SHAREHOLDERS VALUE

CREATION

DR RAVI INDER SINGH

 SHAREHOLDERS VALUE CREATION
• WHAT IS THE FINAL OBJECTIVE OF A
COMPANY?
 SHAREHOLDERS VALUE -MEANING
• THE VALUE THAT A SHAREHOLDER IS ABLE TO
OBTAIN FROM HIS INVESTMENT MADE IN THE
COMPANY. THIS VALUE IS MADE UP OF CAPITAL
GAIN, DIVIDEND PAYMENTS, PROCEEDS FROM
BUYBACK PROGRAMS AND ANY OTHER PAYOUT
THAT A COMPANY MIGHT MAKE TO THE
SHAREHOLDERS.
 SHAREHOLDERS VALUE-MEANING ---
CONTD….
• THE SHAREHOLDER VALUE IS THE VALUE OF THE
COMPANY (FIRM) MINUS THE FUTURE CLAIMS (DEBTS.)
THE VALUE OF A COMPANY CAN BE CALCULATED AS THE
NET PRESENT VALUE OF ALL FUTURE CASH FLOWS PLUS
THE VALUE OF THE NON-OPERATING ASSETS OF THE
COMPANY. SO: SHAREHOLDER VALUE = CORPORATE
VALUE (FIRM VALUE) - FUTURE CLAIMS (DEBTS.)”
• NON OPERATING ASSETS INCLUDE: MARKETABLE
SECURITIES, EXCESS REAL ESTATE ETC.
• FUTURE CLAIMS INCLUDE : DEBT, CONTINGENT
LIABILITIES, UNDERFUNDED FUNDS LIKE PENSION FUND
ETC.
 SHAREHOLDERS VALUE CREATION-
ADVANTAGES
• SVA HOLDS THAT MANAGEMENT SHOULD
FIRST AND FOREMOST CONSIDER THE
INTERESTS OF SHAREHOLDERS IN ITS
BUSINESS DECISIONS.
• SVA TAKES A LONG-TERM VIEW AND IS
ABOUT MEASURING AND MANAGING
CASH FLOWS OVER TIME. IT PROVIDES THE
USER WITH A CLEAR UNDERSTANDING OF
VALUE CREATION OR DEGRADATION OVER
TIME WITHIN EACH BUSINESS UNIT.
 ADVANTAGES-Contd…
• SVA OFFERS A COMMON APPROACH, WHICH
IS NOT SUBJECT TO THE PARTICULAR
ACCOUNTING POLICIES THAT ARE ADOPTED.
IT IS THEREFORE GLOBALLY APPLICABLE AND
CAN BE USED ACROSS MOST SECTORS.
• SVA FORCES COMPANIES TO FOCUS ON THE
FUTURE AND THEIR CUSTOMERS, WITH
SPECIFIC ATTENTION TO THE VALUE OF
FUTURE CASH FLOWS.
 DISADVANTAGES

• THE CONCENTRATION ON SHAREHOLDER VALUE DOES

NOT TAKE INTO ACCOUNT SOCIETAL NEEDS.
SHAREHOLDER VALUE FINANCIALLY BENEFITS ONLY THE
OWNERS OF A CORPORATION; IT DOES NOT PROVIDE A
CLEAR MEASURE OF SOCIAL FACTORS SUCH AS
EMPLOYMENT, ENVIRONMENTAL ISSUES, OR ETHICAL
BUSINESS PRACTICES. THEREFORE, A MANAGEMENT
DECISION CAN MAXIMIZE SHAREHOLDER VALUE WHILE
ADVERSELY AFFECTING THIRD PARTIES

• IT CAN BE EXTREMELY DIFFICULT TO ESTIMATE

FUTURE CASH FLOWS ACCURATELY—A KEY COMPONENT
OF SVA. THIS CAN LEAD TO THE USE OF FAULTY OR
AMBIGUOUS FIGURES AS THE BASIS FOR STRATEGIC
DECISIONS.
 DISADVANTAGES-Contd…
• THE DEVELOPMENT AND IMPLEMENTATION
OF AN SVA SYSTEM CAN BE LONG AND
COMPLEX.

• MANAGEMENT OF SHAREHOLDER
VALUE REQUIRES MORE COMPLETE
INFORMATION THAN TRADITIONAL
MEASURES AND CAN THEREFORE TAKE UP
MANAGEMENT TIME.
 METHODS USED TO MEASURE
SHAREHOLDERS VALUE
TRADITIONAL METHDODS USED TO MEASURE MODERN METHODS USED TO
FINANCIAL PERFORMANCE MEASURE FINANCIAL
PERFORMANCE

