Creating and Measuring Shareholder Value in British Corporations

Master's Thesis 2011 65 Pages

Business economics - Operations Research


Table of Contents

1 – Introduction
1.1 – Background
1.2 – Rationale for Topic
1.3 – Research Question
1.4 – Research Aim and Objectives
1.4.1 – Aim
1.4.2 – Objectives
1.5 – Scope and limitations

2 – Research Methods
2.1 – Research Approach
2.2 – Research Philosophy
2.3 – Research Methods
2.3.1 – Quantitative Methods
2.3.2 – Qualitative Methods
2.4 – Data Collection
2.4.1 – Literature Study
2.4.2 – Empirical Data
2.5 – Sample of Study Companies
2.6 – Summary

3 – Theoretical Framework
3.1 – Creating Shareholder Value
3.1.1 – Introduction and History of Shareholder Value
3.1.2 – What is shareholder value? – Value – Shareholder Value Defined
3.1.3 – Shareholder Versus Other Stakeholders
3.1.4 – Value Drivers
3.1.5 – What Is Value Creation?
3.1.6 – Facts about Shareholder Value Creation
3.1.7 – Ways to Create Shareholder Value – Operations Excellence – Getting the Financial Structure Right
3 .1.7.3 – Being Focused – Credible Earning Growth – Information – Stock Repurchases
3.1.8 –Value Network for Shareholders
3.1.9 – Value Based Management (VBM)
3.2 – Shareholder Value Creation – How To Measure It?
3.2.1 – Introduction
3.2.2 – Traditional and Old Accounting Measures – Plusses and Shortcomings –Earnings Per Share (EPS) –Return On Investment (ROI) – Return On Equity (ROE)
3.2.3 – Recently developed measures – why are they better than the old? –Total Shareholder Return (TSR) –Economic Value Added (EVA) –Market Value Added (MVA) – Discounted Cash Flow (DCF) –Cash Flow Return on Investments (CFROI)
3.3 – The Comparison of the New Measures

4 – empirical studies
4.1.1 – Ways to create shareholder value
4.1.2 – Shareholder value creation as key corporate objective
4.1.3 – Shareholder value creation in the long run
4.1.4 – Value Based Management
4.2.1 – Valuation Methods
4.2.2 – The benefits of measuring the shareholders value creation
4.2.3 – Development of measures that the companies use
4.2.4– Advantages and shortcomings of the chosen measures

5.1.1 – Ways to create value for shareholders
5.1.2 – Shareholder value creation as a key corporate objective
5.1.3 – Shareholder value creation in the long run
5.1.4 – Value Based Management (VBM)
5.2.1 – Analysis of valuation methods
5.2.2 – The benefits of measuring shareholder value creation
5.2.3 – Development of the measures that the firms use
5.2.4 – Advantages and shortcomings of the chosen measures
5.3 – A Comparison Between The Empirical Findings And Theoretical Framework

6 – Conclusion, Recommendations and Suggestions
6.1 – Conclusion
6.2 – Recommendations
6.3 – Suggestions for future research


appendix 1

appendix 2

appendix 3

1 – Introduction

This Introductory chapter discusses the background, research issue, rationale of the research, the purpose and scope of the research paper.

1.1 – Background

The shareholder value in business industry is the most commonly used term in present age. The wildfire of equity culture is quickly spreading from United States to the whole world business industry and it has been grasped as critical today as it was in the last few decades. In United Kingdom the new systems of measurement for the creation of shareholder value were established in the last few years and these systems have been slowly but widely set up in number of firms. In fact, in the United Kingdom some of the firms like Ironsides Lubricants and SCA have adopted shareholder value creation as their key business objective.

While in other areas of Europe the idea of shareholders value creation had spread rapidly and more early. For instance in Germany, one of the market leading companies named as Veba – divisions closed to chief executive officer date back to the beginning of Veba, removed the managers for long-time, and made redundant hundreds of workers – all in the investors name. That chief executive officer was concerned about the value of shareholder. The chief executive officer said “Rewarding shareholders is the only approach to confirm that other people in the company are served also. It does not seem fine when all the jobs are in the under performing entities” (Eitemann at al, 2000).

