Ten Ways to Create Shareholder Value

Summary

Rappaport suggest 10 basic governance principles for value creation that help company to develop sound
strategies for creating shareholder value.

1) Dont manage earnings or provide earnings guidance

Companies play earning expectations game, according to survey companies provide regular profit
guidance to Wall Streets analyst and manage earnings with accountings manipulation by limiting critical
R&D spending just to meet earning benchmarks. Author quoted the WorldCall, Enron and Nortel
Networks examples

2) Make strategic decision that maximize expected value, even at the expense of
lowering near terms earnings
In making strategic decisions, company needs to focus on operational units that have a potential to create
long term growth and guarantee capital investment. Moreover operational units that have limited potential
should be restructured or divested. What mix of investments across operating units should produce the
most long term value?

3) Make acquisitions that maximize expected value, even at the expense of lowering
near terms earnings
Major acquisitions can create or destroy value faster than any other corporate activity. Value oriented
managements evaluate risk and recognize challenges of post-merger integration moreover management
needs to identify clearly where, when and how it can accomplish real performance gains by estimating the
present value of the resulting incremental cash flows and then subtracting the acquisition premium.

4) Carry only assets that maximize value

Value oriented companies focus on activities that contribute most to long term value and keep eyes
whether there are buyers willing to pay a meaningful premium over estimated cash flow value to the
company for its business unit if the business unit isnt much profitable than company should opt for
selling option otherwise keeping it is the best. Moreover also focus on activities that contribute most to
long term value such as research and strategic hiring. Outsource lower activities such as manufacturing.

5) Return excess cash to shareholder when there are no value-creating opportunities in

which to invest

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Value conscious companies with large amounts of excess cash and limited value-creating investment
opportunities return the money to shareholder through dividends and share buy backs. This way
shareholder earn better return elsewhere and reduce risk that management will use excess cash to make
ill-advised investments. When companys stock price is low, buying is the best option and when its
high, paying dividend is the best option.

6) Reward CEOs and other senior executives for delivering superior long-term returns
Companies served stock options once as a healthy value ethos but are an imperfect vehicle for motivating
long-term, value-maximizing behavior. Value oriented companies overcome the short comings of stock
options by adopting either discounted indexed option plan or discounted equity risk option (DERO) plan.
DERO exercise price rises annually by the YTM on the ten years U.S T-note plus fraction of the expected
equity risk premium minus dividend paid to the holders of underlying shares.

7) Reward operating-unit executives for adding superior multiyear value

Companies usually incorporate both annual and long term incentive plans that reward operating
executives for exceeding goals for financial metrics such as revenue and operating income. Its unfair to
link bonuses to the budgeting process induces managers to underestimate performance possibilities. They
need to develop Shareholder Value Added metrics which gives clear advantage over traditional measures.

8) Reward middle managers and frontline employees for delivering superior

performance
Companies can develop 3 to 5 leading indicators of value which are quantifiable, easily communicated
that influence frontline employee directly and significantly affect the long term value of business.

9) Require senior executives to bear the risk of ownership just as shareholder do

Companies need to seek ways to balance the interests of executives and shareholders between benefits of
requiring senior executives to have meaningful and continuing ownership stakes and resulting restrictions
on their liquidity and diversification.

10) Provide investor with value relevant information

Prepare a corporate performance statement that allows analysts and shareholders to readily understand the
key performance indicators that drive companys long-term value.

The Rewards and the Risks

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By focusing on new business opportunities a company can deliver superior long-term returns. These 10
principles can still be bottleneck for companies like high-tech startups which rely on healthy stock price
to finance growth and send positive signals to shareholders.