Shareholder Value: Creation, Maximization, Destruction And Restoration
Shareholder value is widely discussed and debated. The
simple understanding is “the value addition to the equity
contributed by the shareholder of a business enterprise”. It
is supported on the ground that the equity contributor,
who assumes the highest and ultimate risk in a business
venture, is entitled to all residual surpluses of the gains.
This value addition is measured in monitory term, since the
equity contributed is also in that term. The yardstick is the
enhancement in value of initial equity and the
accumulation over a period of time commonly known as
net worth. When such net worth is represented by higher
tangible market value than the initial amount of equity, it
may be called as a creation of shareholder value over a
period of time.
Since, the entire concept is described and measured in
monetary terms, the Finance function assumes lead among
other functional management. Thus, the goal set for
Financial Management is “Shareholder Value Creation”.
Further, the shareholder is assuming highest risk among
other stakeholders; it is argued that the he is entitled to
have maximum share in the fruits of the success of the
business venture. Therefore, all literature echoes the goal
of Financial Management as “Maximising Shareholder
Value”.
The Financial Management is expected to achieve this goal
through three vital decision, viz. Investment Decision
(What project should be selected to invest so that the
return on investment exceeds the cost of capital );
Financing Decision ( What should be the mix of borrowed
funds carrying fixed charge on the earning and owned
funds having claim on all residual earning) and Dividend
Decision ( How much of the residual earning should
distributed among the equity contributors and how much
should be reinvested in the business).These 3 decisions, if
taken in a most prudent manner on a continuous basis,
then it obliviously enhances shareholder value.
As regards, small and medium business ventures, where
the ownership and management is one, the issue of
shareholder value is normally insulated from the agency
problem. But for large and publicly owned corporate, this
agency problem affects the goal. The agency issues means,
when the business is managed by appointed agents
(Directors, CEO, top management executives, etc.), who
have their own goals to achieve and if these personal goals
are in conflict with the main goal of “Maximizing
shareholder value” then the decision making process may
not always be prudent. Management science advocates for
goal congruence between individual one and organization
goal, but it is difficult to practice successfully on continuous
basis. Thus, the shareholder value, even if created by one
set of agents can be destroyed by another. Though, the
system has made at attempt to address this issue through
corporate governance, transparency and regulatory
mechanism, but the recurrence of corporate scam could
not be altogether stopped.
The financial services business has further aggravated the
issues of destruction of share holder value, through agency
problem. This business produces financial products and
provides allied services. The financial products are quite
different then ordinary goods and services. Ordinary goods
and services have present utility for the buyers. The seller
does some value addition to the original goods before
selling them to the buyer and therefore, the buyer pays
higher price. Further, the buyer has legal remedy if the
product / services do not fulfill the condition claimed, or
he cannot enjoy peaceful consumption. A financial product
is differing here on all fronts. The buyer has future utility
and that to a perceived one. The seller hardly does any
value addition. (A mutual fund or a share can not be made
beautiful by seller). There is no remedy for product failure
because it the future utility is sold. Thus, when the future
hopes are sold, such deals become very dangerous
especially when the buyer (investors) awareness is lacking.
A financial service by its nature does the business on
“Others People Money”. Thus, if it is infected by severe
agency problems, then the shareholder value of those
business enterprises is damaged heavily. Further, such
events have chain effect because of shaking of confidence
in the system. As results stock market crashes and
shareholder value (though created by one set of agents)
get reduced across all business.
The world and India, both have witnessed such
phenomena on regular intervals and it is evident that
directly or indirectly, the financial service sector has played
major role in such disaster. For example, the world has
witnessed major cataclysm such as 9/11, tsunami, etc. but
the insurance sector is not adversely affected as compared
to recent one when largest insurance group face crises
because of debacle of financial services giants.
The above discussion leads to two issues. First, whether
the goal of financial management should be redefined,
especially for the financial sector, and second what further
measures society as whole (not only governments) should
undertake to check the impact of agency problem. The
answers are sought in next NICOM 10 by our institute. We
invite one and all concerned with above topic to contribute
in the conference.
system has made at attempt to address this issue through
corporate governance, transparency and regulatory
mechanism, but the recurrence of corporate scam could
not be altogether stopped.
The financial services business has further aggravated the
issues of destruction of share holder value, through agency
problem. This business produces financial products and
provides allied services. The financial products are quite
different then ordinary goods and services. Ordinary goods
and services have present utility for the buyers. The seller
does some value addition to the original goods before
selling them to the buyer and therefore, the buyer pays
higher price. Further, the buyer has legal remedy if the
product / services do not fulfill the condition claimed, or
he cannot enjoy peaceful consumption. A financial product
is differing here on all fronts. The buyer has future utility
and that to a perceived one. The seller hardly does any
value addition. (A mutual fund or a share can not be made
beautiful by seller). There is no remedy for product failure
because it the future utility is sold. Thus, when the future
hopes are sold, such deals become very dangerous
especially when the buyer (investors) awareness is lacking.
A financial service by its nature does the business on
“Others People Money”. Thus, if it is infected by severe
agency problems, then the shareholder value of those
business enterprises is damaged heavily. Further, such
events have chain effect because of shaking of confidence
in the system. As results stock market crashes and
shareholder value (though created by one set of agents)
get reduced across all business.
The world and India, both have witnessed such
phenomena on regular intervals and it is evident that
directly or indirectly, the financial service sector has played
major role in such disaster. For example, the world has
witnessed major cataclysm such as 9/11, tsunami, etc. but
the insurance sector is not adversely affected as compared
to recent one when largest insurance group face crises
because of debacle of financial services giants.
The above discussion leads to two issues. First, whether
the goal of financial management should be redefined,
especially for the financial sector, and second what further
measures society as whole (not only governments) should
undertake to check the impact of agency problem. The
answers are sought in next NICOM 10 by our institute. We
invite one and all concerned with above topic to contribute
in the conference.
