Shareholder Value Analysis Framework
Shareholder Value Analysis Framework
Shareholder Value Analysis Framework
Part 6
FINANCE
January 2000
SHAREHOLDER VALUE
Clare Minchington and Graham Francis,
Open University Business School
The creation of shareholder value is seen as an important objective for
companies. This article reviews the theoretical basis for shareholder value
calculations, and analyses common measures such as EVA. It concludes
with details of recent research conducted by the authors that examines the
extent of the adoption of value-based measures.
Rappaport (1986) suggested seven drivers within a business that can be managed to
create value :
a growth in sales;
The theory is that improvements in these value drivers lead to an increase in shareholder value.
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Multiple
value
drivers
Figure 1
Management Quarterly
Single
value-based
measure
Shareholder
value
A common theme of value-based measures is that they take these drivers and summarise them
into a single measure, be it Economic Value Added (EVA is a Stern Stewart registered trademark),
shareholder value analysis (SVA), or any of the other value-based measures that have been
developed (see Figure 1).
This idea is echoed in the words of Ehrbar (1998), a senior vice-president of Stern Stewart, who
wrote the following :
The mandate under an EVA management system is to increase EVA as much as possible in order
to maximize shareholder wealth. (p 134)
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The cash flow from the end of the competitive advantage period is treated as a perpetuity
and discounted back to the present value. The perpetuity can be assumed to be constant or
growing.
Management Quarterly
Part 6
January 2000
Actual
1999
2001
2002
Future
2003
2004
onwards
Sales growth, %
12
12
12
12
12
12
2.8
2.8
2.8
2.8
2.8
2.8
15
15
15
15
15
15
30
30
30
30
30
30
Actual
1999
2001
2002
2003
Future
2004
onwards
M
Sales
Operating profit
3606.1 3714.3
3714.3
388.8
412.1
432.7
445.7
445.7
81.0
85.9
90.2
92.9
92.9
469.8
498.0
522.9
538.6
538.6
Tax
116.6
123.6
129.8
133.7
133.7
166.7
155.3
151.5
131.5
92.9
36.0
29.2
25.8
16.2
0.0
150.5
189.9
215.8
257.2
312.0
Depreciation
Analysis 2
2001
2002
2003
Future
2004
onwards
150.5
189.9
215.8
257.2
312.0
Discount factor, 9%
0.917
0.842
0.772
0.708
7.871
138.0
159.9
166.6
182.1 2455.8
A multiple such as enterprise value (the market value of equity plus the market value of
debt) (EV) to earnings before interest, tax, depreciation and amortisation (EBITDA), known
as EV/EBITDA, is used.
In this example, we assume a simple perpetuity with no growth from the year 2004 onwards, as
shown in Analysis 2. The discount factor used should be the WACC of the company.
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Management Quarterly
Analysis 3
646.6
Terminal value
2455.8
Enterprise value
3102.4
500.0
Shareholder value
2602.4
We then calculate the shareholder value as shown in Analysis 3. The calculation first results in an
enterprise value for the organisation as a whole. The market value of the debt must then be
subtracted to obtain the shareholder value.
Alternatively, the shareholder value of a company can be calculated using the present value of
the economic profits of the company into the future, rather than the free cash flows. This
calculation is included as an appendix to this article for those who are interested. Note that it
gives an answer that is identical to that calculated using the free cash flows.
Residual income
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This is essentially a residual income (RI) calculation. RI is very similar in principle to EVA,
although it lacks some of its detailed refinements. RI has long been advocated by academics as a
measure that is theoretically superior to return on capital employed. This type of measure is also
known as economic profit. Rather than considering all future cash flows, the EVA model looks
annually at the value created by the company. This approach can more easily be linked to a
performance-related pay scheme for management, but it also opens up the old problem of encouraging short-termism by focusing on annual targets.
EVA offers a refinement over RI in that the problems of using historic accounting data are
addressed through adjustments being made to the raw profit and asset values. Common adjustments are the following :
Using the figures for Angel from the above example, and assuming a capital employed of 1000
million (see also the appendix), the EVA or economic profit for the year 2000 can be calculated
as shown in Analysis 4.
