Anas Mujaddidi

Assignment 1

Advanced Corporate Finance (MBA II)

Summary

Executives have developed tunnel vision in their pursuit of shareholder value, focusing
on short-term performance at the expense of investing in long-term growth. It's time to
broaden that perspective and begin shaping business strategies in light of the competitive
landscape, not the shareholder list. In this article, Alfred Rappaport offers ten basic
principles to help executives create lasting shareholder value. For starters, companies
should not manage earnings or provide earnings guidance; those that fail to embrace this
first principle of shareholder value will almost certainly be unable to follow the rest.
Additionally, leaders should make strategic decisions and acquisitions and carry assets
that maximize expected value, even if near-term earnings are negatively affected as a
result. During times when there are no credible value-creating opportunities to invest in
the business, companies should avoid using excess cash to make investments that look
good on the surface but might end up destroying value, such as ill-advised, overpriced
acquisitions. It would be better to return the cash to shareholders in the form of dividends
and buybacks. Rappaport also offers guidelines for establishing effective pay incentives
at every level of management; emphasizes that senior executives need to lay their wealth
on the line just as shareholders do; and urges companies to embrace full disclosure, an
antidote to short-term earnings obsession that serves to lessen investor uncertainty, which
could reduce the cost of capital and increase the share price. The author notes that a few
types of companies--high-tech start-ups, for example, and severely capital-constrained
organizations--cannot afford to ignore market pressures for short-term performance. Most
companies with a sound, well-executed business model, however, could better realize
their potential for creating shareholder value by adopting the ten principles.

For example, a vast majority of financial executives report that they would reduce value-
increasing expenditures to meet earnings targets. Such earnings management is futile,
however, because earnings do not measure economic value well and the positive effects
of such earnings management practices, if any, are short-lived. Rather, companies should
make strategic decisions that maximize expected value, regardless of the effect on short-
term earnings. This principle applies to acquisitions as well. Nonetheless, most
companies and investment bankers consider the impact of price-to-earnings multiples on
EPS to evaluate a deals attractiveness. This criterion, however, is unrelated to the
economic soundness of a merger and acquisition transaction. Another extension of the
value-maximizing principle applies to underproductive assets. Implementing this
principle means continually monitoring whether detachable assets, such as business units,
brands, or real estate, can attract potential buyers who are willing to pay a premium. It
also means outsourcing low-value-added activities when they can be reliability performed
by others.

Value-maximizing behavior extends to financing principles like dividend policy and share
repurchases. Value-conscious companies return cash to shareholders when no credible
investment opportunities exist. Four of the value-enhancing principles relate to
structuring compensation and incentive packages for senior management and middle
management based on such economic measures of value as shareholder value added, not
on stock options or accounting-based measures such as earnings. Finally, companies
should disclose value-relevant information, such as revenue and expense accruals and a
range of their anticipated values.