If shareholders think that the performance of corporation is below what was expected, they can seek to remove and elect the new board of directors with their voting power in the coming election. And if shareholders make this board replacement possible, the new elected board of directors will select a new team for corporation management. But selecting a new board of directors in this way is proved relatively expensive and attain success rarely that result into the selling of shares by shareholders (Brealey, et.al, 2007).

It is obvious that the owners of corporation are shareholder and the board of directors is elected by shareholders in order to represent them. The primary objective of any business is to increase the value of shareholder and managers in the developed nations must concentrate on maximizing the shareholder value (Koller, et.al, 2010).

If the directors and managers don't intent to increase value, there is continuously a threat of an unreceptive takeover. In addition the share price of such corporations falls, because of the wrongheaded strategy; it makes easy for other corporations to buy the majority shareholding power and take over the operating power.

Today, the huge institutional investors are progressively more affecting the corporations' corporate and strategic policies. They are producing a heightened understanding of the contribution of incentives that are compensation-based in motivating efforts of executive on creating value of shareholder. Corporations are compensating executives of senior positions with shares options and shares. Therefore, price of share at present significant for many executives of senior positions.

Today many executives recognize that the shareholders value creation is vital and the major competitive management groups of the world are replying to the need to create shareholder value by implementing new methods and new techniques for the best management of their corporations.

Conventionally a variety of methods were adopted to present to know that how much shareholder value had been created. Some of these methods are Return on Investment (ROI), Earning Per Share (EPS), and Return on Equity (ROE). In addition, a number of institutions that are providing consultation services have been providing their own methods in order to recommend these methods to their clients.

In current globalize and complex business world that is depicted because of competition corporations are required to accelerate growth through profits, measure the creation of shareholders value and always learn from setbacks and success. The corporations that create the shareholder value can only grow, obtain new capital and earn profits. The management of corporation is forced by active shareholders to assess and describe that how they are creating shareholders value and they don’t accept if they find companies busy other than creating shareholders value (Crowther, 2003).

Without any doubt nowadays the primary goal of corporations is the improvement of value for shareholders and this means increasing the profits generated for those stakeholders who have actual ownership interest in the corporation. This notion of creating value for shareholders appears as an essential and crucial to various corporations and directs them to adopt this process actively. Corporations create value for shareholder with the help of set of strategies, basing on what they consider would assist in creating more value.

1.2 – Rationale for Topic

When managers take into account the alternative strategies, with the expectations to build up the maximum competitive advantage in sustainable mode, will be those strategies that will assist to create the maximum value for shareholders also (Rappaport, 1998). Corporations can select superiority in those operations which are closely linked to profitability. They can establish their financial structure to the right position, which is nearest to fundamental drivers for free cash flow. They can select to be concentrated and this is more closely related to profitability because are considered as relative advantage. Corporations can also create shareholders value with the help of convincing growth of earnings that matches the essential driver development and numerous other methods are in position to create value for shareholder (Resti and Sironi, 2007).

The rationale for research comes up from this number of different methods to create shareholders value. There is continuously a scope for creating shareholders value in corporations and can benefit themselves of value-creating guidance. Then the strategies are implemented within the outline of that scope. In this way it valuable to explore how these strategies is managed in workplace for some selected companies. On the other hand, it is not merely sufficient to have these strategies in place; it is essential for several indicators to make sure whether shareholder value had been produced or not. Therefore, corporations are required to measure and confirm that they are on the right track of creating shareholders value. “What gets measured and assessed gets finished” (Resti and Sironi, 1999) this was a renowned declaration by Percy Barnevik’s that statement highlight the significance of measurement.

The measuring shareholders value is not a new idea. Many attempts to determine shareholders value have been established on figures taken from past performance. Study presents that numerous conventional accounting methods used to measure value have disadvantages (Pappaport, 1998). They contain a quietly low connection with the value creation for shareholder for instance return on the capital employed (ROCE), return on equity (ROE), return on the investment (ROI). This low connection of Return on Equity can be partially explained by the misrepresentation initiated by non-cash type of these methods, their exercise of using asset values that are historical, the deferrals effects, etc. (Koller, et.al., 2010)

There are number of innovations and inventions that are devised to remove the limitations of the conventional framework of accounting, if as observe from the perspective of 21st century. Such types of new developments to enhanced measurement of performance influencing business world today, produced in us, the interest also to examine the process of measurement exercised at the present time within the numerous corporations. In fact, depending on what is discussed above the issue of research for this research paper is as a result originated as follows:

How do the corporations measure value creation for shareholders?

