In recent years the concept of
creating shareholder wealth has been a widely debated topic within the business
society, with a vast number of businesses following the concept that if the
company builds value then the share price will follow. Queen (2014) argues that the role of a
corporation is to strike a balance between their economic responsibility to
shareholders and their social responsibility towards society; recently
companies have aimed to integrate shareholder maximisation and stakeholder
management in order to achieve longer wealth creation for shareholders. On paper the concept seems an easy one to
follow, be responsible towards society as well as conducting business in a
manner that will also maximise shareholders returns!
Shareholder theory dictates that a corporation’s
only social responsibility is to engage in free competition without committing
fraud with the objective to increase profits thus benefiting shareholders
(Friedman, 1970). In contrast to this
stakeholder theorists believe that corporations have a responsibility to
shareholders as well as stakeholders because the actions of a firms managers
impact the owners as well as stakeholder groups (Freeman, 1984), I personally
would agree with stakeholder theorists, by taking into consideration
stakeholders such as suppliers, employees and society a firm can be seen as a
responsible, surely that alone can create shareholder value as consumers are
more likely to purchase from corporations who are ‘good’ and boycotting those
who are ‘bad’.
In order to create shareholder
value firms must have three key elements, a clear strategy, the capabilities to
achieve these strategies and the finance in order to implement these strategies. If companies devise a strategy but do not
have the organisation capabilities to implement it, it can result in a loss in
shareholder faith which is reflected by a fall in share price with Enron and
Tesco being prime examples of this in the media.
Wealth creation measures can be entirely
reliant on the stock market as it can be assumed that the stock market operates
efficiently and that the price of any share is determined through the market’s
expectations about the firm’s value creation abilities.
Earnings per share can be used as a
an measure to evaluate a firms value creation, a successful company will have a
high growth in their earnings per share, however many critics have argued that
it is the discretion of the company to decide what is an ‘exceptional’ items
therefore this figure can be subject to manipulation, this EPS figure also
doesn’t take into account a company’s debt position.
It should be noted that shareholder
value creation is a choice, not an obligation; directors of publicly held
companies have a general duty of loyalty and care for the corporations they
serve but not to the shareholders of the firm. William Lazonick, a professor of economics
put forward a viable argument criticising the idea of shareholder value
creation, he notes that
since the late 1970s companies have moved from a ‘retain and reinvest’ approach
to a ‘downsize and distribute’ philosophy which has resulted in short termism
and employment instability. This
argument has also been backed by James Montier, a behavioural finance writer
who claimed that shareholder value maximisation failed the very people it was
intended to benefit- the shareholders.
He argues that despite enormous increases in CEO compensation and a rise
in financial incentives through stock ownership shareholders are no better
off. To illustrate this point he used the
example of IBM verus Johnston and Johnston, IBM switched its focus to
shareholder value maximisation while Johnston and Johnston emphasized its
responsibility to customers and employees and indeed it showed that the stock
of Johnston and Johnston from 1971-2013 outperformed IBM. This example could shows that Queen (2014)
had a viable argument in suggesting companies need to strike a balance, after
all how can a company maximise shareholder wealth if they don’t take into
consideration the very people they rely on to keep their business running;
their employees and their customers.
The other side of the argument is that CEO’s should focus on
shareholder value creation as after all they are the owners of the company,
however it is proposed that there is a right and wrong way of doing this.
Karl Stark and Bill Stewart the co-founders of Avondale highlight a
number of principles to follow; to increase revenue by choosing
the right customers, offering them differentiated products and treating them
well, improve gross profits by choosing
the right suppliers and working with them to create win-win partnerships and
increase returns on operating cost investments by choosing the right employees and
working with them to maximize their productivity and creative ability.
Rapparort (2006) highlighted two principles
of creating shareholder value are to make strategic decisions that maximise
expected value even at the expense of lowering near term earnings and to carry
only assets that maximise value. These
principles were evidenced when the BBC news reported that EasyJet made the
strategic decision to back plans to open a new runway at Heathrow airport
instead of Gatwick even though Gatwick airport is EasyJet’s largest UK
base. This decision will require EasyJet to invest
a large amount of finance in order to expand Heathrow, however they explain
they made this decision as it was in the ‘best interest of the passengers’ and
that if they were to choose Gatwick it would result in higher fees for Gatwick
passengers due to an increase in airport charges. This is a prime example of Karl Stark and Bill Stewart’s principle of
treating your customers well, by choosing to back Heathrows plans Easyjet can
offer a better service to its customers which should increase brand loyalty,
encourage repeat purchases and this positive action should be reflected in
their share price thus creating shareholder value.
As we can see in the share price graph below,
when this story was published on January 30th share price dropped
significantly, this could suggest that whilst the Heathrow expansion is
beneficial for its customers, its investors have a different opinion on the
matter. However we can see in the lead up to this
announcement share price increased significantly suggesting that whilst
investors would not have known for certain that Easy jet planned to back
Heathrow they may have had a good idea that this was going to be announced.
Easyjet share price 26th Jan to 6th of February
It is obvious that an increasing number of firms are becoming more
focused on creating shareholder value, having read a number of blogs and
academic literature it seems that on paper the idea is viable however many are
sceptical about its execution in the modern day business environment. For me the most important aspect of creating
shareholder value is ensuring the key principles are followed correctly by an
organisation then I believe they should see an increase in market share price,
thus rewarding the CEO’s and motivating them to continue to create shareholder
value. As Easyjet have not yet began their expansion
at Heathrow airport I cannot discuss whether or not it has created shareholder
value but I am confident it will!
References:
Freeman, R. E. (1984). Stakeholder
management: Framework and philosophy. Mansfield, MA: Pitman.
Friedman, M. (1970, September 13). The
social responsibility of business is to create profits. New York Times
Magazine,
pp. 122–126.
Financial
Times. (2014, February 6). easyJet plc, EZJ:LSE summary - FT.com. Retrieved
from http://markets.ft.com/research/Markets/Tearsheets/Summary?s=EZJ:LSE
Lazonick, W.,
& OSullivan, M. (2000). Maximizing shareholder value: a new ideology
for corporate governance. Economy and Society, 29(1),
13-35. doi:10.1080/030851400360541
Montier, J.
(2014, November). James Montier on Livestream [Video file].
Retrieved from http://new.livestream.com/livecfa/EIC-Montier/videos/65181626
Queen, P.
(2014). Enlightened Shareholder Maximization: Is this Strategy Achievable?Journal
of business ethics.
Rappaport, A.
(2006). Ten Ways to Create Shareholder Value. Retrieved from
Harvard Business Review website:
http://cmsu2.ucmo.edu/public/classes/young/Guidance%20Research/Ten_ways_to_create_sharholders_value-Alfred_Rappaport.pdf
Stark, K.,
& Stewart, B. (2012, January 18). Maximizing Shareholder Value Is Not
a Dumb Idea. Retrieved from
http://www.inc.com/karl-and-bill/maximizing-shareholder-value-is-not-a-dumb-idea.html
Westcott, R.
(2015, January 30). BBC News - Budget airline Easyjet backs Heathrow expansion.
Retrieved from http://www.bbc.co.uk/news/uk-england-london-31060825
No comments:
Post a Comment