This document discusses four principles of corporate finance that CEOs can use to make good financial decisions even without the CFO present. The four principles are: 1) the core-of-value principle which establishes that value is created through returns on capital and growth, 2) the conservation-of-value principle which states that only improving cash flows creates value, 3) the expectations treadmill principle which explains how stock prices reflect changes in expectations rather than just performance, and 4) the best-owner principle which says that a business's value depends on its owner and strategy. The document provides examples of how CEOs can apply these principles to decisions around mergers and acquisitions, divestitures, project analysis, and executive compensation.
This presentation was created by Babasab Patil, and all copyright belongs to him. Please visit his website at: http://sites.google.com/site/babambafinance/
The board of directors might decide it is in the best interest of shareholders to sell the corporation to new owners. In theory, a change in control only makes sense when the value of the firm to new owners, minus transaction costs, is greater than the value of the firm to current owners.
This Quick Guide examines the market for corporate control.
It answers the questions:
• Why do companies merge?
• Do mergers improve performance?
• Who gets the value in a merger?
• How do companies protect themselves from hostile bids?
• Do these protections help shareholders?
For an expanded discussion, see Corporate Governance Matters: A Closer Look at Organizational Choices and Their Consequences (Second Edition) by David Larcker and Brian Tayan (2015): http://www.gsb.stanford.edu/faculty-research/books/corporate-governance-matters-closer-look-organizational-choices
Buy This Book: http://www.ftpress.com/store/corporate-governance-matters-a-closer-look-at-organizational-9780134031569
For permissions to use this material, please contact: E: corpgovernance@gsb.stanford.edu
Copyright 2015 by David F. Larcker and Brian Tayan. All rights reserved.
Finance Assignment Help by EssayCorp Experts in AustraliaJohnsmith5188
Finance assignments assist students with understanding resource the board, inspecting, assessment and influence the executives and accordingly, the creation of cost-based choices. Understudies regularly need money task tests for contextual investigations and reports, which are the most widely recognized among account assignments.
MBO Guide - Turning Executives into Ownersmdelcarlo
This guide is designed for managers who are considering a management buy-out (MBO). It provides background on management buy-outs, how to spot an MBO opportunity, outlines the typical buy-out process, funding and legal structures, highlights many of the key issues that management will face and explains how DVR Capital can assist in negotiating value for the management team.
This presentation was created by Babasab Patil, and all copyright belongs to him. Please visit his website at: http://sites.google.com/site/babambafinance/
The board of directors might decide it is in the best interest of shareholders to sell the corporation to new owners. In theory, a change in control only makes sense when the value of the firm to new owners, minus transaction costs, is greater than the value of the firm to current owners.
This Quick Guide examines the market for corporate control.
It answers the questions:
• Why do companies merge?
• Do mergers improve performance?
• Who gets the value in a merger?
• How do companies protect themselves from hostile bids?
• Do these protections help shareholders?
For an expanded discussion, see Corporate Governance Matters: A Closer Look at Organizational Choices and Their Consequences (Second Edition) by David Larcker and Brian Tayan (2015): http://www.gsb.stanford.edu/faculty-research/books/corporate-governance-matters-closer-look-organizational-choices
Buy This Book: http://www.ftpress.com/store/corporate-governance-matters-a-closer-look-at-organizational-9780134031569
For permissions to use this material, please contact: E: corpgovernance@gsb.stanford.edu
Copyright 2015 by David F. Larcker and Brian Tayan. All rights reserved.
Finance Assignment Help by EssayCorp Experts in AustraliaJohnsmith5188
Finance assignments assist students with understanding resource the board, inspecting, assessment and influence the executives and accordingly, the creation of cost-based choices. Understudies regularly need money task tests for contextual investigations and reports, which are the most widely recognized among account assignments.
MBO Guide - Turning Executives into Ownersmdelcarlo
This guide is designed for managers who are considering a management buy-out (MBO). It provides background on management buy-outs, how to spot an MBO opportunity, outlines the typical buy-out process, funding and legal structures, highlights many of the key issues that management will face and explains how DVR Capital can assist in negotiating value for the management team.
