Shareholder Value - A Business Experience

RoyE. Johnson

• Publisher: Butterworth-Heinemann
• Year: 2001
• Print ISBN: 9780750653824
• eBook ISBN: 9780080498133
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

Shareholder Value presents a powerful and useful toolkit of market-based perspectives, analytic approaches, valuation techniques, and specific financial metrics for use in everyday business life. The author helps a broad spectrum of professionals understand the salient points and real world implications of a 'value management' movement which has taken hold in many corporations in the United States and around the world. This movement is being supported by some of the major institutional investors who influence financial markets. The main goal of 'Shareholder Value' is to help working professionals grasp the concept of value 'creators' and 'destroyers', along with the implications. He also provides tools to measure the success (or failure) of major strategic and operational initiatives and enables corporate managers to understand how shareholder value is created, and then directs behaviour toward 'value-based' planning and action. Although mainly aimed at the professional market, 'Shareholder Value' will also be of use to students of business and finance as it is intended to provide a comprehensive foundation for important elements of business strategy and acquisition valuation, corporate financial analysis, capital investments, corporate financing and economic value based metrics.AUTHOR'S REVIEW:When developing this book, I strived to achieve the following: - Provide the finance professional and student of finance with a comprehensive template of shareholder value concepts and techniques - geared toward use in a corporate setting - Give the non-financial professional an understanding of the underpinnings and behavioural aspects of economic value management - Outline and provide details of an effective process for implementing a value-based financial performance system within a corporation - ...And, combine learning with enjoyable reading by presenting technical material through a story. The "story" and "characters" are unique features of Shareholder Value - A Business Experience. The reader can get an appreciation of the environment surrounding value-based management, along with challenges that arise when transitioning from traditional "accounting" performance (where earnings and earnings per share reign supreme) to "economic" performance (where cash flow and return on investment are emphasized). Characters occupying operating and staff roles have been created to represent people that those working inside companies (large, medium and small) may encounter and, also, to invoke some humour. Insights into how to function in different corporate roles can be gained by following the characters through the story. - Presents a combination of analysis and case study in which a strong technical treatment is blended with a fictional case study to offer clarity and explanation - A practical and effective implementation process for a comprehensive financial performance system - Offers a perspective of the role of different corporate and business unit functions in the implementation of value-based financial performance within a company

1

Getting started

The cup of early morning black coffee tasted good. “At least we’ve crossed one hurdle”, sighed Jason Aradvizer, who had a lot on his mind that first day of July. His totally relaxing and satisfying, if not spectacular, golfing vacation had ended just two days ago, but the matters at hand put it in the distant past. Jason was experiencing a typical set of ‘first day on the job’ thoughts by wondering if he had done the right thing, even though he felt so positive about this new challenge. “What better way”, he reminded himself, “to conclude a corporate and consulting career than to take on this assignment as a consultant to the Chief Financial Officer of Growthstar Inc., a publicly traded industrial products and services company on the verge of a new market expansion strategy. The opportunity to utilize my thirty-something years of experience to ‘reinvent’ a significant segment of the corporate finance function seems almost too good to be true … but”, as he mused to himself, “some poor soul has to do it!”

“The business landscape has changed”, he thought to himself. “Boards of Directors are paying more attention to their large institutional shareholders, and making the enhancement of shareholder wealth a ‘priority’ for the Chief Executive Officer (CEO). Many CEOs, in turn, are now realizing that increasing the company’s stock price is not their challenge alone, and are pushing ‘shareholder value creation’ down to their business unit and division general managers. Even key staff members in virtually all functional disciplines and support areas are getting ‘clued in’ to the importance of achieving shareholder value objectives, not just growing revenue and net earnings”.

