Essay Example on CEOs of all companies have a role to maximise their shareholder’s Wealth








CEOs of all companies have a role to maximise their shareholder’s wealth Goedhart and Wessels 2010 and hence satisfy their needs They work towards this goal by evaluating their company s performance via various perspectives resource based theory perspective Cho and Pucik 2005 shareholder theory perspective Hillman and Dalziel 2003 or stakeholder perspective Friedman and Miles 2002 Harrison and wicks 2013 But now the dual theory which includes stakeholder and shareholder theory has become more popular amongst masses as it includes both financial and non financial information Jackson 2011 1 Financial performance measures involves looking at the company's profit EVA EPS 2 Non financial performance measures involves taking in consideration other factors as well like market efficiency share leadership customer satisfaction Transition from Traditional to Modern Financial Measures Rappaport s research in the 1970s along with Black et 2010 reveal that even though the earnings of Standard Poor s 400 companies fell dramatically during the 1970’s their ROEs actually rose through increased levels of asset turnover and gearing Hence a higher ROE may still lead to wealth destruction which is not in line with the economic principles of shareholder value creation

An example of a company that focused its approach on earnings and ROE is Enron Stewart III 2003 68 The management of Enron was so focused on earnings per share EPS and ROE that they started to use debt to a great extent This caused the leverage to rise drastically but still the managers were not keen to tap into equity markets to relieve financial stress fearing that it would have an adverse impact on earnings figures However positive earnings figures did not create value for shareholders and thus prevent the company from collapsing Ehrbar and Stewart 1999 Modern Financial Indicator Economic Value Added EVA Capital ROC WACC Positive Aspect Thus the Economic value Added EVA indicator was introduced by Stewart 1990 p 137 Economic Value Added is better than the traditional accounting profits as a way of value creation as it takes account of the cost of capital and thus the riskiness of a company's operations Lehn Makhija 1996 p34 It comes the closest in revealing the true economic profit of any company and adjusting for accounting distortions by up to 164 adjustments Steward 1991 Blair 1997 There are situations when entities may pay tax to showcase that they have made profit for their shareholders and hence a falsification is carried with owners This is a common corporate issue which is rectified by EVA as it explicitly recognises when managers get capital they should pay for it as it were a wage IJBM 2009 

Hence it has been implemented in many giant companies to generate shareholder value Dodd and Chenn 2009 In 1997 Wallace s research proved that using management bonus plans under EVA measures encourages the management to surpass the regular performance level and even after the deductions of management s bonuses the profit to shareholders would still be more than it would be without the bonus system IJBM 2009 Hence this induces EVA plays a pivoting role in dealing with principal agent problem and unite the interests of the management s owners and ordinary employees along with catering to shareholder s needs Jensen and Murphy 1990 Companies named Eli Lilly Bausch Lomb Briggs Stratton and Herman Miller who have recently converted to EVA measure have proved to be exceptionally strong performers they have far outpaced the market as a whole and other firms in their industries Ehrbar and Stewart 1999 In1996 SPX a failing auto parts entity in Muskegon Michigan enforced EVA and its stock price rose from the approximately 15 to 69 a share in next two years the company created nearly 350 million of shareholder wealth in its first year and 400 million in the second year CEO at Coca Cola Goizueta behind the largest wealth creating company in 1994 reported that he was pleased to be one of the first to adopt EVA By 1996 the company had maximized the shareholders wealth by 125 billion Ehrbar and Stewart 1999 It is the framework showcasing an inclusive new system of corporate financial management that guides every decision from annual operating budgets to capital budgeting strategic planning and acquisitions and divestitures Steve Einhorn former director of global equity research at Goldman Sachs states that EVA is a power tool for investors to identify companies with good prospects and companies can use it to communicate their goals and achievements to them

Ehrbar and Stewart 1999 Negative Aspect As EVA is a short term financial measure EVA performance measure works by reducing the excess capacity resulting in a reduced asset base Jan Bouwens and Roland F Spekle This reduced extra capacity is important for the firm as it caters for a flexible response to new growth opportunities Moreover this aroused divestment comes at the cost of reduced value capturing activity in future periods which is regarded as myopia Ashton Hopper and Scapens 2007 This way of reducing asset base to improve EVA not only puts the company under myopia but also misleads the shareholders together with adding a great amount of risk to their wealth Hogan and Lewis 1999 found no evidence of EVA having a positive effect on goal alignment than more traditional incentive plans EVA tends to produce parochial behaviour which is problematic when company goal accomplishment needs cooperation Jan Bouwens and Roland F Spekle Griffen 2004 explored EVA users under performed from its peers and market for a time period until 5 years In Malmi Ikaheimo s 2003 field study of six organisations explored a huge diversity in the real use of such measures from an almost inclusive implementation to a mere rhetorical reference to EVA concepts together with no meaning true meaning helping in decision making or management

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