Each technological age has been marked by a shift in how the industrial platform enables companies to rethink their business processes and create wealth. In the talk I argue that we are limiting our view of what this next industrial/digital age can offer because of how we read, measure and through that perceive the world (how we cherry pick data). Companies are locked in metrics and quantitative measures, data that can fit into a spreadsheet. And by that they see the digital transformation merely as an efficiency tool to the fossil fuel age. But we need to stretch further…
Artificial intelligence (AI) is everywhere, promising self-driving cars, medical breakthroughs, and new ways of working. But how do you separate hype from reality? How can your company apply AI to solve real business problems?
Here’s what AI learnings your business should keep in mind for 2017.
10
66 harvard business review | hbr.org
t’s become fashionable to blame the pursuit of
shareholder value for the ills besetting corporate
America: managers and investors obsessed with next
quarter’s results, failure to invest in long-term growth,
and even the accounting scandals that have grabbed head-
lines. When executives destroy the value they are sup-
posed to be creating, they almost always claim that stock
market pressure made them do it.
The reality is that the shareholder value principle has
not failed management; rather, it is management that has
betrayed the principle. In the 1990s, for example, many
companies introduced stock options as a major compo-
nent of executive compensation. The idea was to align the
interests of management with those of shareholders. But
the generous distribution of options largely failed to mo-
tivate value-friendly behavior because their design almost
guaranteed that they would produce the opposite result.
To start with, relatively short vesting periods, combined
with a belief that short-term earnings fuel stock prices, en-
couraged executives to manage earnings, exercise their
options early, and cash out opportunistically. The com-
mon practice of accelerating the vesting date for a CEO’s
Companies profess devotion to shareholder value but rarely follow the practices
that maximize it. What will it take to make your company a level 10 value creator?
by Alfred Rappaport
I
S
IM
O
N
P
E
M
B
E
R
T
O
N
Ways to Create
Shareholder Value
Y
E
L
M
A
G
C
Y
A
N
B
L
A
C
K
september 2006 67
Te n Wa y s t o C r e a t e S h a r e h o l d e r Va l u e
options at retirement added yet another incentive to
focus on short-term performance.
Of course, these shortcomings were obscured during
much of that decade, and corporate governance took a
backseat as investors watched stock prices rise at a double-
digit clip. The climate changed dramatically in the new
millennium, however, as accounting scandals and a steep
stock market decline triggered a rash of corporate col-
lapses. The ensuing erosion of public trust prompted a
swift regulatory response–most notably, the 2002 passage
of the Sarbanes-Oxley Act (SOX), which requires compa-
nies to institute elaborate internal controls and makes cor-
porate executives directly accountable for the accuracy of
financial statements. Nonetheless, despite SOX and other
measures, the focus on short-term performance persists.
In their defense, some executives contend that they
have no choice but to adopt a short-term orientation,
given that the average holding period for stocks in profes-
sionally managed funds has dropped from about seven
years in the 1960s to less than one year today. Why con-
sider the interests of long-term shareholders when there
are none? This reasoning is deeply flawed. What matters
is not investor holding periods but rather the market’s val-
uation horizon – the number of years of expec.
HwA’s team of finance assignment experts would be delighted to help students solve finance assignment and finance homework through quality sample solutions.
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The first chapter introduces us to Corporate finance is essential .docxoreo10
The first chapter introduces us to Corporate finance is essential to all managers as it provides all the skills managers need to; Identify corporate strategies and individual projects that add value to the organization and come up with plans for acquiring the funds. The types of business forms are; sole proprietorship, corporation and partnerships. A sole proprietorship form of business possesses different advantages and disadvantages. A partnership maintains roughly similar pros and cons of a sole proprietorship. A corporation is a legal entity that is separate from its owners and managers. Advantages include a smooth transfer of ownership, limited liability, ease of raising capital. The disadvantages include; double taxation, and a high cost of set-up and report filing. The chapter then deals with Objective of the firm, which is to maximize wealth. The final topic is an in-depth look at Financial Securities, which are markets and institutions.
