Ch. 13: Managing for Shareholder Value  2002, Prentice Hall, Inc.

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Presentation transcript:

Ch. 13: Managing for Shareholder Value  2002, Prentice Hall, Inc.

Top Creators of Shareholder Value 1999 invested cost of MVA capital return capital Microsoft 328,257 10, %12.64% Gen Elect 285,320 65, % 11.92% Intel 166,902 23, % 12.92% Wal-Mart 159,444 36, % 9.82% Coca-Cola 157,536 13, % 11.24%

Market Value Added MVA = Firm Value - Invested Capital Firm value = market value of the firm’s outstanding debt and equity securities. Invested Capital = the sum total of the funds that have been invested in the firm.

Value Creation The combination of opportunity and execution. Opportunities must be recognized, and Employees must be ready, willing and able to take advantage of the opportunities.

Business Valuation: The Accounting Model Using the P/E ratio: If a firm’s P/E ratio is 20, then a dollar increase in earnings per share will create $20 in additional equity value per share. Problem: ignores R&D, which would reduce earnings per share, but should increase future earnings!

Business Valuation: Free Cash Flow Valuation Model Value = the PV of the firm’s projected free cash flows for all future years.

Business Valuation: Free Cash Flow Valuation Model Value = the PV of the firm’s projected free cash flows for all future years. Value = FCF + FCF + FCF + … + Terminal value ( 1+k) 1 (1+k) 2 (1+k) 3 (1+k) n

Value Drivers Variables that managers can tweak to increase firm value. Examples: Sales growth operating profit margin net working capital to sales ratio property, plant and equipment to sales ratio cost of capital

Economic Value Added

Net operating weighted average invested EVA t = profit after - cost of x capital t-1 tax (NOPAT) t capital (k wacc )

Economic Value Added Net operating weighted average invested EVA t = profit after - cost of x capital t-1 tax (NOPAT) t capital (k wacc ) alternative definition: Return on weighted average invested EVA t = invested - cost of x capital t-1 capital (ROIC) t capital (k wacc )

Paying for Performance Shareholder and manager interests are aligned when: contributions of individuals and groups toward creation of shareholder value are measured using EVA, and rewards are structured accordingly.

Components of a Firm’s Compensation Policy base pay bonus: quarterly, semi-annual, or annual long-term compensation: options, grants

Designing a Compensation Program 1) How much to pay? 2) Base pay versus at-risk or incentive compensation 3) Linking incentive compensation to performance 4) Paying with a cash bonus versus equity