Value Imperative: Managing for Superior Shareholder Returns

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9780029206706: Value Imperative: Managing for Superior Shareholder Returns

Moving beyond the strategies that managers have employed to create shareholder value -- now the standard for business performance -- management experts James McTaggart, Peter Kontes, and Michael Mankins reveal their powerful new framework for the systematic, day-to-day management of shareholder value. The authors attack head-on the fundamental weaknesses in current management practices, namely, the stranglehold that budgeting has over strategic planning and the lack of imagination in management plans that prevents real changes and consequences. They provide a systematic approach to "value based management" that eliminates these weaknesses, offering proven strategies for managing large, complex companies to consistently produce superior results for stockholders.
Building on more than 16 years of consulting experience with many of the largest and best-known companies in North America, Europe, and Australia, the authors delineate the fundamental principles of value creation, as well as the primary obstacles. Starting with the principle that "cash flows drive value," McTaggart, Kontes, and Mankins show how to create a single governing objective that will enable managers to make decisions most likely to increase the company's competitive, organizational, and financial strength. Building on the objective of maximizing shareholder value, they outline the value based management framework that directly links a company's strategies and organization to its value in capital markets. Using real-world examples, they describe how to develop business and corporate strategies that substantially improve competitive position and increase market value, often within only two to five years. And as most large companies lack the internal processes necessary to manage for value on a sustained basis, the authors show managers how to build the five key processes that are institutional value drivers: governance, strategic planning, resource allocation, performance management, and top management compensation. Mastering these capabilities is fundamental to the ongoing, consistent creation of shareholder value over time.
All companies, the authors argue, inherently possess an enormous potential to create higher value for their shareholders. With hundreds of examples of companies that have successfully employed the beliefs, principles, and practices of value based management, this book shows general managers how to generate superior returns and realize their business's full value potential.

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About the Author:

James M. McTaggart is the chairman of Marakon Associates, an international management consulting firm founded in 1978.

Excerpt. Reprinted by permission. All rights reserved.:

Chapter 1

The Governing Objective

We believe that all companies, especially publicly owned companies, should be managed to create as much wealth as possible. By this we mean that the company's resources should be managed to make them worth more than they would be if managed in any other way or by any other firm. This is an enormously demanding objective. To achieve it, management must focus on the continuous pursuit of opportunities to increase the value of the company's resources and establish maximizing wealth as not one of many equally important objectives, but as the preeminent or governing objective. Creating wealth is much more than a fiduciary responsibility, it is a hallmark of great management and great companies.

This book deals with the management of companies that are owned by private shareholders. For managers of shareholder-owned companies, maximizing wealth, or the worth of the company's human and financial resources, necessarily means the same thing as maximizing the value of the enterprise to its owners, or maximizing shareholder value. For the majority of companies with publicly traded shares, owners and managers have at their disposal a continuous objective appraisal of their success in wealth creation as reflected in the price of the companies' common stock. This assertion of the equivalence between the objectives of maximizing wealth and maximizing shareholder value is questioned by many managers who believe that investors typically undervalue, or fail to recognize, the wealth created by their companies. We will present considerable evidence to allay this concern, but for now, those with misgivings about the validity of capital market valuations might remember Winston Churchill's observation about democracy: "...it has been said that democracy is the worst system devised by the wit of man, except for the others."

Today virtually all chief executives and directors of publicly traded companies, especially in the United States, acknowledge that creating value for shareholders is an important corporate objective. But they face an awesome array of competing priorities, including other financial measures, such as earnings growth and return on investment; other strategic objectives, such as global cost competitiveness and market share leadership; and concerns for the welfare of their employees and the communities in which they operate. Thus, the major problem they face is not necessarily setting the objective itself but making it operational. One chief executive who obviously overcame this problem and expressed his conclusions as vividly as anyone ever has, put it this way:

The objective of our company is to increase the intrinsic value of our common stock. We are not in business to grow bigger for the sake of size, not to become more diversified, not to make the most or best of anything, nor to provide jobs, have the most modem plants, the happiest customers, lead in new product development, or to achieve any other status which has no relation to the economic use of capital. Any or all of these may be, from time to time, a means to our objective, but means and ends must never be confused. We are in business solely to improve the inherent value of the common stockholders' equity in the company.