In the second chapter, we are introduced to financial statements, Cash flow and taxes. Financial statements include; the Income statement and the Balance sheet. An income statement is a financial statement that shows a company’s financial performance regarding revenues and expenses, over a particular period, mostly one year. A balance sheet, on the other hand, is a financial statement that states a company’s assets, liabilities and capital at a particular point in time. Under the cash flow, the chapter covers on the Statement of cash flows, indicates how various changes in balance sheet and income statement accounts affect cash and analyses financing, investing and operating activities. A free cash flow shows the cash that an organization is capable of generating after investment to either maintain or expand its database. Under taxes, Corporate and personal taxes are well explained and the scenarios under which they apply.
Chapter Three analyzes Financial Statements. This analysis is broken down into; Ratio Analysis, DuPont equation. The effects of improving ratios, the limitations of ratio analysis and the Qualitative factors. Ratios help in comparison of; one company over time and one company versus other companies. Ratios are used by; Stockholders to estimate future cash flows and risks, lenders to determine their creditworthiness and managers to identify areas of weaknesses and strengths. Liquidity ratios show whether a company can meet its short-term commitments using the resources it has at that particular time. Asset management ratios exemplify how well an organization utilize its assets. Debt management ratios, leverage ratios as well as profitability ratios are explained.
The DuPont equation focuses on several issues. These are; Debt Utilization, Asset utilization and the Expense Control. Consequently, Ratio analysis has various problems and limitations. These include; Distortion of ratios from seasonal factors, various operating and accounting practices can distort comparisons and also it i ...
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Sustainability has become an increasingly critical topic as the world recognizes the need to protect our planet and its resources for future generations. Sustainability means meeting our current needs without compromising the ability of future generations to meet theirs. It involves long-term planning and consideration of the consequences of our actions. The goal is to create strategies that ensure the long-term viability of People, Planet, and Profit.
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1. Introduction and Key Concepts of Sustainability
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To download the complete presentation, visit: https://www.oeconsulting.com.sg/training-presentations
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2. The problem
Strategic decisions can be com-
plicated by competing, often spurious
notions of what creates value. Even
executives with solid instincts can be
seduced by the allure of financial
engineering, high leverage, or the idea
that well-established rules of eco-
nomics no longer apply.
Why it matters
Such misconceptions can undermine
strategic decision making and slow
down economies.
What you should do about it
Test decisions such as whether to
undertake acquisitions, make dives-
titures, invest in projects, or
increase executive compensation
against four enduring principles
of corporate finance. Doing so will
often require managers to adopt
new practices, such as justifying
mergers on the basis of their
impact on cash flows rather than on
earnings per share, holding regular
business exit reviews, focusing on
enterprise-wide risks that may
lurk within individual projects, and
indexing executive compensation
to the growth and market performance
of peer companies.
3. 3 The CEO’s guide to corporate finance
It’s one thing for a CFO to understand the technical methods of
valuation—and for members of the finance organization to apply them to
help line managers monitor and improve company performance.
But it’s still more powerful when CEOs, board members, and other non-
financial executives internalize the principles of value creation.
Doing so allows them to make independent, courageous, and even un-
popular business decisions in the face of myths and misconceptions
about what creates value.
When an organization’s senior leaders have a strong financial compass, it’s
easier for them to resist the siren songs of financial engineering, excessive
leverage, and the idea (common during boom times) that somehow the
established rules of economics no longer apply. Misconceptions like these—
which can lead companies to make value-destroying decisions and slow
down entire economies—take hold with surprising and disturbing ease.
What we hope to do in this article is show how four principles, or corner-
stones, can help senior executives and board members make some of their
most important decisions. The four cornerstones are disarmingly simple:
1. The core-of-value principle establishes that value creation
is a function of returns on capital and growth, while highlighting some
important subtleties associated with applying these concepts.
2. The conservation-of-value principle says that it doesn’t matter
how you slice the financial pie with financial engineering, share
repurchases, or acquisitions; only improving cash flows will create value.
3. The expectations treadmill principle explains how movements
in a company’s share price reflect changes in the stock market’s
expectations about performance, not just the company’s actual performance
(in terms of growth and returns on invested capital). The higher
those expectations, the better that company must perform just to keep up.