He continued talking silently to himself, as he typically did at the beginning of major work assignments … “Every key manager in this company, and every other ‘for profit’ enterprise, needs to gain an understanding of ‘value-based’ performance and measurement – some obviously more than others. My role is to facilitate both the accumulation and application of a ‘new body of knowledge’ in Finance, for execution in various parts of this company. I need to help these people think differently about the financial aspects of their business. They need to understand that there is a ‘story’ about shareholder value in their financials, which the traditional ‘accounting-based’ approach and measures will not reveal or be able to explain. With the help of the new ‘economic-based’ approach and measures, I can help these people uncover that message. To do this, I need to make financial theory understandable and useful to them”.

“There are also potential ‘gold mines’ and ‘minefields’ in the company’s strategies, future plans, and capital investment programs which need to be evaluated. The major analytic routines and the notion of ‘how’ and ‘where’ to apply a time-tested valuation technique, as well as a couple of new ones, need to be driven into the organization”.

He concluded his self-reflection with the same thought he had felt so many times. “It’s always exciting and always a challenge. Many people in business really do need a dose of ‘new thinking’ to an ‘age-old problem’ – how to get that stock price up and sustain it. The financial framework, approaches and measures – in and of themselves – do not contain all the answers, but they can help in ‘driving’ managers toward acting in the best interests of the shareholders”.

Jason then began to focus on the present situation. His former graduate school colleague, Jonathan Steadfast, had been with Growthstar for the past ten years, rising from the post of Corporate Controller and appointed as the company’s CFO five years ago. Jonathan’s acceptance of the new ‘economic metrics’ during the past year had convinced Jason that the environment at Growthstar was right for a revamping of the planning and analysis systems, plus key measurement and reporting functions, within finance.

Concerns still loomed in Jason’s mind, however, as he looked over the corporate organization chart, which had his handwritten notes from conversations with Jonathan, highlighting the various personalities of the corporate vice presidents.

John (Jack) Earningsly, Corporate Controller, was going to be a ‘tough sell’ – a classic accountant who knew (and used) every accounting treatment to boost quarterly earnings per share (EPS) and often seemed to be more concerned about where an item went rather than what it meant. He scratched his head as he thought about Jonathan’s comment that Jack had not ever made an incorrect accounting entry or misinterpreted a FASB ruling. The fact that Jack hung his CPA certificate above his college degree in his office was not lost on Jason. Neither was Jack’s comment, in their only meeting, questioning what a bunch of new measures would really add to the company, except more work for an already burdened accounting staff. Last year, Jack celebrated his twentieth anniversary with Growthstar, having spent his entire career with the company in some capacity. He joined Growthstar as Accounting Manager after five years with the company’s auditing firm, having been the junior and senior auditor, then manager, for the Growthstar account. Being one of the longest-serving employees, and the longest-tenured corporate executive, he had no plans of leaving and had developed his own agenda. He also had visions of occupying the CFO’s office if Jonathan decided to move on or retire.

Moving on to Earl D’Mark, Growthstar’s Treasurer, Jason smiled. Earl was a fortyish ‘young tiger’ whom Jason had met a few years ago at a shareholder value conference. Earl had a master’s degree from a rock-solid, if not overly prestigious, mid-west graduate business school, and seemed to almost worship cash flow, deriding EPS as far as was politically palatable in a company which had historically been ‘earnings driven’. “Jack and Earl’s luncheon conversations must be interesting”, thought Jason, wishing he might be a ‘fly on the wall’ as he mentally compared the almost opposite views of these two key finance executives. From the time of his arrival at Growthstar three years ago, Earl had been one of the proponents of adopting more ‘economic-based’ ways to analyze the company’s businesses and investments and, according to Jonathan, had been almost relentless in his admonitions, much to the dismay of Jack. While an experienced treasurer, Earl was a bit ‘light’ on some of the more technical aspects of valuation theory and its application, and welcomed an experienced outsider, to add credibility to the undertaking which Jonathan had now sponsored. To indicate his support for the endeavor, Earl had promised to make his best financial analyst available for up to 50% of his time over the next several months, to assist Jason with the ‘number crunching’. Earl was, obviously, the ‘coach’ – a consultant’s name for a key ally to get support for important findings and recommendations, especially since he had gained Jonathan’s ear during the past year or so, and Jonathan was the CEO’s closest confidant.

