Ch. 13: Managing for Shareholder Value
2002, Prentice Hall, Inc.
(cid:211)
Top Creators of Shareholder Value 1999
invested
cost of MVA capital return capital
56.16% 12.64% Microsoft 328,257 10,954 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%
Market Value Added
MVA = Firm Value - Invested Capital
Firm value = market value of the firm’s outstanding debt and equity securities.
Invested Capital = the sum total of the
funds that have been invested in the firm.
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.
Business Valuation: The Accounting Model
• Using the P/E ratio:
• If a firm’s P/E ratio is 20, then a dollar
increase in earnings per share will create $20 in additional equity value per share.
• Problem: ignores R&D, which would reduce earnings per share, but should increase future earnings!
Business Valuation: Free Cash Flow Valuation Model
• Value = the PV of the firm’s projected free cash
flows for all future years.
Business Valuation: Free Cash Flow Valuation Model
• Value = the PV of the firm’s projected free cash
flows for all future years.
Value = FCF + FCF + FCF + … + Terminal value ( 1+k)1 (1+k)2 (1+k)3 (1+k)n
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
Economic Value Added
Economic Value Added
Net operating weighted average invested EVAt = profit after - cost of x capital t-1 tax (NOPAT)t capital (kwacc)
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)
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.
Components of a Firm’s Compensation Policy
• base pay • bonus: quarterly, semi-annual, or
annual
• long-term compensation: options,
grants
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