We recognize, of course, that not everyone agrees that the governing objective of a company should be to maximize wealth or shareholder value. For example, here is one unequivocal opinion to the contrary:

Many managers in the United States still operate under the twin fictions that their most important stakeholders are shareholders, and that their primary purpose in management is to enhance shareholder value. Whether this is true from a legal perspective in the case of publicly traded firms is worthy of debate; but from a strategic and operational perspective, it is dead wrong for any firm -- publicly traded or privately held. A business does not exist for the benefit of investors, nor should it be run under that premise.

This and other challenges to managing for shareholder value are not uncommon, and we will respond to them later in this chapter. But first we need to clarify the governing objective and what it means for managers of public companies.

Elaborating the Governing Objective

The phrase "maximizing shareholder value" is often interpreted to mean something different from what we intend here, carrying at times even a negative connotation. By maximizing shareholder value, we do not mean that managers should make uneconomic decisions to try to hype a company' s stock price. The capital markets are much too astute to be fooled by any such maneuver, at least for long. Nor do we mean that managers should invest their time or energy in any sort of corporate image campaign designed to woo securities analysts to make "buy" recommendations or institutional investors to make "buy" decisions. The company's fundamental economic performance will speak for itself, and no amount of Madison Avenue spin control will have any but the most fleeting effect on a company's stock price. And finally, we do not mean to suggest in any way that corporations should become rapacious exploiters of their employees, customers, communities, or the environment.

In essence, the objective of "maximizing shareholder value" can only be achieved through a process of creating options and making choices. Every manager in every company is called upon to make thousands of decisions a year. All the most important decisions will involve making trade-offs, such as increasing R&D investments at the expense of current earnings, or increasing prices at the expense of volume growth, or investing to increase production efficiency at the expense of employment. On what basis are these decisions to be made, especially in huge decentralized organizations with operations spreading throughout the world?

Unlike very small companies, the modem corporation has no group of wise men and women at the top who can possibly oversee every decision and ensure that it complies with the company's objectives. Large, complex companies need a set of principles that are understood by all managers and can be used to inform their judgments about which decisions or choices to make. To be consistent and effective, these principles must be linked clearly to a single overriding decision criterion, or governing objective. We will argue that maximizing shareholder value is superior to any other governing objective a company might adopt because it will lead managers to make the decisions most likely to increase the company's competitive, organizational, and financial strength over time.

To make this point more concrete, it is useful to consider the following situation. The general manager of a highly profitable business unit within a large global company has identified three alternative strategies the business could pursue: the "Deluxe" strategy, which would focus on offering a highly differentiated product to select highend customers at a premium price; the "No Frills" strategy, which would focus on offering a good-quality but low-cost product at a low price to the mass market; and the "Everyman" strategy, which would serve all segments of the market by offering different features for the same basic product at attractive prices. Which strategy should the business pursue?

To answer this question, let us assume further that management has conducted a detailed analysis of each strategy, incorporating all the expected future benefits and costs to the business that would result from adopting any one of them. On the basis of this analysis, management has also estimated what the business would be worth if it were to implement any one of the alternatives successfully. The results of this analysis are shown in Exhibit 1.1.

With this information we can now rephrase the question to illustrate how the governing objective should be applied in this situation: Assuming that the business unit management team is capable of implementing each of these alternatives, are there any circumstances in which the general manager should choose either the Deluxe or the Everyman strategy?

We believe the answer is "No." The company's governing objective requires that choices of this type will be decided on the basis of maximizing value, which means in this case that management must choose to pursue the No Frills strategy. Note that this is true even when all three strategies in fact create value, because managing every business to create value is the minimum objective, not the governing objective, of a well-run company.

Experience tells us, however, that there are many instances where the No Frills strategy might not even have been identified, let alone selected, as the best strategy for this business. This is the central problem faced by all companies seeking to maximize wealth creation and, therefore, shareholder value: How can management ensure that each business in the portfolio will be able to identify, develop, and implement strategies to maximize the value of the resources with which it is entrusted?

