Chapter 13 - Managing for

Shareholder Value

Top Creators of Shareholder Value

for 2001 ($ Millions)

Gen Elect
Microsoft
Wal-Mart
Intel
Citigroup

MVA
339,200
325,872
221,166
169,980
155,695

invested
cost of
capital
return
capital
82,111
20.0% 9.4%
26,343
21.5% 13.7%
65,677
12.4%
8.9%
41,397
9.0%
16.2%
104,210 14.7% 12.0%

Market Value Added

MVA = Firm Value - Invested Capital
Firm value = market value of the firms
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.
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 firms 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 firms projected free cash
flows for all future years.

Business Valuation:
Free Cash Flow Valuation Model
Value = the PV of the firms 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

Economic Value Added

Net operating

EVAt =

profit after
tax (NOPAT)t

weighted average

cost of
capital (kwacc)

invested
x capital t-1

Economic Value Added

Net operating
weighted average
invested
EVAt = profit after cost of
x capital t-1
tax (NOPAT)t
capital (kwacc)
alternative definition:
Return on
weighted average
EVAt = invested
cost of
x
capital (ROIC)t
capital (kwacc)

invested
capital t-1

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 Firms
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