Shareholder Value Creation in Companies

Value creation is key in creating and maintaining a successful company. However, some companies don’t acknowledge this and remain implementing an outdated and narrow approach to value creation in which they focus on optimising short term financial performance and ignore the broader influences that would determine their success long term.

Blackberry is a company that only focused on the short term financing activities and has been chasing the market ever since the decline in the usage of their phones. This has led to product delays and products that have failed to take off, in particular their Playbook tablet that was launched without email or a calendar. These activities have all led to Blackberry’s share price dropping by 77% in the last year. Furthermore, most recently the CEO of Blackberry, Thorsten Heins was removed from his position as he failed in his primary objective to the save the company yet still received a $22 million severance payment. This again shows Blackberry is not acting in the shareholders best interests and not even on the other side of the argument, the stakeholders interests.  

Competition is driving more companies to adopt a shareholder value maximisation approach in their business.  It is believed that managers should strive to maximise this value and in doing so social welfare is maximised. A normative consensus is now widespread that corporate managers should act exclusively in the economic interests of the shareholders yet no country, even the most shareholder-friendly USA or UK, have a legal requirement that managers should act solely in shareholders’ interest.

One of the methods identified to ensure this value is created and that can be used to ensure a long term view is accounted for is the value pentagon. This consists of five actions:

1.       Increase the return on capital

2.       Raise investment in positive spread units

3.       Divest assets from negative spread units to release capital for more productive use

4.       Extend the planning horizon

5.       Lower the required rate of return 

If managers are to follow the actions from the value pentagon they should not only increase value for shareholders but also increase the success and longevity of their company.

However numbers aren’t everything, suppose managers are unaware that they have increased the company’s share price to a level where the stocks intrinsic value is higher than the market value, this would defeat the long term view of a company. They would find it difficult in securing more finance for investment activities (so wouldn’t be able to meet point 3 of value pentagon) as shareholders are unlikely to buy shares if they are viewed as overpriced and existing shareholders may also be inclined to sell.

With this in mind it is important that shareholder wealth should be at the forefront of managers actions as in a semi-strong form market any news that is made public can affect the share price, as in the case of Blackberry.