SHAREHOLDER

VALUE

MICHAEL HAKEL

OCTOBER 2000
Michael Hakel Fremdsprachliches Seminar
Shareholder Value WS 2000 / 2001

1. INTRODUCTION ............................................................................3

2. DEFINITION ...................................................................................3

3. THE SHAREHOLDER VALUE ANALYSIS ....................................3

4. IMPLEMENTING SHAREHOLDER VALUE...................................4

5. THE SHAREHOLDER SCOREBOARD .........................................4

6. PROBLEMS WITH SHAREHOLDER VALUE ................................5

7. APPENDIX .....................................................................................6

8. BIBLIOGRAPHY ............................................................................8

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Michael Hakel Fremdsprachliches Seminar
Shareholder Value WS 2000 / 2001

1. INTRODUCTION

Due to wrong decisions making in management like missing of opportunities

to redeploy cash to value-creating growth or in absence of profitable
investment opportunities to distribute the cash to shareholders the market
penalized the company’s shares. This leads to the “value gap”, i.e., difference
between the book value and the market value. A positive “value gap” is an
invitation for corporate raiders to bid for the company and replace the
management.
The only compelling takeover defense is to close the “value gap”. This can be
achieved by the delivering of superior shareholder value.

2. DEFINITION

Shareholder value is the total benefit to shareholders from investing in a

company. The question now is how this benefit can be evaluated.
The common accounting methods like ROI (Return On Investment) and ROE
(Return On Equity) are not quite reliable as their data depends on book
keeping principles like depreciation or the length of a period.

3. THE SHAREHOLDER VALUE ANALYSIS

The shareholder value network (Appendix A) can be used to show the

influence of management decisions on shareholder value.
Operating:
Decisions such as pricing, product mix, distribution, customer service level
etc. affect primarily on the three value drivers (valuation parameters): sales
growth, operating profit margin and income tax rate.
Investment:
Decisions such as increasing inventory levels and capacity expansion affect
mainly the two value drivers: working capital and fixed capital investment.
Finance:
The cost of capital value driver is determined by the risk of business and
management’s financing decisions.

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Michael Hakel Fremdsprachliches Seminar
Shareholder Value WS 2000 / 2001
The final value driver, which is the value growth duration, is the
management’s best estimation of how long the investment will achieve a rate
of return.
Shareholder value depends on three valuation components:
1. Cash flow from operations
2. Discount Rate
3. Loan capital (debt)
Shareholder value = Corporate value – Debt
Corporate value = Present value of cash flow from operations during
the forecast period + Residual value + Marketable
securities

4. IMPLEMENTING SHAREHOLDER VALUE

Implementation of shareholder value will vary among companies, depending

on its size, global reach, employee mix, culture, management style and sense
of urgency. Shareholder value is typically implemented in three phases:
1. Management must be convinced of a genuine need for change
2. The details of change must be defined and introduced to all levels
3. Change must be reinforced to ensure that it is sustained

5. THE SHAREHOLDER SCOREBOARD

There is no shortage of rankings of publicly traded companies. The major

business magazines rank companies by size of sales, profit, assets or total
stock market value. These magazines also emphasize financial measures
such as earnings per share and ROE to assess corporate performance.
However, the main consideration for investors is neither size nor historical
financial performance but the total rate of return that is, dividends plus share
price increases. The Shareholder Scoreboard (Appendix C) is annually
published and focuses exclusively on performance for the investors with
ranking of the rate of return. It serves not only to remind CEOs and boards of
directors of their fundamental responsibility to shareholders but also provides
a performance database for the public.

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Michael Hakel Fremdsprachliches Seminar
Shareholder Value WS 2000 / 2001
Total return to shareholders is the measure of performance for pension funds
and mutual funds. It shows clearly which companies are concerned about
shareholder value and which are not. It is important to understand that
shareholder value and rate of return may not be exactly the same but they are
closely linked together. These figures can only give us an idea of what it is as
no one can predict the future. Nevertheless shareholder value analysis
provides information on which companies are worth to invest in.

6. PROBLEMS WITH SHAREHOLDER VALUE

Companies are social beings, operating as part of the society with ethical and
moral responsibilities to their employees, customers, suppliers, the
government, and now increasingly to the environment. There are
responsibilities that go with this social existence and it may seem that the
discharge of these responsibilities may sometimes be wealth destroying for
the shareholders. As a result there is a conflict of shareholders interest to that
of other stakeholders (Appendix B). But is the conflict real? It may rightly be in
the very short term, but over a reasonably long period of time there is no real
contradiction between the interests of the shareholders and those of the other
stakeholders. A company, which is not profitable because it has been tending
more to its employees or anyone other than its shareholders, will destroy
wealth by using useful economic resource less efficiently and reduce the
possible investments in the economy, a situation to the disadvantage of all
stakeholders. At the end of the day, the only thing that really counts is
shareholder value as the people that have borne the risk by investing in the
business need to be rewarded. If they are not, the business will find it difficult
to find others in the future who will, and existing investors will seek to get out
in favor of better investments. Such a business is doomed to shrink and die.
Obviously such a situation is good for none of the stakeholders as well.

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Michael Hakel Fremdsprachliches Seminar
Shareholder Value WS 2000 / 2001

7. APPENDIX

A. The Shareholder Value Network1

Corporate Shareholder Return

Shareholder Value
! Dividends
Obective Added (SVA)
! Capital Gains

Valuation Cash Flow From

Discount Rate Debt
Components Operations

! Sales ! Working
Growth Capital
Value ! Value
! Operating Investment ! Cost of
Growth
Drivers Profit Margin ! Fixed Capital
Duration
! Income Tax Capital
Rate Investment

Management
Decisions Operating Investment Financing

1
Rappaport, Alfred (1998, p.56)

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Michael Hakel Fremdsprachliches Seminar
Shareholder Value WS 2000 / 2001

B. Problems With Shareholder Value

Corporation

Customers Employee Suppliers Government Shareholder

C. The Shareholder Scoreboard

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Michael Hakel Fremdsprachliches Seminar
Shareholder Value WS 2000 / 2001

8. BIBLIOGRAPHY

Rappaport, Alfred (1998): Creating Shareholder Value: A Guide For Managers

And Investors, 2nd. Edition, New York
http://www.endries.de/ref.htm
http://www.trainart.de/shareholder.htm
http://www.peterkeen.com/emgbp012.htm
http://www.manager-magazin.de/news/artikel/0,1113,48539,00.html
http://www.cabs.de/c30help/c31h0100.htm
http://www.bztrust.ch/bz_broschueren/bz_broschuere1/shareholder.htm