For the best answer of this research issue, creating shareholder value will be explored in common as a base to the issue of research. The issue of research will deal with the numerous valuation methods adopted by different corporations to measure value creation for shareholder and also the merits and demerits of these numerous methods whenever determined.

1.3 – Research Question

- How do corporations measure value creation of shareholders?

1.4 – Research Aim and Objectives

1.4.1 – Aim

The purpose of this research paper is to know that how the shareholders value is created and managed in an organization.

1.4.2 – Objectives

1. To conduct a systematic research of various methods adopted by corporations to measure shareholder value creation.
2. To present a general overview of how the value of shareholder is created as a base to measure shareholder value.

1.5 – Scope and limitations

The creation and measurement of shareholders value can be explored from different viewpoint. This study is mostly depending on the facts received from the stakeholders or shareholder. When it is perceived as stock market viewpoint, the information is also collected in the research mostly from the stock market. If the research is established on the corporation point of view then the facts used will primarily be gathered from the selected company. Every viewpoint is very vital to examine. On the other hand because of time restriction and the scope of the research issue we are compelled to make some limitations.

In our research we are undertaking this issue from the viewpoint of the company. We select this viewpoint since it is in fact the company that is setting in place various strategies and employing the measures for value creation of shareholder. We, thus, think that our research questions would be answered in best way if we employed the perspective of company. We have performed interviews just in the companies. Although we are taking into account this problem on that viewpoint, in our research work we can when it is considered very impending refer to some data of secondary nature from the companies but this can only happen occasionally.

We also restricted our research to British companies because we intend to find what is being performed in Britain and provided that the new methods for measuring value creation for shareholder have reached Britain in the last five years, we intend to find out what has occurred up to now. Furthermore, we are gathering from headquarter the empirical data because we intend to collect the information from level of group and for many of the British companies the headquarters are located in Britain. This makes it very easy and possible for us provided the time restriction of our research.

Our research is also restricted to few corporations that we think are in condition to disclose information that can be employed in to order answer our research issue in better way. Therefore not all British companies will be incorporated in our research. Those businesses in our research are big and capable to present such information that we require, they are multinational, produce value for shareholders and they are listed corporation on stock exchange. Further about the selection of businesses is incorporated in the section of methodology.

Several factors can influence the value of shareholders for instance the environment adjacent the businesses, poor climate of business, currency fluctuations and political conditions. We are not supposed to wrap up the above discussed factors in our research because information of the background will be dealt in common and it is not the major concentration of our study. On the other hand they are discussed incompletely merely when our selected companies as a sample believe them to be critical factors influencing their operations.

2 – Research Methods

This chapter will cover the procedure with the help of which our research will be conducted. It explains and talks about the different practical issues that will be used in the thesis.

2.1 – Research Approach

In order to answer our research issue we will use various approaches. At first the explorative approach will be used that will move with the literature in order to record the issues linked to the value of shareholders that will help in getting the basic essential information for the issue of research. Secondly, descriptive technique will also be used in theoretical section in which we will present insight to the existing methods of creating value for shareholders and the existing methods of measuring value creation of shareholders. Our thesis will also have prospective section where we will describe that when should be done to create and measure the value for shareholders. We are sure that these approaches will be proved as best approaches in conducting our research since these will let to document our issue in better way, prescribe and explain moreover, all these approaches are very important in for the answer of our research issue.

2.2 – Research Philosophy

Hermeneutics approach is the interpretive knowledge or sense that has particular concentration to background and original reason. It acquires the point that not anything can be explained without some viewpoint so the main concern is to secure the viewpoint and explain the background of those people which are studied and the own viewpoint of researcher should be made clear and precise (Patton, 1990). This type of approach has solid concentrations on the view overall and it supposes that all social names, actions and values have a basis of human (Bierman Jr., 2001).

