Importance of Shareholder Value in Improving Firm’s Performance
The firm’s ability to accurately establish and measure shareholder value (SHV) is crucial for assessing financial performance and moving the firm toward established objectives. Among other strategic objectives such as profitability, efficiency, market share and growth, shareholder value is most important measure to evaluate corporate’s long-run financial performance.
The discounted cash flow method (DCF) definition of shareholder value is the present value of the firm’s future cash flows (FCFs) discounted at its weighted average cost of capital (WACC), add to this initial cash, marketable securities and other investments, and subtract the value of debt. This approach makes sense that a company can only make an economic profit only after it has repaid the cost of capital. Investors are interested in not only knowing how the company performed in the past but also more importantly how it is likely to perform in the long–run(say,3 to10 year period). This long-run focus of investors makes a connection to firm’s strategy that lies at the core of any enterprise success. The CFC term in shareholder value definition also makes SHV focus on long-term value creation and therefore it is easily integrated into the strategic management process. In strategic management process a performance measurement system is used as a means to monitor, evaluate and control performance measures. It is said that if you can’t measure, you can’t control. By establishing meaningful measureable shareholder value objectives (from pro forma models) in the strategy formulation process and finally monitoring, evaluating, and controlling the financial results will ensure that an organization is aiming at its strategies to achieve its overall goals and objectives. Therefore, shareholder value (SHV) management system plays a vital role in every organization as it offers key tools for performance measurement system and provides forward looking indicators to assist management in predicting and controlling company’s economic performance.
Traditional accounting measures such as earning per share (EPS), return on investment (ROI) and return on assets (ROE) are also used by corporations and analyst to assess corporate performance. The drawback of these approaches is that they are not forward looking to predict the future performance, do not consider cost of capital in calculation and are influenced by accrual based accounting.
In addition to the SHV model defined above, there are few other important “SHV measures,” which are:
- economic value added(EVA) and market value added(MVA)
- cash flow return on investment(CFROI)
- total business returns(TBR) and total shareholder return(TSR)
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