Enhancing and Measuring Shareholder Value: UK FTSE 350

Introduction: The Challenge of Shareholder Value

Most UK companies describe themselves as being in the business of maximising value for their shareholders, but the bigger question remains: how is value defined, measured, and managed? Many of these companies have developed corporate mission statements that appear meaningful to the firms in their day-to-day operations. In more recent years, however, cases of accounting scandals have undermined confidence in these promises. It is evident that despite mission statements designed to attract shareholders and assure them of returns, the internal interests of these companies are often given first priority.

For instance, the collapse of Enron and Parmalat destroyed value for both their shareholders and stockholders, with many employees losing their jobs and pensions. These failures can be attributed to decisions that did not take long-term value into consideration. Value-destroying decisions are not usually driven by greed or dishonesty alone; instead, they often result from pursuing legitimate business objectives such as growth or increasing market share. The core problem is that managers frequently lack an understanding of the difference between decisions that result in higher short-term profits and those that genuinely create sustainable value.

Enhancing Shareholder Value Through VBM

In response to these challenges, several approaches have been developed to enhance shareholder value. In early 2004, the International Federation of Accountants (IFAC), in partnership with CIMA, published the report Enterprise Governance — Getting the Balance Right. This report offered a holistic view of companies in the FTSE. Enterprise governance is described as "a set of responsibilities and practices exercised by the board and executive management with the goal of providing strategic direction, ensuring objectives are achieved, ascertaining that risks are managed appropriately, and verifying that organisational resources are used responsibly" (Information Systems Audit and Control Foundation, 2001).

The Enterprise Governance report served as a reminder not to overlook the performance dimension of the enterprise governance framework. It covers the philosophy and practice of managing for long-term value. Value-Based Management (VBM) is a widely used approach in this context. VBM is an attempt to restore the basis of value creation and to focus on acceptable returns on shareholders' capital — which lies at the heart of the market economy. More specifically, VBM can be understood as a management approach, or philosophy, characterised by the metrics used to measure performance. It gauges whether or not a company is generating value for its shareholders by measuring the difference between return on equity and the cost of capital.

McTaggart defines VBM as a "formal, systematic approach to managing companies to achieve the objective of maximising value creation and shareholder value over time" (McTaggart et al., 1994). According to Copeland, VBM "is an approach to management whereby the company's overall aspirations, analytical techniques, and management processes are all aligned to help the company maximise its value by focusing management decision-making on the key drivers of value." Companies such as Boots, Lloyds TSB, and Cadbury Schweppes adopted the VBM agenda and made explicit public commitments to increase shareholder value.

Key Drivers of Shareholder Value

In 2002, research from PA Consulting claimed that companies with a VBM agenda manage to create value even during market downturns. It was recognised, however, that VBM can struggle to operate effectively during periods of severe market difficulty. It is therefore worth investigating whether managing for shareholder value can be part of the solution to restoring faith in capital markets. Creating shareholder value requires strategy: companies ought to be managed with shareholder value as the central objective. Creating value is not about applying a prescribed set of tools but about building competitive advantage in the marketplace — "managing for value begins with strategy and ends with financial results." Strategy lies at the heart of enterprise success, and strategic planning is a principal focus of value management. Successful strategies are the end products of a structured and disciplined decision-making process.

Research has focused on the relationship between firm capabilities and market performance measures such as market share, brand awareness, and customer satisfaction. With respect to customer satisfaction, the relationship between customer satisfaction and stock prices suggests that satisfied customers are economic assets characterised by high returns and low risk (Fornell, Mithas, Morgeson III, & Krishnan, 2006). Advanced levels of customer discontent harm a firm's future stock returns, leading to the conclusion that reducing customer dissatisfaction can boost a firm's stock returns (Luo, 2007). The effects of both customer satisfaction and customer complaint on the stock value of firms are also well documented (Luo & Homburg, 2008), and customer satisfaction has been linked to stock prices on the basis of abnormal portfolio returns compared against risk-adjusted benchmark portfolios (Luo & Nguyen, 2008).

Product quality and new product development are also found to have significant impacts on financial performance. The impact of product quality on stock market value has been assessed using event studies that examine how information about the quality of a firm's new products affects abnormal returns (Tellis & Johnson, 2007). Analysis of 101 new product delay announcements underscores the importance of managing product development effectively, demonstrating the magnitude of the economic impact of being late to market (Hendricks & Singhal, 1997). The short- and long-term impact of marketing actions on financial metrics — including top-line, bottom-line, and stock market performance — has been investigated by comparing the effects of new product introductions and sales promotions on firm and investor performance (Pauwels, Silva-Risso, Srinivasan, & Hanssens, 2004).

Advertising and R&D are considered significant factors influencing financial returns. Stock prices have been shown to incorporate investors' unbiased beliefs about the value of R&D (Chan, Josef, & Sougiannis, 2001). Empirical evidence for the long-term benefit of R&D in terms of stock return and operating performance indicates that R&D increases are beneficial investments, though the market is often slow to recognise the full extent of those benefits (Eberhart, Maxwell, & Siddique, 2004). A firm's advertising and R&D expenditures can generate awareness and support among both finance executives and senior management. Importantly, after accounting and finance factors related to systematic risk are controlled, increases in advertising-to-sales and R&D-to-sales ratios can lower a firm's systematic risk (McAlister, Srinivasan, & Kim, 2007).