Shareholder value

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Shareholder value is a business buzz term, which implies that the ultimate measure of a company's success is to enrich shareholders. It became popular during the 1980s, and is particularly associated with former CEO of General Electric, Jack Welch. The term used in several ways:

  • To refer to the market capitalization of a company (rarely used)
  • To refer to the concept that the primary goal for a company is to increase the wealth of its shareholders (owners) by paying dividends and/or causing the stock price to increase
  • To refer to the more specific concept that planned actions by management and the returns to shareholders should outperform certain bench-marks such as the cost of capital concept. In essence, the idea that shareholders money should be used to earn a higher return then they could earn themselves by investing in other assets having the same amount of risk. The term in this sense was introduced by Alfred Rappaport in 1986.

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[edit] Definition

For a publicly traded company, Shareholder Value (SV) is the part of its capitalization that is equity as opposed to long-term debt. In the case of only one type of stock, this would roughly be the number of outstanding shares times current shareprice. Things like dividends augment shareholder value while issuing of shares (stock options) lower it. This Shareholder value added should be compared to average/required increase in value, aka cost of capital.

For a privately held company, the value of the firm after debt must be estimated using one of several valuation methods, s.a. discounted cash flow or others.

[edit] Maximizing shareholder value

This management principle, also known under value based management, states that management should first and foremost consider the interests of shareholders in its business decisions. Although this is built into the legal premise of a publicly traded company, this concept is usually highlighted in opposition to alleged examples of CEO's and other management actions which enrich themselves at the expense of shareholders. Examples of this include acquisitions which are dilutive to shareholders, that is, they may cause the combined company to have twice the profits for example but these might have to be split amongst three times the shareholders.

[edit] Criticism

The sole concentration on shareholder value has been widely criticized[citation needed]. While shareholder value benefits the owners of a corporation financially, it does not provide a clear measure of social issues like employment, environmental issues, or ethical business practices. A management decision can maximize shareholder value while lowering the welfare of third parties. It can also threaten the long-term health of a company by, for example, emphasizing dividends above investment in opportunities for growth.

[edit] Alternative Definition based upon Criticism: Stakeholder Analysis

The intrinsic or extrinsic worth of a business measured by a combination of financial success, usefulness to society, and satisfaction of employees, the priorities determined by the makeup of the individuals and entities that together own the shares and direct the company. This is sometimes referred to as stakeholder analysis. However, this concept is difficult to implement in practice because of the difficulty of determining equivalent measures for usefulness to society and satisfaction of employees. To give an example, how much additional "usefulness to society" should shareholders expect if they were to give up $100 million in shareholder return. In response to this criticism, defenders of the shareholder value concept argue that employee satisfaction and usefulness to society will ultimately translate into shareholder value.

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