4. The best-owner principle states that no business has an inherent
value in and of itself; it has a different value to different owners or
potential owners—a value based on how they manage it and what strategy
they pursue.
Ignoring these cornerstones can lead to poor decisions that erode the value
of companies. Consider what happened during the run-up to the financial
crisis that began in 2007. Participants in the securitized-mortgage market
all assumed that securitizing risky home loans made them more
valuable because it reduced the risk of the assets. But this notion violates
the conservation-of-value rule. Securitization did not increase the
aggregated cash flows of the home loans, so no value was created, and the
initial risks remained. Securitizing the assets simply enabled the risks
4. 4The CEO’s guide to corporate finance
to be passed on to other owners: some investors, somewhere, had to be
holding them.
Obvious as this seems in hindsight, a great many smart people missed it
at the time. And the same thing happens every day in executive suites and
board rooms as managers and company directors evaluate acquisitions,
divestitures, projects, and executive compensation. As we’ll see, the four
cornerstones of finance provide a perennially stable frame of reference
for managerial decisions like these.
Mergers and acquisitions
Acquisitions are both an important source of growth for companies and
an important element of a dynamic economy. Acquisitions that put
companies in the hands of better owners or managers or that reduce excess
capacity typically create substantial value both for the economy as a
whole and for investors.
You can see this effect in the increased combined cash flows of the many
companies involved in acquisitions. But although they create value overall,
the distribution of that value tends to be lopsided, accruing primarily
to the selling companies’ shareholders. In fact, most empirical research
shows that just half of the acquiring companies create value for their
own shareholders.
The conservation-of-value principle is an excellent reality check for
executives who want to make sure their acquisitions create value for their
shareholders. The principle reminds us that acquisitions create value
when the cash flows of the combined companies are greater than they
would otherwise have been. Some of that value will accrue to the
acquirer’s shareholders if it doesn’t pay too much for the acquisition.
Exhibit 1 shows how this process works. Company A buys Company B for
$1.3 billion—a transaction that includes a 30 percent premium over its
market value. Company A expects to increase the value of Company B by
Give each business unit a date stamp,
or estimated time of exit, and review them
regularly. This keeps exits on the agenda
and obliges executives to evaluate businesses
as their “sell-by date” approaches.
5. 5 The CEO’s guide to corporate finance
40 percent through various operating improvements, so the value of
Company B to Company A is $1.4 billion. Subtracting the purchase price
of $1.3 billion from $1.4 billion leaves $100 million of value creation
for Company A’s shareholders.
In other words, when the stand-alone value of the target equals the market
value, the acquirer creates value for its shareholders only when the value
of improvements is greater than the premium paid. With this in mind, it’s
easy to see why most of the value creation from acquisitions goes to
the sellers’ shareholders: if a company pays a 30 percent premium, it must
increase the target’s value by at least 30 percent to create any value.
While a 30 or 40 percent performance improvement sounds steep, that’s
what acquirers often achieve. For example, Exhibit 2 highlights four
large deals in the consumer products sector. Performance improvements
typically exceeded 50 percent of the target’s value.
Our example also shows why it’s difficult for an acquirer to create a
substantial amount of value from acquisitions. Let’s assume that
Company A was worth about three times Company B at the time of the
acquisition. Significant as such a deal would be, it’s likely to increase
Company A’s value by only 3 percent—the $100 million of value creation
depicted in Exhibit 1, divided by Company A’s value, $3 billion.
Q4
Stakeholders
Exhibit 1 of 2
To create value, an acquirer must achieve performance improvements
that are greater than the premium paid.
1.01.0
0.3
0.4
1.4
0.11.3
Premium paid by
acquirer
Target’s market
value
Target’s stand-
alone value
Value received
Value created
for acquirer
Price paid
$ billion
Value of
performance
improvements
6. 6The CEO’s guide to corporate finance
Finally, it’s worth noting that we have not mentioned an acquisition’s
effect on earnings per share (EPS). Although this metric is often considered,
no empirical link shows that expected EPS accretion or dilution is an
important indicator of whether an acquisition will create or destroy value.
