Ch. 13: Managing for Shareholder Value

1
Ch. 13 Managing for Shareholder Value
? 2002, Prentice Hall, Inc.
2
Top Creators of Shareholder Value1999

• invested cost of
• MVA capital return capital
• Microsoft 328,257 10,954 56.16 12.64
• Gen Elect 285,320 65,298 19.29
  11.92
• Intel 166,902 23,626 35.44 12.92
• Wal-Mart 159,444 36,188 13.24
  9.82
• Coca-Cola 157,536 13,311 31.22
  11.24

3
Market Value Added

• MVA Firm Value - Invested Capital
• Firm value market value of the firms
  outstanding debt and equity securities.
• Invested Capital the sum total of the funds
  that have been invested in the firm.

4
Value Creation

• The combination of opportunity and execution.
• Opportunities must be recognized, and
• Employees must be ready, willing and able to take
  advantage of the opportunities.

5
Business ValuationThe Accounting Model

• Using the P/E ratio
• If a firms P/E ratio is 20, then a dollar
  increase in earnings per share will create 20 in
  additional equity value per share.
• Problem ignores RD, which would reduce
  earnings per share, but should increase future
  earnings!

6
Business ValuationFree Cash Flow Valuation Model

• Value the PV of the firms projected free cash
  flows for all future years.

7
Business ValuationFree Cash Flow Valuation Model

• Value the PV of the firms projected free cash
  flows for all future years.
• Value FCF FCF FCF Terminal value
• ( 1k)1 (1k)2 (1k)3
  (1k)n

8
Value Drivers

• Variables that managers can tweak to increase
  firm value.
• Examples
• Sales growth
• operating profit margin
• net working capital to sales ratio
• property, plant and equipment to sales ratio
• cost of capital

9
Economic Value Added
10
Economic Value Added

• Net operating weighted
  average invested
• EVAt profit after - cost of
  x capital t-1
• tax (NOPAT)t capital
  (kwacc)

11
Economic Value Added

• Net operating weighted
  average invested
• EVAt profit after - cost of
  x capital t-1
• tax (NOPAT)t capital
  (kwacc)
• alternative definition
• Return on weighted
  average invested
• EVAt invested - cost of
  x capital t-1
• capital (ROIC)t capital
  (kwacc)

12
Paying for Performance

• Shareholder and manager interests are aligned
  when
• contributions of individuals and groups toward
  creation of shareholder value are measured using
  EVA, and
• rewards are structured accordingly.

13
Components of a Firms Compensation Policy

• base pay
• bonus quarterly, semi-annual, or annual
• long-term compensation options, grants

14
Designing a Compensation Program

• 1) How much to pay?
• 2) Base pay versus at-risk or incentive
  compensation
• 3) Linking incentive compensation to performance
• 4) Paying with a cash bonus versus equity