Increasingly, investors and managements are trying to gauge how good a company is at creating shareholder value. As ever, consultants have sprung up to service this need. Chicago-based HOLT Value Associates helps both corporations and investors to assess whether a strategy is likely to create shareholder value. HOLT's system draws upon the research of Nobel Prize winners Franco Modigliani and Merton Miller and seeks to value a share like a bond. If a bond is paying an interest coupon of 10% and the yield which the market requires from bonds of its maturity and quality is also 10%, it should trade at its par value of, say, £100. If, however, the required yield is 20%, the bond should trade below par: at £50 if the par value is £100, since an interest coupon of £10 on a £50 market price would produce a yield of 20%. Similarly, if a company is earning a return on its equity of 10%, and this is also its cost of capital, the reasoning is that its market value should equal the book value of its shareholders' funds. If the return earned is below the cost of capital, its shares should then trade in the market at a discount to the book value of its shareholders' funds, and vice versa.
Systems such as that used by HOLT help determine whether a company is earning more or less than its cost of capital. It is then a simple step to assess the appropriate capital strategy.