While in the positivist situation there is a mind-independent which can be explained through objective words. This approach presents that statement is only significant is it is synthetic in nature and stands for the truth which is experiential or analytic or empirical that signify the truth as formal. The statement meaning is provided from the technique of its verification (Ryan et al, 1992). In addition to this, Bierman Jr. (2001) present that the empirical study is the main and significant section in the positivistic method because the scientific value need to be confirmed with the help of empirical research.

Positivistic approach is the best option for our research because we gathered the data of empirical nature from the corporations and we conclude on the basis of these facts and it is vital for our research. Therefore, this type of data has much importance for our research. In addition, the data is gathered on the company viewpoint towards creating and measuring the value of shareholders as a background, that provide the expression of ignoring our personal opinion and community customs from our research. It is vital for our research because it presents how the measurement and creation of value for shareholder is and not how it looks like to be.

2.3 – Research Methods

It is possible to use two methods in the research these are named as quantitative methods and qualitative methods.

2.3.1 – Quantitative Methods

In the quantitative research the central point of the study remains the quantity and its objectives are predictions, description, control, hypothesis testing and verification. Its associate expressions are empirical, experimental, and statistical. The sample in this research can be random, large, and even representative. The collection of data will be performed with the help of inanimate tools such as tests, scales, surveys, computers and questionnaires. The analysis style is deductive in quantitative study by statistical techniques and their findings may be narrow, precise or reductionist (Merriam, 1998).

2.3.2 – Qualitative Methods

In comparison, the qualitative research method typically consist on the field work that requires the researcher to visit physically the concerned people, the organization itself so that the behaviour of actual setting can be observed; but as exceptions some of the qualitative research can be carried out with the use of documents only. In qualitative research the researcher concentrates on quality that can be explain as nature and real meanings. The related words for this can be grounded, naturalistic and particular. In this type of method the size of sample can be nonrandom, small, and theoretical or focused. The qualitative research objectives are generally description, gaining knowledge, finding, hypotheses and meanings generating. For the collection of data in this type of researcher is the main tool, and can conduct interviews of the target population, interpretation and documents. The analysis model remains inductive in nature by the researcher while the results are wide-ranging, expansive, holistic, and completely descriptive (Merriam, 1998).

Both qualitative and quantitative sort of research methods will be used in conducting our research. Although, the nature of research method adopted generally depends on the nature of research that present what kind of information is required, but a grouping of both methods can be helpful for this thesis since it will make possible to understand, determine and deal with the research issues in more detail. We believe that this will also contributes to the significance of our research.

2.4 – Data Collection

“Research is just collecting the data and information you require to solve the research question and thus assist you to answer the research problem” (Booth et al, 1995). To conduct our research paper, we required to gather the data. As collecting the data was one of the significant elements of our research work, so in this regard we needed to identify that type of data that can assist to answer our research question in better way. In this regard we came to the decision to use the experimental/empirical data and literature study so that we would be capable to provide fair view of what has been done and what is happening at present in the area of our study. The below discussion would explain each kind of information and thoroughly discusses about our selection of each kind of data collection methods.

2.4.1 – Literature Study

From the study of literature we intend the facts that had been gathered by other people for numerous purposes and are exist to be used for other studies. We use various sources to collect the facts from literature study. In our research we use, books, journals, articles, annual reports, databases and web search engines. The survey of literature has been performed in relation to the literature material above discussed. Through the study of literature we fetch out the baseline information that assisted us to establish basic foundations for creation and measurement of shareholders value. For this purpose the annual reports of has also been studied and all this data of secondary type assisted us to understand our research problem in better way.

2.4.2 – Empirical Data

Empirical data means the facts and figures gathered from the fieldwork by the researcher. As we discussed in the qualitative research approach that there are numerous methods that can be employed for data collection. From these range of methods we adopted the interviews for gathering our empirical research data. The discussion that has been adopted in interviews covers the motives why we select to conduct interviews, how the interviewees have been chosen, interview structure, the interview questions formulation and the interview type.

We select to conduct the interviews for data gathering on account of the type of our research and we were influenced that interviews are most excellent way we can adopt to collect information that was complete, reliable and up to date that was required for our research. This notion is supported by Merriam (1998) who stated that in qualitative researches interviews are only way to collect qualitative data required for identifying the phenomenon under the research.

