The Objective of a Limited Company is to maximise Shareholder Wealth John Gore
Shareholder Wealth
Shareholder Wealth is the valuation of the future earnings expressed directly as dividends and indirectly as the present and future value of the shares held. Need to measure these two components of shareholder wealth and assess risk to each. Wealth creation strategy should be interpreted in relation to risk (high risk = high returns). Need to define how much risk is built into the objective of maximisation of shareholder wealth
§ Publicly Quoted Companies : Shareholder wealth can be measured as share value (quoted on the stock market) and current and future flow of dividends
§ Private Companies: Shareholder value is dividend flow (present and future) and share of net assets of the company or what the shares can be sold for to another buyer.
Dividends
A consistent dividend strategy by a company can allow the shareholder to predict future dividend income and discount it back to a NPV to value the shares held. However, this is subject to market and specific company risk.
Asset Valuation
Share values are a reflection of net assets or dividend yield ? Therefore it is important to value assets :
§ Balance Sheet
o Net Book values - may be at historic (less depreciation), therefore depends on depreciation rates applied.
o Replacement value
o Realisable value
o Goodwill may be value less in the case of a distressed sale
§ Break-up value : Asset stripping - but can unlock value tied up in patents, land underutilised assets
§ Earnings Valuation
o based on dividend flow - the dividend yield may be expected to be higher for unquoted companies as the shares are not easily marketable and therefore a greater proportion of the value should be derived from the dividend rather than the share value
o based on price - earnings ratios P/E ratios - but are companies comparable in relation to their markets, gearing, products, management teams etc.
can be based on ratios based on EBIT or EBITDA to separate out the impact of depreciation strategy and borrowings (interest) and tax position (tax owing or tax credits)
§ Cash Flow Valuation : based on future cash flows (but impacted on by gearing especially short and mid-term liabilities
§ Market valuation
o for quoted companies - may result in share premiums on acquisitions
o for unquoted companies - by negotiation etc
How much of these measures of value of a company are reflected in the share price and its changes? Should the companies manage for the highest share value or more any of the other measures of value from which the share holder may not benefit? Opportunity to manage for short-term profit to boost earnings and share price (P/E) and/or dividend yield, that doesn't retain sufficient profit in the business for future investment (assets or working capital)
Risk Assessment§ For companies can be measured (subjectively) as the beta of the company or sector. With betas in excess of one, indicates a higher risk and therefore greater volatility (more returns in a growing market, but greater losses in a falling market). /
§ Extent of gearing increases risk to the equity holder, as in case of failure, they are paid out last (preferred and deferred ordinary stock).
§ Exposure to speculative market trading may increase the risk but maximise the profits of the company, as likewise the failure to hedge against currency changes.
§ The Operating and Financial Review (OFR) proposed by the DTI to be included in the company's annual report is planned to cover risk assessment of the market in which the company operates.
Ethical and Legal Business
Although the share holders may be insulated from the legality of the company operations, ethical issues may impact on maximisation of profits. Some businesses will seek to operate in a ''green'' or ''environmentally'' friendly way which may not optimise profits but which may attract investors for whom this is a preferred strategy.
The OFR proposal (above) includes the reporting on non-commercial issues such as social and environmental performance to make the company accountable for all of its impacts, not just the financial results. This would involve social accounting where other stakeholders welfare is affected such as employees, local community etc, eg. Employee welfare in terms of training, hours worked, working conditions; employment practices overseas, community projects; other impacts of practices and products.
Additionally legislation is moving to some form of environmental accounting to measure the impact on the environment and the use of natural resources. There is a major barrier to the introduction of legislative requirements in this area with respect to standards and measurement of impact with respect tot he comparability of different companies impacts. Already environmental impact studies have to be made for all major new projects in the UK
A new concept of Sustainability brings together both the social and environmental accounting ie not to prejudice the future ability to continue to meet the needs of the community. These recent moves will re-balance the maximisation of shareholder wealth with the wider corporate responsibility to the community. Already a factor with high profile companies such as the Oil industry players.
Conclusions
· Maximisation of shareholder wealth must be balanced with acceptability of risk
· Need to define shareholder wealth as current or potential
· How much of the assets accrue to the shareholder through share price in publicly quoted companies ?
· Is shareholder wealth only future dividend flow ?
· Impact of new legislation and self governing corporate standards of social, environmental and sustainable responsibilities on traditional measures of share holder wealth.