Deals that strengthen near-term EPS and deals that dilute near-term
EPS are equally likely to create or destroy value. Bankers and other finance
professionals know all this, but as one told us recently, many nonetheless
“use it as a simple way to communicate with boards of directors.” To avoid
confusion during such communications, executives should remind
themselves and their colleagues that EPS has nothing to say about which
company is the best owner of specific corporate assets or about
how merging two entities will change the cash flows they generate.
Divestitures
Executives are often concerned that divestitures will look like an
admission of failure, make their company smaller, and reduce its stock
market value. Yet the research shows that, on the contrary, the stock
market consistently reacts positively to divestiture announcements.1
The
divested business units also benefit. Research has shown that the profit
margins of spun-off businesses tend to increase by one-third during the
three years after the transactions are complete.2
These findings illustrate the benefit of continually applying the best-
owner principle: the attractiveness of a business and its best owner will
Kellogg acquires
Keebler (2000)
Present value of announced
performance improvements as
a % of target’s stand-alone value
Net value created
from acquisition as a %
of purchase price
Premium paid as
a % of target’s
stand-alone value
PepsiCo acquires
Quaker Oats (2000)
Clorox acquires
First Brands (1998)
Henkel acquires
National Starch (2007)
45–70
35–55
70–105
60–90
30–50
25–40
5–25
15
10
60
55 5–25
Q4
Stakeholder
Exhibit 2 of 2
Dramatic performance improvement created significant
value in these four acquisitions.
1
J. Mulherin and Audra Boone, “Comparing acquisitions and divestitures,” Journal of
Corporate Finance, 2000, Volume 6, Number 2, pp. 117–39.
2
Patrick Cusatis, James Miles, and J. Woolridge, “Some new evidence that spinoffs create
value,” Journal of Applied Corporate Finance, 1994, Volume 7, Number 2, pp. 100–107.
7. 7 The CEO’s guide to corporate finance
probably change over time. At different stages of an industry’s or
company’s lifespan, resource decisions that once made economic sense
can become problematic. For instance, the company that invented a
groundbreaking innovation may not be best suited to exploit it. Similarly,
as demand falls off in a mature industry, companies that have been in it
a long time are likely to have excess capacity and therefore may no longer
be the best owners.
A value-creating approach to divestitures can lead to the pruning of good
and bad businesses at any stage of their life cycles. Clearly, divesting
a good business is often not an intuitive choice and may be difficult for
managers—even if that business would be better owned by another
company. It therefore makes sense to enforce some discipline in active
portfolio management. One way to do so is to hold regular review
meetings specifically devoted to business exits, ensuring that the topic
remains on the executive agenda and that each unit receives a date stamp,
or estimated time of exit. This practice has the advantage of obliging
executives to evaluate all businesses as the “sell-by date” approaches.
Executives and boards often worry that divestitures will reduce their
company’s size and thus cut its value in the capital markets. There follows
a misconception that the markets value larger companies more than
smaller ones. But this notion holds only for very small firms, with some
evidence that companies with a market capitalization of less than
$500 million might have slightly higher costs of capital.3
Finally, executives shouldn’t worry that a divestiture will dilute EPS
multiples. A company selling a business with a lower P/E ratio than that
of its remaining businesses will see an overall reduction in earnings
per share. But don’t forget that a divested underperforming unit’s lower
growth and ROIC potential would have previously depressed the entire
company’s P/E. With this unit gone, the company that remains will have a
higher growth and ROIC potential—and will be valued at a corre-
spondingly higher P/E ratio.4
As the core-of-value principle would predict,
3
See Robert S. McNish and Michael W. Palys, “Does scale matter to capital markets?”
McKinsey on Finance, Number 16, Summer 2005, pp. 21–23 (also available on
mckinseyquarterly.com).
4
Similarly, if a company sells a unit with a high P/E relative to its other units, the earnings
per share (EPS) will increase but the P/E will decline proportionately.
8. 8The CEO’s guide to corporate finance
financial mechanics, on their own, do not create or destroy value. By the
way, the math works out regardless of whether the proceeds from a sale
are used to pay down debt or to repurchase shares. What matters for value
is the business logic of the divestiture.