Human Resources, which Jason had called ‘Personnel’ until it got him in trouble several years ago with an important client, was going to be interesting. Jason gazed attentively at his notes on Florence (known to everyone as ‘Flo’) Withetide, realizing that he had spent virtually no time thinking about the comments that Jonathan had provided about her. Flo was a classic case of the Horatio Alger success story – a woman approaching middle age who started as an executive secretary in another company. She attended night school and earned a college degree after eight years of part-time study. She then worked her way up through compensation, recruitment and human resource administration to the position of Director for one of Growthstar’s competitors. Almost everyone in Growthstar felt she was a ‘steal’ when she was enticed to join the company as Vice President, Human Resources to replace the retiring incumbent. For Flo, this job was the crowning achievement for a long road of hard work, so much so that she seemed unwilling to take strong positions on anything that the CEO might not agree with. To call her a ‘yes’ person would be unfair, but she literally calculated the impact of every comment she made to the CEO, especially on subjects he (the CEO) felt strongly about. “She’s going to be a very intriguing person to figure out”, Jason thought out loud, as he mentally progressed to the stage where his work would require changes to the compensation plan. “Oh well”, he rationalized, “we’re a few months away from that issue”.

Valerie (Val) Performa, Vice President of Corporate Strategy and Development, was the exact opposite of Flo. Born and raised in an affluent family, she earned her bachelor’s degree from a prestigious east coast college and a master’s in business, concentrating in marketing, from an equally prestigious west coast university by the age of twenty-four. ‘Sophisticated’ was the term Jonathan had used as a ‘one-word descriptor’ for Val. She was also a very gracious person and, while confident of her ability, was one who listened to others and appeared to be open-minded and respectful of the opinions of others. She had moved rapidly in her twelve-year career, and was the youngest vice president ever appointed at Growthstar, having joined the company two years ago.

With a working knowledge of financial concepts, she had developed a reputation as a ‘big picture’ person constantly striving to be on top of – some thought ahead of – the next major strategic breakthrough in the overall global economy and Growthstar’s markets. During the past year, she had formalized the strategic planning process, and the two businesses now had their ‘first ever’ strategies. She had collaborated with Earl D’Mark to generate ‘high-level’ financial expressions for these strategies, which represented a good first step in developing meaningful financial outlooks.

In terms of Corporate Communications and Investor Relations, Jonathan had managed this area himself, working closely with Val, Jack and Earl to structure the ‘message’ that he and the CEO took to the investors. This would soon change, as an Investor Relations Officer was about to join the company. Jonathan, while still somewhat tied to the ‘old school’, did believe in open and candid reporting – good or bad – to the ‘street’.

Finally, the ‘big man’ – Ian Lord – Chairman, President and Chief Executive Officer. Ian was a striking figure. Standing ‘six-foot five’, he was a basketball star at a Division 1 university in his ‘playing days’. Everything about him was impressive, especially his thick, silver-colored hair, and he had built a reputation over the past thirty years as a tough, yet fair, task master – one who demanded nothing short of excellence, both for himself and his subordinates. His only major shortcoming, according to Jonathan, was a predisposition to certain conclusions, even if convincing analysis demonstrated a totally different result. Ian was not irrational, as he could be swayed, but he did go into situations with at least a strong idea, if not a conviction, of what he thought the outcome should be. Ian was not fond of ‘heavy’ analysis. He wanted answers and decisions, not a lot of detail. Ian had the ability to get to key issues quickly, and was very decisive. He expected no less from those who worked for him. He was the quintessential executive who wanted all memos and letters to be no more than one page, with a recommended course of action supported by brief, yet compelling, rationale. “This isn’t so surprising”, thought Jason, as Ian fitted a profile of several CEOs he had worked for and advised.

