creation of shareholder value

The Primary Goal of Companies: Increasing Profit and Maintaining Growth

The primary goal of any company or corporation is to increase profit and maintain growth. When the two priorities are met, the shareholder becomes a central player in achieving the two aims. We will entertain shareholders with numerous offers that only impact short-term goals and make the business’s future unlikely. As a result, any decision taken by the management affecting the owners must take the long run into account. It is the managers’ and investors’ responsibility to engage in long-term growth strategies while ensuring that shareholders receive a good return on their investment. The author argues that shareholders are more concerned with short-run earnings rather than the long-run (Rappaport, 2006). Henceforth, management at no time should it decide with the aim of trying to align with the interest of shareholders; it may result in reduced performance by the company.

The Importance of Guiding Principles for Shareholder Value Creation

To begin, the author emphasizes that the management should be guided by the ten principles that ought to follow when creating shareholders value (Rappaport, 2006). Even though the rules have some excellent points, the paper shows misinterpretation of rational behavior of human being. Thus, it cannot necessarily add value to shareholders wealth, and they seem unpopular to the shareholders and the investor. For instance, the principle of does not manage earnings or provide earnings guidance. Haksever et al., suggest that none of the shareholders will feel comfortable to be in a company, which has no guidelines and advice on the streams of income from the investment (Haksever et al., 2004). The second principle also if adhered to, will not create value to the shareholder. The principle of maximizing expected value, at the expense of lowering the near term earning. Shareholders are rational, and they react to reasonable expectation. Nobody will feel good to gain little at present at the expense of the future.

Creating Shareholder’s Wealth: Ten Ways to Add Value

Ten ways of creating the shareholder’s wealth by the author in the article come up, with many aspects adding up to wealth creation of shareholders. Despite some unrealistic principles such as those mentioned earlier. The paper contributes a lot of knowledge in the world of business management and the wealth creation among shareholders and investors (Rappaport, 2006). Senior managers and investors should possess excellent management skills, superior accounting system, and accountability, and invest in long-term growth. The managers believed in shareholders ideology which included; short-term earning, believes that it would fuel stock prices, executives were stimulated to manage earnings, cash out when any chance arises, exercising their options early and accelerating the vesting date for a chief executive officers options at retirement (Rappaport, 2006). The investors earning from shares raised tremendously, the stock price rose to the level of double-digit, but these did not last for long due to changes in the corporate world. It was brought about by sharp stock market decline and accounting scandals which caused a corporate collapse. The downfall of the corporate sector gave direction for the known swift regulatory response commonly known as the 2002 passage of the Sarbanes-Oxley Act (SOX) (Rappaport, 2006). Under the act, companies are required to establish intricate internal controls and make corporate executives directly accountable for the accuracy of financial statements.

Examples of Applying and Violating the Principles

As earlier mentioned, the author gives out a clear explanation of the ten principles. Moreover, the author gives examples of companies that at one time violated or followed any of the underlying principles and the consequences that followed afterward. The author, for instance, provides an example of Kmart, ESL investment, the company adhered to the 4th principle “carry the only asset that maximizes value” (Rappaport, 2006). The business by 2002, its shares were trading at less than $1(Rappaport, 2006). The management after deciding to sell stress to home depot and sears, closing underperforming stores, and reducing capital spending levels and clearing sales. The changes made the company shares to be trading at $30 by the end of 2003, and the following year it reached $ 100 (Rappaport, 2006). The principles include not giving shareholders earning guidance, making a strategic decision that maximize expected value even at the expense of lowering earnings, carrying only assets that maximize the value, returning cash to shareholders when there are no value-creating chances to invest in the activities. Then, rewarding senior executives; delivering superior long-term returns for the company operation. Finally, satisfying middle managers and frontline employees for giving a top performance on the significant value drivers that affect directly senior executive to bear the risk of ownership just as shareholders do (Rappaport, 2006).

