Introduction
The modern day business world is characterized by numerous dynamics which present a real challenge to the achievement of the set objectives. As such, there has been an increasing pressure mounted on business executives to ensure that the firms they have been entrusted to manage perform and meet the set targets. There are various measures which are used to determine the performance of a firm.
The success path of a typical business is divided into short-term, medium-term, and long-term. Most business leaders tend to concentrate on achieving short-term success expectations and in so doing, more often not overlook the long-term success of a firm. This erodes the real shareholder value (Rappaport 5). This essay discusses the various ways to create shareholder value of a firm.
Ways of creating shareholders’ value
There are several ways that have been proposed to guide to business executives to create sustainable wealth to the shareholders who are the preferential stakeholders in any business undertaking.
The first way to is to avoid focusing on short-term earnings expectations. While it is important to ensure that the firm’s long term success is broken down into short term targets, it is often suicidal to concentrate on the short term earnings as a measure of success for the firm. In order to avoid this, a firm needs to avoid making earnings management.
Earnings management always has detrimental consequences to the firm’s eventual success and it is usually impossible to reverse any damage caused by earnings management irrespective of any brilliant decisions made thereafter. Focusing on earnings management always misleads because of various reasons.
First, the earnings are usually derived from the accounting reports, which are mainly prepared based on historical basis. This fundamentally lacks the value creating aspect of the operations since the earnings do not indicate expected returns from the current decisions that the management is making.
The second principle to follow is to make strategic decisions which ensure that the value of the firm is maximized. This should always be practiced even if the management has to sacrifice short-term earnings. Making decisions that maximize the expected value of the firm usually involves making estimates of the expected incremental cash flows from the various investment projects at hand (Rappaport 7). This includes making of acquisitions that maximize the expected value of the firm even if it translates into less earnings in the short term.
Another way is to ensure that the firm only carries assets that maximize the value of the shareholder. It is evident that the value of a firm is more reliant on the future performance than the past results. In light of this, a firm should always carry out regular assessments on its assets.
This determines whether the assets are still used in the most productive manner and whether they provide the best alternative way of generating economic benefits to the shareholders. In doing this, assets that no longer provide value are disposed are the funds raised are used to invest in better projects that maximize the value of the firm or if there are no better projects, the funds are returned to shareholders so that they may evaluate better ways to redeploy their wealth.
The other principles are concerned with the benefits that the employees of the firms are entitled. While an employee compensation is primarily a reward for the work done to the company, it is also used to motivate employees to perform better in the future. The latter is usually a principle that can be used to create shareholder value if employed properly. One way of ensuring that the compensation helps in creating value is to offer rewards to the CEO and the executives based on the long-term returns.
One sure way of ensuring this is to adopt the discounted indexed-option plan. Another alternative is the discounted equity risky option plan. These two methods are superior to the famous employees’ stock options. However, while implementing this, firms should be keen to ensure that the employees are appraised based on their span of control in the organization.
For example, a manager in charge of a functional unit of an organization should be appraised based on the performance of the business line he/she is in charge of. Anyone who fails to deliver on his area of span should not unnecessarily cause other business leaders whose units perform well to miss on their compensation.
Another way of ensuring that executives concentrate on value creation is to share the business risks with the shareholders. There is usually a perceived conflict of interest between the managers and the owners of an organization. This conflict is brought about by the separation of ownership and management.
In effect, the managers who are not necessarily the owners of the business tend to pursue their own interests which are different from those of shareholders who are concerned with value maximization (Hillman and Keim 130). A way of solving this is requiring senior executives to own a significant number of shares in the organization. In so doing, the interests of the executives are aligned with those of the shareholders.
Conclusion
A firm that employs all of these strategies will surely be on the right path to creating value to the shareholders. To most organizations, the challenge is usually in making strategic decisions that ensure the value of the firm is maximized. However, these few guidelines should provide a clear path upon which a firm’s value can be maximized.
Works Cited
Hillman, J. and D. Keim. “Shareholder Value, Stakeholder Management, and Social Issues: What’s the Bottom Line?” Strategic Management Journal (2001): 125-139. Print.
Rappaport, Alfred. “Ten Ways to Create Shareholder Value.” havard Business Review (2006): 1-14. Print.