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What is Shareholder Value?
Shareholder value refers to the value of a publicly traded company, minus its debts. The value of a firm is often calculated as the Net Present Value of all future cashflows, plus the value of all non-operating assets owned by the company. Non-operating assets may include things such as excess real estate, stocks, and overfunded pension plans. The shareholder value of a company can also be seen as anything that would be left over of the company if all creditors are fully paid off. Things such as dividends increase shareholder value, while the issuing of additional shares of stock dilutes it.
The phrase “shareholder value” originated as a business buzzword in the 1980s, and is often associated with businessman Jack Welch, who formerly served as the Chief Executive Officer (CEO) of General Electric. Apart from the mathematical definition, shareholder value can refer to other ideas as well. It is sometimes used to refer to the concept that the chief aim of a public company is to provide financial value to its shareholders, which are its literal owners. More specifically, it can also mean that a shareholder’s money -- that which they used to purchase stock -- should give him a higher return than he could achieve as an individual, investing in other assets of similar risk.
One less-common definition of shareholder value is the current price of all shares of stock, multiplied by the number of shares. However, this value is most often referred to as a company’s market capitalization. This definition leads into one important aspect of the philosophy behind the concept of shareholder value- the fact that it can sometimes emphasize profitability over responsibility. In other words, there is a strong push to increase the price of a company’s stock when organizations are seen primarily as instruments of their owners.
Businesses must of course be profitable to survive in a market economy. Indeed, high stock prices are not only a result, but also a source of corporate wealth and competitiveness. But, one of the main criticisms leveled against the shareholder value philosophy is that it may fail to take into account that businesses are not only economic machines, but organizations of people. These organizations operate in a society where things such as employment practices and ethical conduct are of great importance. Unethical activities which may temporarily increase a company’s shareholder value may end up being detrimental to a company, to the extent that it is held accountable for such actions.
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Discussion Comments
@David09 - I used to think that market capitalization was the real way to define shareholder value. From the article it appears that this is indeed one possible definition.
However upon further reading I am convinced that the more appropriate definition is the lead one: the value of the company minus its liabilities. In the end, that is what the analysts like to call the real “fundamentals,” and that will ensure the company will remain steady amidst the ups and downs of market cycles.
@miriam98 - I think creating shareholder value through future cash flow is a tricky proposition. How do you determine what future cash flow will be, and then quantify that as part of your shareholder value?
I guess one way to do it would be to look at what analysts call the “burn rate.” I think a lot of the dot coms had to deal with this. For years these startups were rolling in a river of red ink; they were burning money every month.
To the extent that they continued to burn through their cash, the shareholder value continued to diminish. At some point even the most cursory glance at their numbers would let you know when “D day” was, so to speak.
@SkyWhisperer - At least you survived. I worked for a company that engaged in unethical business practices, effectively cooking the books to make it look like it was profitable when it wasn’t.
Stock prices fell like a rock. Eventually the company filed for bankruptcy while the SEC launched a formal investigation and then the CEO wound up behind bars.
I agree that you need to be above board if you want to maximize shareholder value for your corporation. The problem is that so many companies feel pressured to perform; every quarter the shareholders except the revenue numbers to continue on an upward trajectory.
If you want to know how to increase shareholder value, just increase your profits. Understand that by profits I am not just talking about revenue, but the margin on that profit as well.
A company can increase its revenue but wind up with smaller margin. This happens because it’s in an increasingly competitive environment where it is forced to reduce prices on its goods and services just to stay afloat.
That was the case in the telecommunications industry, where I worked for nearly ten years. The company slashed rates on long distance calls to the point where it was no longer profitable to service the residential market.
At that point, it had greatly compromised its shareholder value, regardless of other considerations like debt and so forth. Eventually we focused on the business market and dispensed with residential service altogether.
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