Abstract
The purpose of this first chapter is to set the scene with two important assertions. The first is that even under a business paradigm that gives absolute primacy to the interests of shareholders, the fundamental economic objective of a listed company is not and has never been to simply maximise shareholder value or to create shareholder wealth per se. It is to build an organisation that can create wealth for shareholders on an ongoing basis. The second assertion is that the only way to do this is to embrace customer value creation and shareholder wealth creation as joint and mutually reinforcing objectives, and to then pursue these two joint goals in tandem, in a structured and systematic manner.
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Notes
- 1.
Pitman, Brian, “Leading for Value”, Harvard Business Review, April 2003, p. 41.
- 2.
One of the main advocates of customer value creation as a governing objective was Theodore Levitt (see Levitt, Theodore, The Marketing Imagination, Free Press, New York, 1983). The main advocates of shareholder wealth creation as a governing objective were value-based consulting firms like Marakon Associates, Stern Stewart & Co and Alcar, together with the academics that stood behind them such as Dr Bill Alberts, Joel Stern and Professor Al Rappaport.
- 3.
Wang, J., and Dewhirst, H.D., “Boards of Directors and Stakeholder Orientation”, Journal of Business Ethics, Vol. 11, No. 2, 1992, pp. 115–123.
- 4.
This quotation was drawn from the Indian Head Mills Company Manual. It was used in an article entitled “The Chief Shows Them How at Indian Head” in the May 1962 edition of Fortune Magazine, (pp. 129–130), and was used widely in training material produced by Marakon Associates in the 1980s and 1990s. It was reproduced in McTaggart, Kontes and Mankins, The Value Imperative, Free Press, 1994, p. 8.
- 5.
Relatively recent changes to accounting standards have resulted in asset revaluations having an increasingly large impact on book value. While no doubt introduced with good intentions, these changes make it more difficult to understand the true economics of a business and serve as an impediment to the goal of building a value-creating organisation.
- 6.
Under an equity capital construct, economic profitability is defined as return on equity (ROE) less the cost of equity (Ke). Under a total capital construct, it is defined as the return on capital (ROC) less the weighted average cost of capital (WACC).
- 7.
Barbera, M., and Coyte, R., Shareholder Value Demystified: An Explanation of Methodologies and Use, University of New South Wales Press, Sydney, 1999.
- 8.
These metrics were intended for use as single period performance measures by those who devised them. But in practice, many companies used them for both performance measurement and capital allocation.
- 9.
Single period measures should never be used for capital allocation – no matter how sophisticated the measure. In every company that is seeking to systematically enhance the value of the capital its shareholders have invested, capital should be allocated on the basis of the expected value uplift or the shareholder wealth that is expected to be created, through the pursuit of a particular strategy. Once it has been determined which strategy represents the highest value alternative for the business, the strategy is adopted and a business plan built around it. That plan will always include a forecast income statement (or P&L), a forecast balance sheet and forecast cash flow statement for each year of the plan. From these inputs, we can determine the expected economic profitability and the expected economic profit in each forecast year. So, the business plan provides the appropriate benchmarks for each of these measures in each period – with no adjustments to management accounts required, other than to apply a charge for equity capital. Under this approach, the benchmark for economic profitability and economic profit need not be zero. In fact, they are generally not zero.
- 10.
There is no intention here to “pick on” EVA. It was simply the most popular of the proprietary metrics and became the most common term used to represent economic profit, in the same way that the brand name Hoover became the way many referred to a vacuum cleaner in the 1950s and 1960s.
- 11.
McTaggart, Kontes and Mankins, The Value Imperative, Free Press, 1994.
- 12.
Boulos, Haspeslagh and Noda, “Getting the Value Out of Value-Based Management: Findings from a Global Survey on Best Practices”, Harvard Business Review Research Report No. 7478, July 2001, p. 12.
- 13.
Boulos, Haspeslagh and Noda, op. cit., p. 12.
- 14.
Job Hopping is the “New Normal” for Millennials: Three Ways to Prevent a Human Resources Nightmare, Forbes, 14 August 2012.
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Kilroy, D., Schneider, M. (2017). Clarifying the Goal. In: Customer Value, Shareholder Wealth, Community Wellbeing. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-54774-9_1
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