It’s become fashionable to blame the pursuit of shareholder value for the ills besetting corporations: managers and investors obsessed with the next quarters’s results, failure to invest in long-trem growth, and even the accounting scandals that have grabbed headlines. When executives destroy the value they are supposed to be creating, the almost claim that stock market pressure made them to do it.
The reality is that the shareholder value principle has not failed management; rather , it is management that has betrayed the principle. In the 1990s for example, many companies introduced stock options as a major component of executive compensation. The idea was to align the interest of management with those of shareholders. But the generous distribution of options largely failed to motivate value-friendly behavior because their design almost guaranteed that they would produce the opposite result. To start with, relatively short vesting periods, combined with a belief that short-trem earnings fuel stick prices, encouraged executives to manage earnings, exercise their options early, and cash out opportunistically. The common practice of accelerating the vesting date for a CEO’s options at retirement added yet another incentive to focus on short-trem performance.
In their defense, some executives contend that they have no choice but to adopt a short-trem orientation, given that the average holding period for stock in professionally managed funds has dropped from about seven years in the 160s to less than one year today. Why consider the interest of long-term shareholders when there are none? This reasoning is deeply flawed. What matters is not investor holding periods bur rather the market’s valuation horizon.the number of years of expected cash flow required to justify the stock price. While investors may focused unduly on near-term goals and hod shares for a relatively short time, stock prices reflect the market’s long view. Studies suggest that it takes more than ten years of vale-crearing cash flows to justify the stock prices of most companies. Management’s responsibility, therefore, is to deliver those flows.that is, to pursue long-trem value maximization regardless of the mix of high- and low-turnover shareholders. And no one could reasonably argue that an absence of long-term shareholders gives management license to maximize short-trem performance and risk endangering the company’s future. The competitive landscape, not the shareholder list, should shape business strategies.
Principles:
Do not manage earnings or provide earnings guidance.
Make strategic decisions that maximize expected value, even at the expense of lowering near-term earnings.
Make acquisitions that maximize expected value, even at the expense of lowering near-term earnings.
Carry only assets that maximize value.
Return cash to shareholders when there are no credible value-creating opportunities to invest in the business.
Reward CEO’s and other senior executives for delivering superior long-trem returns.
Reward operating-unit executives for adding superior multiyear value.
Reward middle managers and frontline employees for delivering superior performance on the key value drivers that they influence directly.
Require senior executives to bear the risks of ownership just as shareholders do.
Provide investors with value-relative information.