Project analysis and downside risks
Reviewing the financial attractiveness of project proposals is a common
task for senior executives. The sophisticated tools used to support
them—discounted cash flows, scenario analyses—often lull top manage-
ment into a false sense of security. For example, one company we
know analyzed projects by using advanced statistical techniques that
always showed a zero probability of a project with negative net
present value (NPV). The organization did not have the ability to discuss
failure, only varying degrees of success.
Such an approach ignores the core-of-value principle’s laserlike focus on
the future cash flows underlying returns on capital and growth, not
just for a project but for the enterprise as a whole. Actively considering
downside risks to future cash flows for both is a crucial subtlety of
project analysis—and one that often isn’t undertaken.
For a moment, put yourself in the mind of an executive deciding whether
to undertake a project with an upside of $80 million, a downside of
–$20 million, and an expected value of $60 million. Generally accepted
finance theory says that companies should take on all projects with
a positive expected value, regardless of the upside-versus-downside risk.
But what if the downside would bankrupt the company? That might be
the case for an electric-power utility considering the construction of
a nuclear facility for $15 billion (a rough 2009 estimate for a facility with
two reactors). Suppose there is an 80 percent chance the plant will be
successfully constructed, brought in on time, and worth, net of investment
costs, $13 billion. Suppose further that there is also a 20 percent chance
that the utility company will fail to receive regulatory approval to start
operating the new facility, which will then be worth –$15 billion. That
means the net expected value of the facility is more than $7 billion—
seemingly an attractive investment.5
The decision gets more complicated if the cash flow from the company’s
existing plants will be insufficient to cover its existing debt plus the
debt on the new plant if it fails. The economics of the nuclear plant will
then spill over into the value of the rest of the company—which has
5
The expected value is $7.4 billion, which represents the sum of 80 percent of $13 billion
($28 billion, the expected value of the plant, less the $15 billion investment) and 20 percent
of –$15 billion ($0, less the $15 billion investment).
9. 9 The CEO’s guide to corporate finance
$25 billion in existing debt and $25 billion in equity market capitalization.
Failure will wipe out all the company’s equity, not just the $15 billion
invested in the plant.
As this example makes clear, we can extend the core-of-value principle
to say that a company should not take on a risk that will put its future cash
flows in danger. In other words, don’t do anything that has large
negative spillover effects on the rest of the company. This caveat should
be enough to guide managers in the earlier example of a project with
an $80 million upside, a –$20 million downside, and a $60 million expected
value. If a $20 million loss would endanger the company as a whole,
the managers should forgo the project. On the other hand, if the project
doesn’t endanger the company, they should be willing to risk the
$20 million loss for a far greater potential gain.
Executive compensation
Establishing performance-based compensation systems is a daunting task,
both for board directors concerned with the CEO and the senior team
and for human-resource leaders and other executives focused on, say, the
top 500 managers. Although an entire industry has grown up around
the compensation of executives, many companies continue to reward them
for short-term total returns to shareholders (TRS). TRS, however, is
driven more by movements in a company’s industry and in the broader
market (or by stock market expectations) than by individual performance.
For example, many executives who became wealthy from stock options
during the 1980s and 1990s saw these gains wiped out in 2008. Yet the
underlying causes of share price changes—such as falling interest rates
in the earlier period and the financial crisis more recently—were frequently
disconnected from anything managers did or didn’t do.
Using TRS as the basis of executive compensation reflects a fundamental
misunderstanding of the third cornerstone of finance: the expectations
treadmill. If investors have low expectations for a company at the beginning
of a period of stock market growth, it may be relatively easy for the
company’s managers to beat them. But that also increases the expec-
tations of new shareholders, so the company has to improve ever
faster just to keep up and maintain its new stock price. At some point, it
becomes difficult if not impossible for managers to deliver on these
accelerating expectations without faltering, much as anyone would even-
tually stumble on a treadmill that kept getting faster.
This dynamic underscores why it’s difficult to use TRS as a performance-
measurement tool: extraordinary managers may deliver only ordinary
TRS because it is extremely difficult to keep beating ever-higher
share price expectations. Conversely, if markets have low performance