We consider the interviews as best approach on the grounds provided by Dalphnem (2000) who labeled interview as a controlled and prescribed interaction that employs verbal conversation as the primary technique of posing questions that has some specific shape and direction. It is particularly devised and gives the chances to the interviewer to investigate the motives for the responses given by people.

We gathered a load of information as the interviewees, in charge or dealing with shareholders value creation and measurement, were from different departments who working with not so much similar tasks. Before conducting interviews we kept the interviewees in contact in order to tackle with some issues for instance, change in time schedule, change in the position of the person we had selected for interviews, etc. In doing all this we are sure that we discussed with the right person of every company.

Regarding the interview structure, we used interviews of semi-structured type where a combination of less and more structured questions was adopted. We are certain that such type of structure is appropriate for our research because in our research for some areas we required all interviewees to provide their viewpoint and it was essential to have the similar section for all people. This forms the standardized section of the interview that has similar questions. The questions also had flexible perspective where these were to be answered pursuing the information accessible for interviewees and also basing on the type of operations the businesses ran.

In relation to the question formulation, Merriam (1988) stated that in order to collect useful and relevant data for any research questions are the vital part of interviewing. Keeping in view the significance of questions, for good questions we prepared a questions list basing on our research objectives and research issue. In preparing questions we also take into account the issues highlighted in previous researches done on same topic, therefore our interview questions are balanced and good.

In relation to the interview form, the widespread interview form is person-to-person interview where which one person (the interviewer) draws our information from other person (the interviewee) (Merriam, 1998). In carrying out interviews 5 interviews were person-to-person interviews and 2 of our interviews were conducted through telephone. The rationale for one of the telephone interviews was the office location that dealt with the required information and the cause for the second telephonic interview was the interviewee's desire and wish.

In performing research interviews we created a dynamic affiliation with the interviewees by letting them to express their thoughts freely. In case of difficult questions we made them understand that helped us to obtain the more relevant information in relation to our research issues. Sometimes we asked for instant clarifications in case their answers were not obvious to us and we also stay away from the unnecessary interferences because we had the accountability of directing the interview and assuring that the direction was according to plan.

The data from interviews were recorded in form notes during interviews. Immediately after interviews we created the information portfolio to make sure that nothing was missed. In order to duly check the information we received from interviews we sent our documented portfolios to some interviewee to make certain that noting was misunderstood. From start to end the dynamic connection with interviewees was preserved and we have taken agreement from interviewees for additional clarifications through telephone or on email if needed.

2.5 – Sample of Study Companies

In our research we could not incorporate all the British companies because of the time restrictions and practicability. To narrow down our research sample we establish appropriate criterion that companies must meet to be included into research. The criterion was as:

- The company must not be owned by one shareholder so that there is a reason to create value for shareholder.
- They are British business so that easily accessible and the research purpose was to identify what is the situation is in Britain.
- The companies must be listed so that there is much more probability to determine value creation for shareholders.
- The businesses are creating indirectly or directly value for shareholder since this research could be done in better way in the business confessing that they are creating value for shareholders.
- The businesses have been operating at least since last decade because long operating periods presented stability that could confront challenges in coming period than those businesses established recently.
- Lastly, those businesses are well-built and operating in international market because such businesses are considered to provide more information.

We did not restrict ourselves to particular industries because measuring value creation for shareholders does not base on the industry that is even the cause why the businesses in the research are not classified. After the establishment of this criterion, we then employed a non-probability method of sample that is the convenience sampling technique to the businesses that were satisfying them. Fink and Kosecoff (1998) provided that the convenience sampling is taken as a non-probability sampling whereby selection of single thing represent everyone in the sample who satisfy the set criteria for the research, who are keen to answers all questions and are accessible when they are required. This indicates that we have taken a list of British companies that satisfied the criteria we established and then we sent e-mails to person in charge in order to explain what we aim to explore and asking them if they were concerned in taking part in our research; those companies that positively answered were all incorporated in our research. The names of these seven companies are: Jaguar, ABB, Pennine, Hotpoint, Standard Charted Bank (SCB), HSBC, and Ford.