Analysis 4
388.8
Tax
116.6
272.2
90.0
182.2
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Management Quarterly
Economic Value
Added (EVA)
Value drivers
Shareholder value
analysis (SVA)
Economic profit
Recently introduced
Cash flow return on
investment (CFROI)
Under consideration
0
10
15
20
25
Respondents, %
Figure 2 Value-based performance measures recently introduced or under consideration
When asked why the new value-based measures had been introduced, organisations
appeared to be mainly driven by external or group level pressures :
external pressure :
company takeover;
group pressure :
Several respondents talked about the need to focus on shareholder value, and measures
being implemented as a result of a company takeover.
A number of barriers to the implementation of the new value-based performance measures were
identified by this study. Over 20% of the respondents, who were qualified accountants, were not
aware of the EVA performance measure. Apart from a lack of awareness of the new measures,
many of those who were familiar with the new metrics viewed them as being too complicated
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to apply, and felt that non-financial managers could not easily understand them. A number of
respondents saw the measures as yet another management fad. This is typified in the comments
of one respondent, who described EVA as being the flavour of the month, but is basically an
existing tool given a marketing boost and high profile. Those who were supportive tended to
focus on the whole organisation. For example one respondent wrote EVA is well worth using to
emphasise the whole company. The study identified a number of companies that used valuebased measures at head office level, but retained traditional profit measures in their divisions.
KPMG, in a 1995 survey of value-based management, described this type of company as light
users, who report overall results in value-based terms, but retain traditional measures within
their performance measurement systems.
The authors have found three types of difficulty which are associated with the
implementation of these new measures in practice :
Technical difficulties : Once a measure has been selected, the barriers to implementation include technical difficulties, such as the establishment of the cost of capital
and the capital asset base.
Summary
Shareholder value has become the mantra in almost every boardroom in the UK. However, as is
the case with many new management ideas, the concept of shareholder value has been around
for many years. In terms of organisational objectives, it is consistent with maximising shareholders wealth. It differs from traditional approaches to measuring performance in the way in
which it calculates and reports that wealth. It has been suggested that merely adopting the
terminology may lead to an increase in a companys share value, owing to an improvement in
the Citys perceptions of the company. However, if companies are to continue to reap real
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Management Quarterly
intrinsic benefits from these measures, it cannot be enough simply to calculate and report these
measures. For an ongoing and sustainable increase in shareholder value to be achieved, organisational changes must be undertaken to shift the focus of the management away from profit
and towards value drivers.
Appendix
To estimate the future economic profits of a company, we must first forecast the future
capital employed. Assuming an opening capital of 1000 million for Angel, and using
the same changes in capital expenditure as in our free cash flow forecast (see Analysis 1),
we obtain the capital values shown in Analysis 5.
These capital values can then be used to calculate the present values of the future
economic profits generated by the organisation, as shown in Analysis 6.
Finally, the shareholder value of the company can be calculated as shown in Analysis 7.
The discounted cash flows approach used in the main article and the economic profits
approach shown in this appendix give identical results for the shareholder value, as
mathematically they are identical calculations that are carried out in a different manner.
Opening capital
2001
2002
2003
2004
2000
36.0
29.2
25.8
16.2
0.0
166.7
155.3
151.5
131.5
92.9
81.0
85.9
90.2
92.9
92.9
Actual
1999
2001
2002
2003
Future
2004
onwards
M
Sales
30
3606.1 3714.3
3714.3
388.8
412.1
432.7
445.7
445.7
Tax
116.6
123.6
129.8
133.7
133.7
272.2
288.5
302.9
312.0
312.0
Interest charge
90.0
101.0
109.9
117.7
122.6
Economic profit
182.2
187.5
193.0
194.3
189.4
Discount factor, 9%
0.917
0.842
0.772
0.708
7.871
167.1
157.9
149.0
137.6
1490.8
Management Quarterly
Analysis 7
Part 6
January 2000
611.6
Terminal value
1490.8
Opening capital
1000.0
Enterprise value
3102.4
500.0
2602.4
References
Further reading
Editors bibliography
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