What is Shareholder Value?

Shareholder value refers to the value of common stock equity owned by corporate shareholders.

Shareholder value

along with

pursue

The concept of shareholder value in the 1990s was deeply rooted: the company focused all its energy on pleasing shareholders, so their stock prices skyrocketed.

This has not been the case for some time. Even taking into account the recent rebound in the stock market, the total return on the S & P 500 has been negative so far in the new millennium. This decade's collapse of Enron and WorldCom (and many other smaller ones) was due to an overeager desire to please shareholders.

Recently, several of our top financial institutions have implode, and the reason is that the executives of these institutions firmly believe that it is their mission to pursue higher returns for shareholders. The situation is so bad that even Jack Welch stood up a few months ago and said it was "the stupidest idea in the world" (his tenure at GE could also be summed up in pursuit of shareholder value).

Is Jack right? Is this really stupid idea? The key depends on how you understand it. In 1981, an article in the Harvard Business Review introduced a term to the world, and Alfred Rappaport, a professor of accounting, tried to construct a "theoretically complete and practically feasible The model of "operating enterprises" maximizes the "economic value of shareholders".

His goal is to get the company's management to focus less on book profits, and more on economic profits, that is, discounting future expected cash flows from the cost of capital. His theory requires not to place too much emphasis on quarterly earnings, but to focus on creating long-term value. It doesn't sound stupid.

Rapaport, 77, is semi-retired and still writes articles for Harvard Business Review from time to time and is writing a new book. "I don't know how many times I have said it: long-term, long-term, long-term. For me, shareholder value is not an immediate increase in stock prices," he said.

However, this is exactly what happened in the 1990s. Those CEOs who adhere to the credo of shareholder value have fallen behind in an attempt to please the stock market. They are scorched in order to meet their quarterly profit target, but doing so has reduced the company's value.

Why is this happening? Part of it is the greed brought about by the economic incentives in executive compensation, and because of a strange accounting rule, compensation contains excessive stock options. But it also comes from a strong but flawed idea, the "efficient market hypothesis" also born on university campuses.

Efficient market theory was born in the 1960s at the University of Chicago School of Business, and it became popular in the 1990s that the stock market was priced correctly. If the stock price is correct, maximizing shareholder value is the simplest thing in the world. The late famous University of Chicago financial scholar Merton Miller stated in 1993: "Focusing on recent earnings may be short-sighted, but focusing on stock prices is not the case, because stock prices reflect not only current earnings, but also The market expects earnings in the coming years. "

The stock price does reflect future expectations, but after decades of research, we now know that the stock price also reflects too much else: sentiment, errors, and often improper incentives in the money management industry. Rappaport said the stock market "contains a lot of misinformation in the short term." As a result, for those who seek long-term shareholder value, stock prices are basically a useless reference signpost.

So is shareholder value a stupid idea? No, but it is a difficult thing to understand, because to understand it properly, you need to ignore your shareholders.