Chapter 1 on Valuation and Reporting in Organization

1. Chapter 1: Why Maximize
Value?

2. Table of Content
 1.0 Financial Objectives of the Firm
 2.0 Managers’Value Creation Strategies
 3.0 How Companies Create Value?
 4.0 Economic Fundamentals
 5.0 Stock Market Long-term Returns
 5.1 Cross Country Comparisons
 6.0 Sloppy Economic Analysis
 7.0 Market Bubbles
 7.1 LBO Bubble
 7.2 The Internet Bubble
 8.0 Value Leads To Healthier Companies
 9.0 Short-term Earnings vs. Long-term Value Creation
Valuation and Reporting in Organizations

3. What are The Financial Objectives Of a Firm
 The stakeholders financial objectives of
the firm are:
 Profit Maximization
 Wealth Maximization
 The stakeholders financial objectives of
the firm are:
 Growth
 Diversification
 Survival
 Maintaining contended workforce
 Becoming research and development leader
 Providing top quality service to customers
 Maintaining respect for the environment
Valuation and Reporting in Organizations

4. Managers’ Value Creation Strategies
Manager should focus on the financial objective of the
shareholder, creating shareholder value
Managers who focus on shareholder value, create
healthier companies, which in turn provide spillover
benefits: stronger economies, higher living standards,
and more employment opportunities.
Companies thrive when they create real economic value
for their shareholders.
Valuation and Reporting in Organizations

5. Managers’ Value Creation Strategies
(cont’d)
What managers need to do? Managers need to:
 Have theoretical understanding of value creation
 Set tangible links between their strategies and value creation
 Install performance management systems that encourage real
value creation, not merely short-term accounting results.
 Educate their investors about how and when the company will
create value
Valuation and Reporting in Organizations

6. How Companies Create Value?
Companies create values by investing capital at rates of
return that exceed their cost of capital
Greater value are created by having growth of returns
on capital exceeding cost of that capital, will create more
value to the company
Value creation principles must be part of important company
decisions such as corporate strategy, mergers, acquisitions,
capital structure.
Valuation and Reporting in Organizations

7. Economic Fundamentals
 U.S stock market’s behavior from 1980 through today is
confusing.
The performance is explained by how closely the stock
market has mirrored economic fundamentals throughout a
century of technological revolutions, monetary changes,
political and economic crisis and wars
The situation is true for European and Asian stock markets,
considering regional different economic prospects.
Valuation and Reporting in Organizations

8. 5. Shareholder Return Index
US equity return on common
stock was on average 6.5% over
the past 200 years, adjusted for
inflation.
Adding the annual 3 to 3.5%
increase in share prices to the
cash yield of 3 to 3.5 % results
in total real shareholder returns
of about 6.5% per year.
Valuation and Reporting in Organizations

9. 5.1 Market Price Levels and
Fundamentals
Valuation and Reporting in Organizations

10. Stock Market Long-term Returns
Elements that were responsible for nearly all the change in
the broad market index are:
Growth in earning
Declines in interest rates and inflation
Temporary emergence of so called mega capitalization
stocks associated with the Internet Bubble of 1990s
Valuation and Reporting in Organizations

11. 7.1 Cross Country Comparisons
 The countries with the lowest returns have
been those that experienced the most economic
upheaval.
Valuation and Reporting in Organizations

12. Sloppy Economic Analysis
 Deviations are short-lived
 Focused on a particular segment of the economy
Managers are best off focusing their energy on long-term
value creation and not worrying about the latest stock
market trends.
Valuation and Reporting in Organizations

13. Market Bubbles
When managers and market participants take their
eye off the fundamentals of long-term value
creation, market bubbles can result. Two main
bubble:
 The LBO Bubble
 The Internet Bubble
Valuation and Reporting in Organizations

14. The LBO Bubble
 The emergence of high-yield bond financing opened the door for smaller
investors, known as leveraged-buyout (LBO) firms, to take a leading role
in the hostile-takeover game.
 LBO firms’ early successes attracted the attentions of other investors,
commercial bankers and investment bankers.
 LBO deals and high-yield debt continue to thrive and play and important
role in corporate restructuring and value creation
Valuation and Reporting in Organizations

15. The Internet Bubble
 Many executives and investors forgot or purposely threw out fundamental
rules of economics in the rarified air of the Internet revolution.
 When the laws of economics prevailed, competition reined in returns in
most product areas.
 The Internet Bubbles shows what happens when manager, investors and
bankers ignore the fundamental principles of economics and the
underlying history of value creation.
Valuation and Reporting in Organizations

16. 11. Creating Value Leads To Healthier
Companies
 Companies dedicated to value creation are healthier and build stronger
economies, higher living standards, and more opportunities for
individuals
 United States and European companies that created the most
shareholder value in the past 15 years have shown healthier
employment growth
Valuation and Reporting in Organizations

17. Companies with the highest total returns to shareholders (TRS) also
had the largest increases in employment.
Valuation and Reporting in Organizations
Correlation between TRS and Employment growth

18. Companies that
emphasize creating value
for shareholders are not
shortsighted.
There is strong positive
correlation between
shareholder returns and
investments in research
and development (R&D).
Valuation and Reporting in Organizations
Correlation between TRS and R&D Expenditures

19. 12. Short-Term Earnings vs
Long-term Value Creation
 Managers are tempt to find ways to keep profits growing in the short-
run, while they try to stimulate longer-term growth
 Capital market reward companies that focus on long-term value creation
 Long-term value creating companies help the economy and other
stakeholders
 Stock market always assist on short-term results, putting pressure on
managers
Valuation and Reporting in Organizations

20. 13. Short-term Earnings vs
Long-term Value Creation (cont’d)
 It is up to managers to sort out the trade-offs between short-
term earnings and long-term value creation
 Managers should be responsive to changes and act
accordingly
 Corporate board needs to investigate and be active to judge
managers, so they choose the right trade-offs
Valuation and Reporting in Organizations

21. Questions?
Valuation and Reporting in Organizations