Managers pursue shareholder value, which says everything about stock-market supply and demand, writes Robert Heller, but nothing about management performance.
With stock-market tumult erasing billions of paper profits in a day, the cult of 'shareholder value' is looking distinctly raddled. Yet the pursuit of shareholder value continues to line the pockets of many executives. Sharp falls in the market have left many options valueless but even a temporary deprivation of fat profits won't easily persuade managerial devotees of crude shareholder value that it is a wildly inappropriate means of defining corporate strategy.
Price Waterhouse, as it then was, came up with a definition of sorts for shareholder value: 'The present value of future cash flows discounted at its weighted average cost of capital less the value of the debt'. The authors then continued: 'Perhaps your company has declared a commitment to shareholder value and you want an explanation'. Yet what kind of management commits itself to a prime directive that it can't even explain?
Commentators also dispense with the technical niceties. While Lou Gerstner has been praised by one magazine for raising IBM's value (on the stock market) 'more than $40 billion in four years'; management guru Henry Mintzberg, writing in the Financial Times, skewered such claims with three well-chosen words: 'All by himself'.
If Gerstner truly were the unique hero, he would also be the villain of every share fall. He would certainly own all the credit, or discredit, for IBM's dismal sales growth in a dynamic industry: 3% last year, down to zero this year. Business Week calculates that IBM would enhance value by selling five major businesses, enabling it to focus on core requirements such as customer service. That proposition hardly squares with enhanced shareholder value of $40 billion.
Others are less convinced by the cult. 'We won't use stock options for our managers, since they don't necessarily reflect corporate activity when they rise or failure when they fall,' Taizo Noshimuro, Toshiba's president, has said. His views are incontestable. Declines in market worth worldwide, and thus in shareholder value, say nothing about relative management performance but everything about the balance of stock-market supply and demand.
If shareholder value is an inappropriate basis for determining corporate strategy, earnings per share fall into the same frame, because they influence share prices. Correlations between earnings and prices are elusive, however, and earnings targets are notoriously inadequate anyway. Earnings are residuals, the result of effective or ineffective management, not only of costs and prices, but of every element in the whole business system.
Managements twist and turn as they search for a new story that will galvanise the analysts and elevate the price-earnings ratio. Jack Welch of General Electric, who pocketed $32 million from last year's options alone, is now reportedly considering a final, pre-retirement remake of the company's business system. His restless shake-ups would probably merit Mintzberg's disapproval as examples of 'change'. They appear to epitomise what he termed the 'ultimate in management noise ... companies being turned round right and left'. Yet this turmoil ('hypermen shouting about hypercompetition and hyperturbulence') has become inseparable from the cult of shareholder value.
One highly reliable ruse is to announce the sale of assets to concentrate on a new 'core'. Divestment may well add one-off value, simply by exploiting the market's low regard for the existing company - and its management.
Surgery is sometimes the only feasible remedy - as in the dismemberment of Dalgety, where not even a rump, let alone a core, remains. Sell-off exercises merely repair the devaluation wrought by past neglect of the real, intrinsic worth of businesses, however. To return to IBM, its PCs once had an Intel-like quasi-monopoly. Successive PC managements devalued the strategic strength of a marvellous brand. Other manufacturers, notably Compaq and Dell, were allowed to seize advantage after advantage, while a five-year lag behind Toshiba in laptops left IBM as a permanent follower.
Compaq's Eckhard Pfeiffer and Michael Dell are by no means indifferent to the share price but their true success lies in the design and creation of business systems that achieve non-financial prodigies of performance.
Dell has brought inventory down to eight days, a third of Compaq's. That must peeve Pfeiffer, who knows that management's proper target is to optimise the business system to achieve best-of-breed performance on all significant measures, internal and external.
Other things being equal, the company's true ability to generate superior revenue and profit growth over time will be mirrored in stock markets, though haphazardly. GE is valued much more handsomely than Hewlett-Packard, despite the latter's 41% greater growth in earnings over a decade. Taking the price as objective puts the cart far ahead of the horse. If putting the business unequivocally first also does wonders for shareholder value, so much the better for everybody - including shareholders.
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