Challenges and Considerations for Shareholder Value Maximization

In contrast, the author fails to explicitly address the following aspect such as the tendency of the managers to continue practicing the short-term goals and strategies. Freeman et al., point that long-term interest of shareholders becomes hard to exercise since the majority of the shareholders are after short-term gains if such environment avails itself (Freeman et al., 2004). The issue becomes more complicated now that no guarantee of maximizing near-term earnings and the future uncertainties of that surround companies, even in absentee of pursuing the long-term shareholder value maximization. It makes the shareholders indifference between the prioritizing interest and gain in short run and long run. Moreover, to measure the stock price is very hard, unless, if the shareholder takes a precise monitoring of stock price within an extended period; approximately ten years as the author highlights. Hence, emphasis on long-run value creation for shareholder does not make a sensible meaning to the shareholder. The stock price keeps on fluctuating from time to time. So, any rational shareholder will prefer more to less, and consider the short-term decision if they yield high value in the stock price. The mix of high and low turnover over the cost of shares and stock makes the future wealth creation unpredictable for the shareholders. Accordingly, the shareholders will choose between the short run and long run depending on value addition to their investment in either of the two. The primary concern of the shareholders is the value of stock price and that of their investment in shares (Freeman et al., 2004). No shareholder will forgo the present high estimates of their stock for more future earnings. Additionally, a shareholder cannot consider current low earning in fear of coming worsening in stock market prices. Hence, they cannot necessarily be directed to invest in the long run.

Limitations and Omissions in the Author’s Arguments

Despite the author coming up with an ethical principle, which can add value to the shareholder and the investor if well followed, the author does not address the issue of economic shocks, political instability, and catastrophes that can affect share performance of any company. These factors always affect the earning from any shares and also the prices of the stock market (Haksever et al., 2004). The paper concentrates mostly on organization behavior, management and rewarding of the employees especially that of senior employee and the other executive stakeholder. Also, it fails to address various ways of promoting performance appraisal of junior workers. The junior workers also need motivation just like the senior employee.

The Role of Competition and External Pressure

The issue of the external pressure such as the competition from the company operating the similar business or offering related services. Very few companies, if any work away from competition. To maximize and create more value to shareholders earning the group should come up with various measures and strategies to counter the rival company in the business (Haksever, 2004). Thus, the author fails to highlight this issue; the factor is crucial in such a way that when the competition is very aggressive, the rival company may opt out of the market. The company gets out of the market if they consecutive make losses with low sales, keeping other factors constant.

Challenges in Applying Principles to Shareholders

It is worth noting that the author’s first, the second and ninth principle of value addition to shareholders cannot apply to any rational shareholder. The first policy states that management does not provide earnings guidance to shareholders. Any sensible invest cannot invest where there is lack of the necessary information concerning future streams of income and the earning of shares and expected returns on stock prices. The second principle states that the investor should make a strategic decision that maximizes expected value, even at the expense of near-term earnings. Any sane investor would consider the short run favorable returns on investments since the future accompanies many uncertainties that cannot guarantee positive returns. And so, the argument of the author will not be considered by many shareholders. The action of stakeholders makes hard for managers and senior employee to run the company. Their decision and interest have a significant impact; comprises a portion of stakeholder in any organization. The ninth principle states that senior executive to bear the risk of ownership just as the shareholder does. The author fails to realize that not all executives will be willing to buy the shares in the company where they are working. According to the Bratton and Wachter, some senior executive does not pay loyalty to their business (Bratton & Wachter, 2010). Thus executive may hold significant high position and yet the company is performing poorly. For that reason, they can’t invest in poor performing company.

Conclusion

Apparently, the author has written an outstanding work. The article highlights various ways of adding the cost of stakeholder notably an emphasis on investment for long-run future streams of income rather than short-run earnings. While giving out multiple examples to justify the importance of each of the principle, the author stresses so much on the predicament that surrounds companies that consider the interest of shareholders and make the decision in short run. The ideas of the author are supported by the example of businesses that follow its principles and those that violate, and the consequences afterward. The author has been able to come up with the ten principles that management should adhere to add value to shareholders. Apart from ten principles, shareholders may violent them, and shareholders are ration human being who prefer earning today than more in unpredicted future in their investments. In spite of the good work on how to create value-addition for the shareholder, the author fails to address the external pressure such as competition from other companies, economic shocks and rational behavior of human being. Recommendation for further studies should include factors that ensure the creation of sustainable value addition for shareholders.

References

Bratton, W. W., & Wachter, M. L. (2010). The case against shareholder empowerment. University of Pennsylvania Law Review, 653-728.

Freeman, R. E., Wicks, A. C., & Parmar, B. (2004). Stakeholder theory and “the corporate objective revisited”. Organization science, 15(3), 364-369.

Haksever, C., Chaganti, R., & Cook, R. G. (2004). A model of value creation: Strategic view. Journal of Business Ethics, 49(3), 295-307.

Rappaport, A. (2006). Ten ways to create shareholder value. Harvard Business Review, 84(9), 66-77.