NET PROIT RAIO EBA

RETURN ON CAPITAL EMPLOYED SBA

RETURN ON SHAREHOLDERS FUNDS MBA

ROA, ROI, PE RATIO

LIMITATIONS OF TRADITIONAL METHODS

• BASED ON ACCOUNTING PROFITS, WHICH

CAN BE EASILY MANIPULATED(SATYAM
COMPUTERS)
• IGNORES TIMING, RISK AND THE COST OF
CAPITAL METHOD
• CONSIDERS ONLY SINGLE PERIOD RETURNS,
RATHER THAN THE ENTIRE STREAM OF CASH
FLOWS OVER THE ENTIRE LIFE OF THE ASSET.
 EBA
• ECONOMIC BASED APPROACH (Economic Value
Added (EVA):
• EVA, A PERFORMANCE MEASUREMENT
CONCEPT INTRODUCED TO THE CORPORATE
ARENA IN THE 1920S, BY THE GENERAL MOTORS
CORPORATION, AND THEN FORGOTTEN.
• STERN STEWART COMPANY, NEW YORK BASED
CONSULTING FIRM, REINTRODUCED IT IN THE
80s AS A REPLACEMENT FOR THE TRADITIONAL
MEASURE OF VALUE CREATION.
 EBA-Contd…
• EVA IS A MEASURE OF THE CORPORATE PERFORMANCE
THAT DIFFERS FROM MOST OTHERS BY INCLUDING A
CHARGE AGAINST THE PROFIT FOR THE COST OF ALL
CAPITAL THE COMPANY EMPLOYS. THE PROPONENTS OF
EVA CLAIM THAT EVA IS THE FRAMEWORK FOR A
COMPLETE FINANCIAL MANAGEMENT AND INCENTIVES
COMPENSATION SYSTEM THAT CAN GUIDE EVERY
DECISION A COMPANY MAKES, FROM THE BOARDROOM
TO THE OPERATION FLOOR.
• EVA = NOPAT – C % (TC)
• IN THE FORMULA, NOPAT IS THE NET OPERATING PROFIT
AFTER TAXES, C% IS THE PERCENTAGE OF THE COST OF
CAPITAL AND TC IS TOTAL CAPITAL.
 MARKET VALUE BASED APPROACH

• MARKET VALUE ADDED (MVA):

MVA OF A COMPANY IS THE DIFFERENCE BETWEEN THE
MARKET VALUE AND BOOK VALUE OF THE COMPANY
• MVA = MARKET VALUE OF THE COMPANY – BOOK
VALUE OF THE COMPANY
• COMPANY VALUE CONSISTS OF DEBT VALUE PLUS
EQUITY VALUE. IF THE MARKET VALUE & BOOK VALUE
OF DEBT ARE THE SAME, THEN
• MVA = MARKET VALUE OF EQUITY- BOOK VALUE OF
EQUITY.
• THE MARKET VALUE OF EQUITY IS THE STOCK PRICE
MULTIPLIED BY THE NUMBER OF SHARES
 SHAREHOLDERS VALUE BASED APPROACH (SBA)
Shareholder Value Added (SVA)
• ALFRED RAPPAPORT INTRODUCED THE SHAREHOLDER
VALUE ADDED APPROACH.
• SHAREHOLDER VALUE IS DEFINED AS CORPORATE VALUE
LESS THE VALUE OF DEBT.
• CORPORATE VALUE IS EQUAL TO THE DCF VALUE OF THE
COMPANY PLUS THE VALUE OF THE NON-OPERATING
ASSETS AND MARKETABLE SECURITIES.

• THE SVA ANALYSIS BEGINS BY FORECASTING THE CASH

FLOWS OVER THE PLANNING PERIOD. THE STEPS
INVOLVED ARE FORECAST CASH FLOW FROM THE VALUE
DRIVERS.
 SBA-Contd…
• CALCULATE THE RESIDUAL VALUE AT THE END
OF EACH PERIOD.
• DISCOUNT THE CASH FLOW AND THE RESIDUAL
VALUE USING THE COST OF CAPITAL.
• THE CUMULATIVE PRESENT VALUE OF THE
CASH FLOW AND THE RESIDUAL VALUE OF
EACH PERIOD MINUS DEBT CLAIMS REPRESENT
THE VALUE AT THE END OF THAT PERIOD. THE
CHANGE IN VALUE FROM THE PREVIOUS
PERIOD IS THE SVA OF THAT PERIOD.
 STRATEGIES TO BE FOLLOWEDFOR
ENHANCING SHAREHOLDERS VALUE
• DONOT MANAGE OR GIVE DIRECTIONS TO
EARNINGS
• TAKE STARETGIC DECISIONS THAT AIM AT
MAXIMISING LONGTERM, EVEN AT THE
EXPENSE OF LOWERING NEAR TERM
EARNINGS
 STRATEGIES-Contd….
• CARRY ONLY THOSE ASSETS WHICH
MAXIMISE THE VALUE
• RETURN CASH TO SHAREHOLDERS WHEN
THERE IS NO PROFITABLE OPPORTUNITY
• REWARD CEOs OR OTHER SENIOR OFFICERS
FOR CREATING LONG TERM PROFITABLE
VENTURE
 STRATEGIES-Contd…..
• REWARD OPERATING UNIT MANAGERS FOR
CREATING LONGTERM VALUES
• REWARD FRONTLINE STAFF FORCREATING
LONGTERM OPERATIONAL VALUES
• REQUIRE SENIOR MANAGERS TO BEAR THE
RISK OF OWNERSHIP JUST AS THE
SHAREHOLDERS DO
• PROVIDE INVESTORS WITH VALUE RELEVANT
INFORMATION.
• Thanks