UK: EDITORIAL - CASH, CAPITAL AND COMMON SENSE. - British managers are at last beginning to appreciate the significance of shareholder value. It has taken an age for this concept to get across the Atlantic, largely because of the staggering failure of fu

Last Updated: 31 Aug 2010

British managers are at last beginning to appreciate the significance of shareholder value. It has taken an age for this concept to get across the Atlantic, largely because of the staggering failure of fund managers and analysts to give it proper attention. Now that it is reaching a wider audience, managers in commerce and industry cannot afford to ignore it.

Consultants are ever keen to turn an idea into an industry. In this case there is nothing to be gained. The underlying principles of shareholder value are pure common sense. They are second nature to almost all owner-managers. To this group, the point of running a business is to generate cash, rather than profits. (As a senior venture capitalist remarked recently, good private businesses have been ruined by discovering the notion of profit.) But shareholder value has another key ingredient besides an appreciation of cash-generation. It is equally vital that cash returns should be measured against capital deployed - which includes newly generated funds retained in the business. This, again, is well understood by the owner-manager, who recognises the sense of taking money out of the business and transferring it to his or her own pocket or pension fund - unless it is going to generate a measurably better return by being reinvested.

At last, public companies are on to the secret. As Terry Smith points out in Many Happy Returns (p56), an increasing number are choosing to hand back surplus funds to their owners rather than diminish shareholder value by continuing to invest in low-yielding operations. As the financial markets come to distinguish between companies which seek to enhance shareholder value and those which destroy it (this is the hard part, since it calls for genuine analysis), their recognition will be reflected in share prices.

What does this mean for Britain's corporate infrastructure? The vision of large numbers of major British businesses busily shrinking themselves (or worse), wholly in the interests of their shareholders, is neither politically nor socially appealing. In The Pursuit of Immortality (p36), Simon Caulkin notes the depressingly high mortality rate among even the largest companies and concludes, echoing Drucker, that the long-term aim of any company is to survive. So are we to be left with a stark choice between short-lived wealth creators and ponderous, stable, underperformers?

The answer is clearly No. A company will survive only as long as all its stakeholders continue to grant it a licence to trade. By establishing the enhancement of shareholder value as the basis on which shareholders grant their part of this licence, the company removes many of the more dubious reasons why the licence might be revoked by any class of stakeholder. The managers who consistently enhance shareholder value - and who communicate this achievement effectively - are those who will give their companies the best chance of survival in the long term.

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