So, there they were – the executive team he would work with at the corporate level. Jonathan had given him a very condensed overview of the business unit general managers (the ‘producers’) which would have to be expanded in the very near future.

Jason looked at his watch. He had spent nearly an hour reviewing his notes and thinking about the corporate officers and his initial interactions with them. With his ‘kick-off’ meeting with Jonathan scheduled to start in less than thirty minutes, Jason turned his attention to the outline of the process he had put together three weeks ago to structure and prioritize the major work activities for the next several months.

The process Jason had developed was the culmination of his many years in consulting. Having used it with several clients during the past five years, he felt confident that it would work well at Growthstar. “A cohesive process”, he reminded himself, “was so important for an undertaking of this magnitude”. However, he also knew that Jonathan was not a process-oriented person. Jonathan would constantly have to be held in check, since he was a lot like Ian in prematurely wanting the ‘answer’. The ‘answer’ – “what good is it”, Jason said to himself, “without the rationale and supporting analysis!”

Now, it was showtime. Jason took a left turn out of the office provided for him and strolled the short distance down the hall to Jonathan’s office. Jonathan preferred a worktable with straight-back chairs to the comfortable couches that many executives, including Ian Lord, Flo Withetide and Val Performa, had in their offices. For some strange reason, Jack Earningsly and Earl D’Mark also had worktables with straight-back chairs in their offices. The two men, who had now known each other for nearly thirty-five years, extended warm greetings as Jason entered Jonathan’s office. Jonathan had instructed his assistant not to stop or announce Jason, unless an important meeting or conference was going on.

“So, you’re going to straighten us out financially”, thundered Jonathan.

Some people felt intimidated by the volume and intensity of Jonathan’s voice, but Jason was not. Besides, he had listened to that voice for so long, that its volume had lost its impact. “I’m going to give it everything I have”, Jason shot back, “assuming the CFO doesn’t ‘stonewall’ me!”

He handed Jonathan the one-page chart he had put together outlining the major tasks and approximate time frames for their completion. “First”, Jason stated, “we have to get everyone on the corporate staff ‘on board’ with some basic definitions and perspectives as to what shareholder value is all about. Then, I explain the transition from ‘accounting’ to ‘economics’ and introduce ‘value-based metrics’ and ‘Economic Profit’ (EP)”.

At that point, Jonathan gave Jason his first reaction. “A year ago, Jack would have tried to ‘blow this apart’ right from the outset. He knows that this tactic won’t succeed now, because the stock market evidence is so compelling against EPS as a proxy for equity value, that he’ll look foolish. In spite of his strong support of accounting measures as adequate for managing the company, Jack is no fool, so maybe this will not be that major an issue”.

“I hope not”, said Jason, “because it can sidetrack the entire process. However, even in the worst possible scenario, it will only cause a delay”. Jason continued … “the next major step is to do a ‘value assessment’ of the company’s business units (BUs). This analysis should highlight performance which creates shareholder value versus that which destroys it, and performance that is value neutral. We begin the assessment work by analyzing the Cost of Capital. As I think you know, this goes well beyond the cost of debt financing to capture the most important and expensive financing instrument used by most companies – namely, common equity. We’ll want to determine if we have one cost of ...

Table of contents

• Cover image
• Title page
• Table of Contents
• Copyright page
• Preface
• List of Exhibits
• 1: Getting started
• 2: Shareholder value and sustainable value: definitions and perspectives
• 3: Value-based metrics: from accounting to economics
• 4: Cost of capital
• 5: Economic profit assessment: value ‘creators’ and ‘destroyers’
• 6: Financial ‘drivers’: support measures
• 7: Market value added (MVA): ‘magnifier’ concept
• 8: Value-based analysis: valuation hierarchy
• 9: Valuation methodologies
• 10: Corporate financial analysis
• 11: Value driver programs: major internal investments
• 12: Mergers and acquisitions: major external investments
• 13: Capital investments: planning, evaluation and control
• 14: Financial reporting and communication: traditional/modification/new
• Epilogue
• Index