2.6 – Summary

The methodological section point out that our research is done by following the positivist approach. The descriptive, explorative and prescriptive methods are employed in different sections of our research. In the research the qualitative research techniques are exercised but few quantitative aspects can be determined as well. The data of literature review is gathered in several documents and internet sites whereas we gather our empirical type of data by conducting interviews. The sample population of our research includes seven British companies.

3 – Theoretical Framework

The theoretical framework includes two parts. The first parts give the general information about the concepts; theories and perspectives on the shareholder value creation in order to create a background for the second part that describes the present methods used to measure shareholder value creation.

3.1 – Creating Shareholder Value

3.1.1 – Introduction and History of Shareholder Value

The theories in relation to shareholder value creation have long history since 50s and 60s and their rational roots are in the excellent work of that time thinkers who have been awarded, for economics, with Nobel Prize. Creation of value for Shareholder came into existence automatically as consequence of work done what recognized as the Capital Asset Pricing Model (CAPM) which claims that the profits both expected and received by shareholders are linked to the risk encountered by having financial assets. As everyone knows, the higher risk results into higher profits. The major approach of the CAPM model which is important to the investor view of the globe is that the time value of money that allows someone to evaluate the today’s value and the development, cash flows and profits of tomorrow. The rate of discount is not only provided from the capital market examination but it also explains what the opportunity cost in relation to equity is for an investor. It also provides that what the business needs to earn to justify the utilization of capital resources engaged in the business. All through the 70s and 80s the implementation of CAPM in business sector began (Black et al, 1998).

After the publication of “Creating Shareholder Value in 1986by Rappaport and Valuation in 1990 by Tom Copeland the considerable importance was given to shareholders value. In every sector, businesses started thinking the faithfulness to shareholder value. This established a transformation in the management process; the managements started to move their concentration on creating value for shareholder.

3.1.2 – What is shareholder value? – Value

Much of literature has been published in relation to the creation of value for shareholders because value creation and its measurement for shareholders is an inspiring term which investigation is an art more than the science. It has a number of explanations and stakeholders present dissimilar analysis about the shareholder value of corporations in any specific situation of that time even the value of today may be disregarded on the value of future time. Although the value of past comes out to be clear, the value of future and present turns out non-visible because of different judgments about value. Though, shareholders value is measured thorough a number of aspects. Information quality, time sphere, control of perception, uncertainty and its acceptance for risk are some aspects that create the perspective of individual on the specific corporation value at any specified time. What the shareholders expect to take place to the cash flow of business is the principal determinant of their value. Value is a particular and subjective beliefs statement in relation to the coming period and stands for a picture about the prospects of company (Knight, 1998). – Shareholder Value Defined

“The entity’s economic value such as a business unit is the aggregate of its equity and debt value. Such type of business value is labeled as corporate value whereas the portion of equity value is considered as shareholder value” (Rappaport 1998). In form of equation it can be defined as: “Corporate value = Debt + Shareholder (equity) value”. This equation can be arranged to calculate shareholder value as: “Shareholder Value = Corporate Value – Debt”. In this equation the debt means the market debt value, speculative claims and liabilities and the corporate value is the worth of the entire business unit. It consists on three following mechanism:

- The net present value of future cash flow from operations.
- The “Residual value” that stands for the business value attributable to the time beyond the forecast period.
- The present value of investments and marketable securities that can be changed to cash and are not vital to running business. (Rappaport, 1998).

Not only the Rappaport explained shareholder value but numerous other writers have also explained shareholder value such as Black et al (1998) stated that shareholder value is the variance between the debt and corporate value whereas the corporate value is the aggregate of the future cash flows discounted at the Weighted Average Capital Cost (WACC). The Ernst and Young tried to explain shareholder value as the total of discounted value of entire cash flow from the business to the shareholders, incorporating what is dispersed when the business is dissolved or sold. Serven (1999) provided that what is significant to shareholders is what occurs to their stock prices and then he explains shareholder value as the market value of a common stock. Although numerous writers provide these definitions, the significant part of many of the definitions is to cover up the Rappaport thoughts of shareholder value.



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creating measuring shareholder value british corporations




Title: Creating and Measuring Shareholder Value in British Corporations