For companies to create value for the shareholders, executives should not focus on the earnings as the framework within which the business is managed. Often, the earnings approach duels on the financial performance of the company within the short-term context and ignores the long-term value aspects of the firm. A financial report for instance from the accountant does not offer estimates of the value of the company nor the growth value of the company within the fiscal period that is in consideration. Also, using earnings as a management tool tempts executives to overinvest or under invest with the sole intention of creating super near-term earnings. In effect, the long-term value of the shareholders is compromised.
The shareholders values can be increased if the management bases their strategic decisions on the maximization of shareholders value at the expense of lowering near earnings. Policy decisions should not be pegged on the impact of such decisions on the shorter-term gains of the company with the deliberate purpose of making the earnings per share (EPS) attractive. Rather, the strategic decisions should be based on the expected value of the companys cash flows from the invested projects. Companies should include these guidelines in their corporate performance statements. For instance, Berkshire Hathaway decision-making framework ensures that earnings guidelines are excluded from decision-making platforms so as to prevent executives and managers from applying the quick-fix approach at the expense expected shareholders value.
In a competitive business environment, acquisitions and mergers happen to boost synergies in the market. Naturally, the value of the firm is created from the daily activities that take place in the business. But a major asset acquisition has a potential to create or diminish value faster than the mentioned activities. The challenge with this strategic decision is that executives usually rely on the EPS prospects to estimate the economic potential of the acquisitions, yet the EPS parameter does not give a clear picture of the future value of the firm after the acquisition. Instead, value-focused firms should adopt strategies that seek to exploit opportunities that enable the company to sell its detachable assets at a premium which maximizes the value of the shareholders. The process entails restructuring of the business after making acquisitions and divesting from areas that are underperforming. An example is Kmart that acquired a hedge fund, restructured and sold some stores at a premium, enabling the company to recover the money spent on the acquisition in a short period.
Viable Investment opportunities are limited. Business firms should reduce the retention ratios in tandem with the diminishing investment opportunities. It is not in the shareholders interest to keep money with the enterprise when there are few investment opportunities. The earnings should be distributed in the form of dividends or share buybacks. Such an action enables the shareholders to grow their value elsewhere and also regulates executives from investing in projects that are risky or making unnecessary acquisitions using the excess funds. Furthermore, the practice prevents managers from pursuing the attractive EPS approach to the management of shareholders funds. However, some companies engage in buybacks as a gimmick to boost the EPS.
Rewarding CEOs and other senior executives for delivering long-term value returns motivate employees to commit themselves to the long-term goals that create value for the organization. Invariably, companies use the stock ownership options approach for senior staff to induce proper management of the funds as the senior workers regard the business as their ventures and thus engage in prudent investment practices. Caution, however, should be taken against the adoption of the standard employee stock options as they have some limitations. For one, the employees cash the shares early and as such may not have the long-term interest in the company. Also, employees gain when there is a positive change in share price and thus, may not care about the long-term performance of the firm. The business institutions should adopt either a discounted indexed-option plan or a discounted equity risk option. The mentioned approaches are ideal because they reward executives depending on the performance of the industry and also consider the risk factors in the market.
The rewarding approach should also be cascaded down to the operating unit executives for adding value to the business over a long-term period. The move would offer motivation to the executives of the various departments for exceeding financial and nonfinancial goals. Rewarding the unit executives would make the senior executives highlight poorly-performing areas of the business and institute measures that align the performances with long-term objectives of the firm. For good performance reasons, the executives should resist the practice of linking budgets to bonus as this strategy creates possibilities of poor performance. However, the method works well where a companys units are inter-dependent. In this case, an overall reward system is practicable.
Moreover, the rewarding consideration should be extended to the middle managers and frontline employees for exemplary performance in their areas of operation. The mentioned approach entails coming up with a quantifiable indicator that recognizes the exceptional input of middle managers and front line staff in the areas that they directly influence business activity. These key value drivers may include marketing of new products, employee turnover rate, customer retention ratio and timely opening new business operation units. The strategy aims to align the activities of every employee to the organizations culture that would create an enabling environment for the attainment of long-term value objectives. The senior executives should focus on the long-term value creation of the mentioned indicators.
The long-term value of the firm partly depends on the commitment of the senior executives to the company. As noted earlier, long-term commitments may be achieved by offering stock options to the executives. But the strategy does not efficiently work because executives do not bear the risk as that of shareholders. Research indicates that senior executives tend to cash on the shares and, therefore, focus on the near earnings to boost the stock prices. Methods such as requiring the executives to have minimum share ownership that is a multiple of their basic salaries are a practical way of tying up the executives to long-term goals of the firm. For instance, eBay share-ownership guidelines require the CEO to own a minimum of five times the basic salary regarding stock options in the company. The impact of this approach, however, is minimal and thus firms should use equity-based incentives, which tie the performance goals with the EPS.
Lastly, provide investors with value-relevant information such as company reports to keep them updated on the specific activities that the management is undertaking to create value for the shareholders. Providing investors with information enable the executives to resist the earnings perspective in the administration of the companys funds. Also, the move would reduce investor uncertainty and, in turn, increase the share price as the investors become privy to the long-term objectives of the company, lessening the demands for quick earnings, especially when other players in industry pursue such short-term policies. It is important to note that the form and content of corporate reports should be continuously improved to furnish the shareholders with the accurate standpoints of the business.
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