Shareholders expect management to carry out on their behalf to create and manage a value where they invested. To carry out this duty, a company must have objectives and goal. These will create clear decisions for the management to lead the firm and it is more practical to everyone in the team where the company is leading. By understanding and following the right route will maximize the shareholder wealth.
Therefore, it is evident that the management is responsible to create a value which can maximise the shareholder wealth. However, in reality, giving an authority to control by management who are only paid staff, the principal “the shareholders” has an issue where the overconfident managers and their dysfunctional behaviour can cause adverse effect. It can even lead the shareholders to sell their shares and there is a potential threat to downfall of the share price. Not only this, if the management is emphasizing too much reliant on the short term success and let it happen the share price increase may result the failure in longer term, for example, six years result prior to downfall of ENRON whose image was boasted that the company had enjoyed good return.
Image Source : http://craneandmatten.blogspot.co.uk/2013/03/fun-facts-about-corporate-accounting.html
Therefore, it is important that the management must ensure to set both short term and long term objective separately. This will enhance the success of the business. Being management team is salaried staff and having a long term objectives, the experienced and skilled staff for example CEO and CFO should be retained. In order to carry out the objectives effectively, nowadays this is a common practice that these Executives are offered a compensation package in terms of higher pay, incentives and share option.
Last year, Barclays Bank had a hard time. They had committed miss-selling of PPI product to customers. The bank claimed their junior staff had done but it was difficult to believe the majority of junior staff could carelessly sell the insurance policies without proper management of the rules and regulations set by the bank authorities. Definitely, Barclay bank had benefited in shorter term with the revenue made from the miss-sold of PPI. However, in long term the bank had suffered the consequences. According to the Guardian Newspaper of 16th November 2012, Barclays Bank was costing bank times and cash to sort these miss-sold PPI reclaiming. This improper action which might be management decision or purely junior staff mistake (hardly believable) as they claimed had caused a bad image and costs to the investors in longer term.
A value can be identified as tangible and intangible. But whatever it is, both are important for the organisation. Wall Street Journal of Feb 2013 stated that Barclays Bank Chief Executive Antony Jenkins said Friday that he would give up his 2012 bonus to rebuild the bank’s image. He accepted the wrong doings of his predecessor and tried his best to recreate the intangible value of the bank he was responsible for.
Creating a value by a shareholder is varied and it could be from the amount invested or the required rate of return or the annual rate of return on capital. However, the main aim is to maximize his investment by choosing a right project. The common and key measurement is NPV Net Present Value of the investment he wishes to do. The investor/shareholders believe the higher the NPV is the better and maximizes the investment they have invested. Sometimes it is difficult to forecast for the longer term due to unforeseen circumstances such as inflation and the potential liabilities in future.
Hence a balance sheet, profit and loss account of a company does not tell the whole story of the company. To understand more about the company and its future prospect, many investors use other investment appraisal too such as EPS Earning per Share, ROCE Return on Capital Employed and etc. Alternatively, the investors are looking at the higher share value to a company in view of getting higher return as per Law of demand and Supply. However, the potential danger is data manipulation by the management like ENRON or setting the shorter term goals to raise the profit by totally ignoring effect on the longer term.
An investor may try his best to forecast on the investment return and at the same time, a company with a good management team have also tried their best to meet their business objectives. Despite of their effort and beyond their control, some unforeseen circumstances can destroy their creation of value in the company or investment.
The recent FT blogs about value creation and value destruction in Brazil is another good example of unforeseen circumstance. Flow of FDI Foreign Direct Investment to Brazil was increased and Brazilian portfolio assets were worth more than $260bn in three years from 2011 to 2013. This inflow of FDI could save the country economy, however, the value of assets held by foreigner fell and resulted a loss of $24bn, implying value destruction of more than $284bn in less than three year. The blames lies in global financial crisis of 2008 and 2009 and critics says it is the cause of Brazil State Capitalism and pointing out the changing roles of private sector and public sector banks.
Therefore, it is recognizable that these current issues in market make the increasing pressure on corporate executives to measure and manage the shareholder value on regular basis. Technically, it could be measurable with different approaches in terms of strategically and financially. Furthermore, it requires educating the managers and having an opportunity to participate in creating company values and increase the capability to maximize the profit. This will enhance to maximize the shareholder wealth too.
References:
http://www.theguardian.com/money/2012/nov/16/ppi-claims-handlers-barclays
http://online.wsj.com/news/articles/SB10001424127887323701904578277492464792404
http://blogs.ft.com/beyond-brics/2014/01/23/investing-in-brazil-value-creation-and-value-destruction/#axzz2s69E0ktS
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