There is a lot of confusion about what maximizing shareholder value means. Very simply, it means: increasing the long-term wealth of the owners of the company. Another way of looking at it is as the process of maximizing the present value of the future cash flows out into infinity (although from a practical standpoint, 30 years does the job).
Think about it like getting an education for your child. There is no career output from your child for 16 to 18 years, in all likelihood. All that time and money is spent preparing a child for the workforce. His or her lifetime earnings and life satisfaction are dependent on this period of investment in the future. What you have invested in is human capital. There are metrics that are proxies for how the child is doing during that 16-18 years: grades, number of intimate friends (an indicator of social skills), genuine (not forced) participation in social activities and sports, etc. All of these give us an idea of how the child is doing and what their prospects are, long before we start to measure their income and net worth. We can think of those as our metrics for measuring intellectual capital and its creation. The time we spend with our child coaching them and guiding them is knowledge management.
Shareholder Value Maximization
While Shareholder Value Maximization has received a lot of press — much of it bad — in the last two decades, its history dates back to the 1970s when companies retained cash and wasted it in building conglomerates for no particular purpose related to creating wealth. The concept of maximizing shareholder value has been corrupted by public company executives which have played games with their stock price so that they could cash in their stock options or justify a higher salary. Many also stopped investing in or under-invested in intellectual capital. This is not the concept we believe in.
Real shareholder value maximization is about the creation of long-term value. We study this in our work on intellectual capital. Research and development — as but one example — is expensed on the income statement and reduces reported income. In reality, it increases the value of the company over the long run because it increases the company’s new products, or cost reductions. The use of GAAP accounting does not accurately reflect the accretion of value due to the R&D activities. Public companies attempt to make disclosures, but analysts are still challenged on knowing how to use the data. The investment in acquiring and training people is expensed from an accounting standpoint, when in reality is an asset that yields great returns.
Since our firm works predominantly with private companies, one would think that the owners always look out into the future and try to build the most value over the long-term. That is not always the case. There are occasions where we see an absence of investment in talent acquisition, talent retention and succession planning. Nothing destroys the value of a privately held business like losing its key man. Owners must acquire and retain their successor.
A lack of investment in human capital shows itself with an absence of job descriptions, a lack of performance reviews and an absence of any of link to key performance indicators. This is paramount to flying in the dark without instrumentation, and it can have potentially fatal consequences.
We also see a lack of investment in keeping up to date with the technology of the industry. Few things stay the same in this world, given the rate of technological change. There needs to be a process for staying abreast of industry and technological changes.
This is barely scratching the surface of the issues that go into the subject. The time and effort invested in working towards the goal of maximizing shareholder value provide their own rewards in both the capital raising process and in the exit planning phase of the mergers and acquisitions process when the owner decides to transition out of the company. If, however, the owner transfers ownership and operations to the next generation, the effort put into maximizing shareholder value becomes more apparent. These would include constantly looking for ways to improve the company, periodically re-engineering the company, re-accessing the customers and market segments the company serves and reviewing its supply chain.
The challenge for the privately held business owner is that they get comfortable with their performance and stop integrating new ideas into this process which could take the company to the next level.