We will deal with this question throughout the book. But we can begin to answer it by noting that managers must first overcome any hesitation they may feel about adopting wealth or value maximization as the governing objective of the company and every business, or business unit, within it. There are enormous internal and external pressures on management not to adopt such an objective, and many reasons are offered for not doing so. We address now the most commonly heard and accepted of these reasons and lay the groundwork for understanding why objectives other than wealth or value maximization will prove inferior in both the short run and the long run.

Addressing Challenges to the Governing Objective

The challenges to adopting value maximization as the company's governing objective generally fall into three camps. The first camp might be called the "capital market skeptics." This group, which includes many chief executives, generally accepts that increasing what they consider the intrinsic or warranted value of the company is an important objective. However, they argue, stock prices are such a poor measure of this warranted value that maximizing share price or shareholder value should not be the company's primary criterion for making important strategic and organizational decisions. The second camp takes the view that product market rather than capital market objectives should dominate decision making. This group of "strategic visionaries," which includes many academics as well as chief executives, argues that companies should focus on building market dominance or some specific competitive advantage in the product markets that will, by implication, also generate adequate financial performance. The third group argues that other stakeholders, such as employees and the community, have an equal or superior claim on the company's resources, and fairness mandates that management should make decisions to "balance" these competing interests. In this chapter we respond briefly to the challenge of the capital market skeptics and more fully to the strategic visionaries and those who argue for balancing stakeholder interests.

The Capital Market Skeptics

One of the most commonly heard objections to adopting maximization of shareholder value as the governing objective is that the prices set by investors in the stock market do not, on average, reflect what the company is really worth. Many believe that the stock market is guilty of "short-termism" or some other form of investor myopia that results in a persistent failure of stock prices to reflect the long-term value of the company. This argument was heard frequently in the 1980s as a management defense against hostile takeovers. For example, in 1986, when Champion International was rumored to be a takeover candidate, the company's CEO, Andrew Sigler, complained:

There is intense pressure [from investors] for current earnings, so the message is: Don't get caught with major [long-term] investments. And leverage the hell out of yourself. Do all the things we used to consider bad management.

The validity for capital market valuations is such an important subject that we will deal with it extensively, especially in Chapters Two, Four, and Five. We note here, however, that the claim that share price is not a good measure of value rests on the twin assumptions that (1) the capital markets systematically misprice (usually translated as underprice) the company's common stock, and (2) managers make strategic investment decisions using more robust, reliable measures of wealth creation than professional investors use. The evidence shows and our experience is, however, that both of these assumptions are wrong. We will demonstrate that in countries with reasonably weldeveloped capital markets, share prices provide the most accurate and least biased appraisal of a company's true value over time. Further, managers are generally not better than investors at estimating value, even though they typically have better information. In fact, it is only by understanding how investors determine values and set share prices that managers can begin to ensure that their strategic investment decisions will lead to consistent and significant wealth creation. We will return to this theme repeatedly throughout the book.

The Strategic Visionaries

Setting a strategic rather than a financial governing objective has considerable appeal for managers. Product market goals such as increasing or dominating market share (in a niche or on a global basis), maximizing customer satisfaction, or producing at the lowest cost all seem more immediate, easier to relate to, and easier to manage than maximizing shareholder value. In one important sense, we agree that good strategic management is essential to creating wealth. But the problem with product market objectives, as we see it, is that they do not have the relationship to good financial performance that their supporters seem to assume. In fact, depending on the particular circumstances of a business, investing to increase market share, to increase customer satisfaction, or to lower relative costs might well reduce shareholder value rather than increase it. Conversely, there are times when reducing market share, reducing customer satisfaction, or increasing relative costs will increase shareholder value. These conflicts, or tradeoffs, between product market and capital market goals are not rare. Indeed, they are the norm, and managers need to have a way of deciding what to do when these trade-offs, must be made.

To illustrate the problem in using a strategic or product market goal as a governing objective, it is helpful to look at maximization of customer satisfaction, which many managers and academics favor over maximization of shareholder value. One often-quoted viewpoint was expressed a number of years ago by Theodore Levitt of the Harvard Business School: "The purpose of a business is to create and keep customers." A very similar theme infuses the statements of many chief executives today, including this one from Paul Allaire, CEO of Xerox, who said: "I have to change the company substantially to be more market driven. If we do what's right for the customer, our market share and our return on assets will take care of themselves."

It goes without saying that no company can cre...

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