Driving Shareholder Value Managing for the New Millennium Dr. Roger A. Morin Georgia State University, Distinguished Professor of Finance Chairman & CEO Utility Research International

FI 8360 Lecture #2 Roadmap F Why Value Value F Value and Capital Markets F The Value Manager F Valuation Frameworks: DCF u NPV, FTE, FCF, APV, etc.

Why Value Value?

Economic Value n E(C t ) Present Value =  t=0 (1 + k) t Future value corresponds to future and uncertain business cash flows, C t. So we discount expected cash flows Cash flow and Risk Because business cash flows occur over many future periods, we locate them in time, then discount and add them all. Timing Because business cash flows are risky, investors demand a higher return: the discount rate, k, contains a risk premium. Risk

Corporate Value infinity Value = Cash Flow t t=0 (1 + Cost of Capital) t

Shareholder value analysis focuses on the factors that investor use to value companies: F Cash Flows F Long-Term Expected Performance F Risk

What is VBM? F A Way of Thinking F A Process for Planning and Execution F A Set of Tools

So What is So Different? Drivers of Value Cash Flow SustainabilityAsset Utilization Growth VALUE old new ??newer

Investor Perspective VBM Links All Management Decisions to the Maximization of Shareholder Value Value-Based Management Strategy Formulation Corporate Development Incentive Compensation Financial Policies & Practices Performance Measures & Inf. systems Employee & Investor Communications

VBM plays a significant role in each stage of the management process Financial Policy Assessment Business Planning Resource Allocation Performance Management Portfolio Assessment

Evolution of VBM Number CrunchingStrategizingIntegrating Mid ‘80’sMid ‘90’s RHS Balance Sheet Finance Raiders Valuation Models LBO’s Divestitures Junk Bond Mkt LHS Balance Sheet Internal Operations Strategy Evaluation Financial Approach to Strategic Planning Holistic, Integrated Investor Perspective Common Language Shared Culture Executive Compensation Performance Evaluation

Benefits of VBM F Better Pay F Better Decisions F Better Morale F Better Performance

What’s In It For Me? F Your stake in the company becomes more valuable F Opportunity to learn new skills F Job creation

Challenge to Create Value F Curse of competition F Curse of beating market expectations

Potential Rewards

Growing Pressures From Sources Of Discipline F Product market –Globalization, technology, deregulation, digital economy, F Market for corporate control –Threat of takeovers F Capital markets –Creditors, shareholders F Market for skilled managers

21 Origination of Value Movement VBM Changing Economics Competition Technological Innovation Information Availability Ruthless Capital Markets Speed-driven, Customer driven Markets

Institutional Pressures F Demonstrated ability to improve performance F Increasing attention on competitive advantage and competitive strategy F Accountability F Internal control mechanisms –Activist boards and investors F Business scorecards

Demise of Accounting Metrics F Accrual accounting undependable F Accounting latitude F Risk excluded F Investment requirements excluded F Dividend policy excluded F Time value of money excluded F EPS growth vs value unrelated F Focusing on short-term earnings growth jeopardizes ability to create long-term value F Accounting model vs Economic model

Decision-Making in a Corporate Tower of Babel F Capital Budgeting: NPV, Cash Flow F Performance Evaluation: ROE, ROI F Investor Relations: EPS, growth F Incentive Bonus: ROE, Cash F Strategy: ????

The Agency Problem F Managers act in their own self-interest (corporate jets, country clubs, perks, etc.) F Shareholders do not have the influence or finances to govern issues such as election of board members F Board members tend to be largely responsive to management; top managers are often board members F Manager’s time horizon may be short-term, due to compensation mode F Managers tends to have lower risk tolerance than owners due to compensation mode

How to reduce the agency problem F Large ownership positions F Compensation tied to shareholder return F Threat of takeovers F Competitive labor markets for corporate executives F VBM

Contributions of VBM F Enhance value for shareholders F Enhance your company’s competitive position in: –Product markets –Market for corporate control –Capital market F Optimize all stakeholders’ interests F Better pay, better performance, better morale, better decisions F Manage assets better F Close the gap between operations, strategy, finance F Think, act, get paid like an owner F Communicate more effectively with investors