDow Jones Industrial Average
Growth of $1,000 invested over 1990-1999
M a rket Forces a nd VBM
ProductM arkets
M arket forCorpora te Control
M anageria lLabor M a rket
Capita lM arkets
Fig ure 4. M a rket Forces a nd VBM
Growing Pressures From Sources Of Discipline
Product market– Globalization, technology, deregulation, digital
economy,
Market for corporate control– Threat of takeovers
Capital markets– Creditors, shareholders
Market for skilled managers
EMBA Finance II 21
Origination of Value Movement
VBM
Changing EconomicsCompetition
Technological Innovation Information
Availability
RuthlessCapital Markets
Speed-driven,
Customer drivenMarkets
Institutional Pressures
Demonstrated ability to improve performance
Increasing attention on competitive advantage and competitive strategy
Accountability Internal control mechanisms
–Activist boards and investors Business scorecards
Demise of Accounting Metrics
Accrual accounting undependable Accounting latitude Risk excluded Investment requirements excluded Dividend policy excluded Time value of money excluded EPS growth vs value unrelated Focusing on short-term earnings growth jeopardizes ability
to create long-term value Accounting model vs Economic model
Decision-Making in a Corporate Tower of Babel
Capital Budgeting: NPV, Cash Flow Performance Evaluation: ROE, ROI Investor Relations: EPS, growth Incentive Bonus: ROE, Cash Strategy: ????
A Typ ica l Fina ncia l M a na gem ent System
Com pensa tion
Ca pita lBudgeting
SettingG oa ls
Stra teg icPla nning
M easuring Perform a nce
?
M a rg ins
Ca sh Flow s Returns
G row th
Bud g etTa rg ets
Ea rn ing s
D ivid end s
CO R P O R ATETO W ER O F BABEL
A Sim plified a nd Focused M a na gem ent System
Com pensa tion
Ca pita lA lloca tion
SettingG oa ls
Stra tegicPla nning
M easuring Perform a nce
UN I FO R M STAN DARDS,GO ALS AN D TER M I N O LO GY
VBM
The Agency Problem
Managers act in their own self-interest (corporate jets, country clubs, perks, etc.)
Shareholders do not have the influence or finances to govern issues such as election of board members
Board members tend to be largely responsive to management; top managers are often board members
Manager’s time horizon may be short-term, due to compensation mode
Managers tends to have lower risk tolerance than owners due to compensation mode
How to reduce the agency problem
Large ownership positions Compensation tied to shareholder return Threat of takeovers Competitive labor markets for corporate
executives VBM
Contributions of VBM
Enhance value for shareholders Enhance your company’s competitive position in:
– Product markets– Market for corporate control– Capital market
Optimize all stakeholders’ interests Better pay, better performance, better morale, better decisions Manage assets better Close the gap between operations, strategy, finance Think, act, get paid like an owner Communicate more effectively with investors