By V. Raghunathan

What exactly is Shareholder Value Added (SVA), or plain Shareholder Value? At one level, the answer is rather simple. It is the value that shareholders earn by investing in a particular stock rather than investing in some other stock of comparable risk. An alternative reply would be that it is the surplus that a firm creates for its owners after meeting all its costs of capital or the expectations of the stakeholders. But the simplicity ends there. And the complexities lie in the details. What are the expectations of the stakeholders, particularly the investors? What factors influence these expectations? How does this change with levels of risk? What is meant by meeting the costs of capital? Is it just the actual payment of cash in the form of dividends or interest, or is it something more? Is Shareholder Value to be understood in a historical context, or in the context of the future?

The broad methods for measuring Shareholder Value fall into 2 main categories: Dividends Model and Earnings Model. The Dividends Model, essentially, views Shareholder Value in terms of what shareholders receive by investing in a stock in a given time-frame. It assumes that the investors will be willing to pay a certain price for a stock only if they expect to receive a stream of future cash-flows from this investment, which, when discounted to its present value at their expected rate of return, exceeds that price. Now, over a certain investment horizon, the shareholders, typically, receive dividends and the benefits of the capital appreciation, if any, at the end of the period. The next issue, then, is the price of the stock at the end of the investment horizon, which depends upon the dividend stream further down the line and the price that the stock would fetch in the further distant future. And so forth ad infinitum.

This gives us a model that, essentially, states that the price of a stock is nothing but the present value of the future stream of dividends ad infinitum. However, nobody can forecast what the exact dividend-stream even next year is going to be. So, assumptions are frequently simplified. And, in making these assumptions, corporate plans, projects in hand, and the competitiveness of the company are taken into account.

The Earnings Model approaches corporate value from a different angle. It assumes that the only value that a corporate can command among investors is the present value of its future expected earnings stream, discounted at the expected rate of return of the investors. In this model, one estimates the future cash-earnings-stream, net of on-going investments. Guesstimates, forecasts, and hunches play a major role in valuation.

These are the fundamental approaches to Shareholder Value measurement. But does it mean that Shareholder Value has no implication for a loss-making firm or one with low profitability? Not at all. Let me illustrate this point. I studied the top and bottom quartile of the BSE Sensex 100 in terms of Return On Net-Worth and Shareholder Return in the secondary market. Shareholder Return is not Shareholder Value; it is the excess of Shareholder Return over the investors' expected return (cost of capital) that creates Shareholder Value. Thus, in some sense, Shareholder Value is the present value of the excess of the Shareholder Return over the appropriate cost of capital over a period of time.

Two facts stood out. One, the top-quartile firms (those with high RONWs) were associated with positive Shareholder Returns while the fourth-quartile firms (low RONWs) were, typically, associated with negative Shareholder Returns (and, hence, loss of Shareholder Value too) although the correlation between RONW and Shareholder Return was rather low. Clearly, higher profitability appears to be important to shareholder value-creation. And, even among low RONW companies, there were firms with relatively high Shareholder Returns and among high RONW companies, there were those with low or even negative Shareholder Returns. These are the companies that should help us understand Shareholder Value better.

Delving deeper into the differences across companies creating or destroying Shareholder Value, one gets interesting insights. Sales growth or marketshare do not, necessarily, create shareholder value. Even companies with high and sustained profitability do not, automatically, add to shareholder value since the high profitability is already discounted in the market value of the share. Additional value accrues only with efforts that increase profitability.

Good corporate governance, more transparency, and superior shareholder relations enable a company to add shareholder value. For example, many firms pay dividends and make rights issue in the same year. Rationally speaking, this is a Shareholder Value-destroying act since needless administrative costs are incurred in the process. A transparent corporate house, with good shareholder relations will be in a better position to convince the top management to set off their dividends against the rights issue.

Creating shareholder value, thus, is not a strategic or tactical move for companies to adopt at an opportune time, but an on-going task. Opportunities to add Shareholder Value exist in virtually every action of a corporate. For example, it is believed that minimising tax-payments reduces value-erosion. And yet, Sundaram Finance is one Non-Banking Finance Company (NBFC) which has consistently paid out an average of Rs 30 crore every year in taxes, and is one of the best NBFCs in the country.

Further, in the Indian context, it is important to note that Shareholder Value is created only if the corporate creates vibrant products or services. When a Western R&D company creates enormous Shareholder Value, it is through the price that the market pays them for the efforts of their research team. Usually, Shareholder Value for Western companies is created only after they have exploited the full potential of shopfloor improvements , reasonably robust governance-practices, and quality considerations. And by keeping principal-agency costs to a minimum. In India, principal-agency costs are replaced by Promoter-Shareholder-Agency costs, which are enormous, and Shareholder Value-eroding, thanks to the existence of 2 different kinds of principals. Namely promoters and plain-vanilla shareholders. Promoters may get rich, but their ventures cease to remain going concerns before long. So, the measure of Shareholder Value, is not a mantra for creating shareholder wealth the easy way.

V. Raghunathan is a professor at the Indian Institute of Management, Ahmedabad

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