Topic 1: Shareholder Value Maximisation Flashcards
What is shareholder value?
Shareholder value is:
- equity value
- enterprise value and invested capital
How is shareholder value measured?
EV - Debt = equity
How is shareholder value created
- maximise the value of the enterprise or firm
- maximise the value with the available resources
- invest in projects where returns > cost
- NPV positive projects
- good decisions
How is shareholder value destroyed
- invest in projects where returns < cost
- not being able to obtain capital on time (opportunity cost, capital constrained)
- dumb decisions
- agency costs
SHareholder value: what about other stakeholders and ethics
eg community, debtors
Define:
- Enterprise Value
- Invested Capital or Capital Employed
- Market Value Added. (Define, and equation)
- Enterprise Value: how much business is worth. Market Value concept, combined value of equity (# shares x price) and debt
- Invested Capital or Capital Employed: amt historically injected by capital providers. Book value concept (on B/S, eg = shareholders funds and Debt = Interest Bearing Debt)
- Market Value Added: Difference between Mkt Val & IC
MVA = Enterprise Value - Invested Capital
Why is shareholder value the decision criterion (the x goal)
- work out by shareholder value whether smart decisions are being made
Expected Cash flows
- in practice / adjustment
- Calculation serves several purposes (3)
- in practice / adjustment: uncommon to formally calculate expected CFs, more likely to estimate. Discount factor is then made higher than the cost of capital to compensate for optimism in CFs
- Calculation serves several purposes (3)
1. incorporate potential outcomes into a single measure
2. If prob of distrn of CFs is asymmetric then it properly weights possible outcomes
3. forces assessment of possible risk outcomes, good discipline / realistic outcomes
Shareholder (Equity) vs Enterprise Value - discuss transferring value
- Lenders return is fixed. Shareholders receive any residual value
- If there is significant default probability, debt holders may not get prespecified returns
- Shareholders may have incentive to take action (step up risk, under invest) that enhance their position relative to debt holders. This is TRANSFERING VALUE from lenders rather than CREATING VALUE
Why is shareholder value maximisation the right objective (4)
What is the goal
LT vs ST
- investors provide capital to support investment. Less capital provision = less economic development
- By following market price signal, this should also maximise value of society resources (capital flows to areas where there is most value creation potential)
- Value is a single measure that incorporates trade-offs (eg LT vs ST)
- If value is not maximised - could make firm potential for takeover putting the assets in the hands of those that can better maximise value
Goal: maximise the PV of future CFs. Invest in all NPV positive projects
Lt vs ST: rewards should be for long term value maximisation rather than ST share price targets
Maximising shareholder value does not mean: (4)
Maximising shareholder value DOES NOT mean:
- statement of strategy
- unjustified overvaluation (should instead develop & implement good strategy). In LT this could be destructive
- Does not necessarily mean the same as maximising current share price. (Too short term)
- Not a whitewash for illegal or unethical actions (eg environmental damage)
Alternatives to shareholder value maximisation (3)
alternatives: focus on:
1. corporate governance
2. tradeoff between competing stakeholders
3. Long term value creation requires a combination of governance, appropriate performance criteria and appropriate incentive structures
Ethics of an action (3)
- duty
- virtue
- consequences
Agency issues
- requirements for conflict (2)
- examples
- costs incurred
- principal / agent relationship
- incentive conflict
Examples
- perks
- shirking
- lower than optimal performance management
- potentially poor investment decisions via overpayments, diversifying investments, over invetsment
Costs incurred:
-monitoring
- bonding costs
- what remains after these two costs is ‘residual’ loss
Governance and Corporate Control
- define
Define:
- governance is the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations.
- Encompasses mechanisms by which companies and those in control are held to account