Strategic Management Accounting for Shareholder Value Maximisation - Essay Example

Introduction Shareholder value maximisation has been a revolutionary notion shifting the focus of management efforts towards shareholders’ interests and investor protection. Management acts as agent of shareholders who are the real owners of a company and therefore are expected to work in the best interest of shareholders. However the interests of other stakeholders of the company are not at all ignorable. Employees, customers, suppliers and society, all make significant contribution towards the economic well being of corporations and ultimately, the shareholders. An enhanced emphasis on shareholder value maximisation over the interests of these stakeholders is largely evident in recent times. The purpose of this report is to illuminate the conception of shareholder value maximisation and also elaborate the consequences of a sole emphasis on shareholder interest and investor protection over other stakeholders. Executive Summary In modern business environment, management is becoming increasingly focused on maximisation of shareholder value rather than the stakeholder value. Maximisation of shareholder value depends on several factors such as a company’s long-term strategies, risk potential, capital investment and future growth prospects. Changes in all these factors are very well reflected in the company’s share price. Management’s focus on shareholder value maximisation enables the corporations to ignore the interests of other stakeholders such as employees, customers, suppliers and society etc. Shareholder value maximisation can only lead to effective results if the interests of all other stakeholders are given equal consideration. Corporations’ Drive for Shareholder Value Maximisation Shareholders are the true owners of a company and have ultimate residual claims on its financial assets. Management is responsible to serve the interests of shareholders and engage the efforts of the whole organisation towards the enhancement of value for shareholders as well as the other stakeholders that have their interest in the corporation. Over the last few decades, the corporations are largely being driven by the sole motive of shareholder value maximisation pronouncing the proposition that management’s sole purpose is to serve the shareholders. The increasing focus of corporate world on the maximisation of shareholder value and a sheer concern for investors’ interests puts forward a debatable issue concerning the impact of shareholder value maximisation in fetching benefits for other stakeholders of the company such as employees, customers, suppliers and the society etc. The wave of shareholder value maximisation axiom has largely diverted the emphasis of corporate management solely towards profitability and stock price augmentation with less regard to the consequences that it might entail. Maximisation of Shareholder Value: The Essential Elements An understanding of the integral elements of management strategies that lead a corporation towards true maximisation of shareholder value is essential for the evaluation of its consequences. The first and foremost responsibility of management, in an effort to maximise shareholder value, is to determine and establish effective strategies that could result in enhanced profits for shareholders evident in the form of capital gains through stock price increases, future growth, capital investment and dividend payments. Hart and Milstein rightly propounds that “the challenge for the firm is to decide which actions and initiatives to pursue and how best to manage them” (2003, p64). In order to achieve the goal of shareholder value maximisation, management needs to take various strategic steps to ensure that the interests of investors are protected. Increasing profitability happens to be an important consideration for the maximisation of shareholder value. The most crucial step in this regard is to minimise the business and financial risk associated with high profits. Hart and Milstein elaborate that “…unless the firm can operate efficiently and reduce its risk commensurate with returns, shareholder value will be eroded” (2003, p58). For instance, if management deems necessary to invest in new international markets carrying high profit prospects as well as high risk, this would lead to adverse effects on the company’s stock price. If the element of risk is higher in the strategies the management is pursuing, the erosion of shareholder sentiment would be highly evident in the company’s share price. Shareholder value depends to a great extent on the future value of a corporation. Future value could be understood in the terms of a company’s future growth prospects and profitability. It puts a great impact on shareholder perception of a company’s investment potential. Ballow, Burgman and Molnar say that “a large future value shows that the market is expecting a lot in the future and there is a risk of quick reduction of shareholder value if the market loses faith” (2004, p33). Shareholder value is maximised when investors expect a rise in profitability of the company in future and is diminished if the shareholders expect the company to suffer losses in future. The risk factor also plays an important role by shaping the shareholder expectation and thus influencing the shareholder value. Shareholders regard future growth of a firm as important in valuing the company. The objective of shareholder value maximisation can be greatly achieved by enhancing the future prospects of the company’s performance. Management opt for investment in capital assets and business expansion strategies in order to suggest that the company is proceeding towards growth. Hart and Milstein illuminate that “the creation of shareholder value thus depends upon the firms ability to creatively destroy its current capabilities in favour of the innovations of tomorrow” (2003, p58). Increase in the company’s capital assets and investment in future projects, while shutting down the business units demonstrating a lack of profitability are the strategies that are regarded by the shareholders as a sign of the company’s future growth and profitability. When management makes enough profits for shareholders, it is generally left with the options like either awarding the shareholders with dividends or retain back the funds for future growth. Both these strategies have prominent impact on the shareholder value. The point that is worth noticing is that management has been increasingly turning its focus from retention of funds to distribution of profits among the shareholders. Lazonick and O’Sullivan point out that “the past two decades have witnessed a marked shift in the strategic orientation of top corporate managers in the allocation of corporate resources and returns away from ‘retain and reinvest’ and towards ‘downsize and distribute’” (2000, p18). This entails that corporations are now focusing on narrowing their investments in future projects and returning as much profits to the shareholders as possible in order to maximise shareholder value. The distribution of profits to the shareholders in the form of dividends takes place when management is able to find no worthwhile project that could lead to more profits in future. The shareholder value theory, in short, suggests that “…if corporate managers cannot allocate resources and returns to maintain the value of the shareholders’ assets, then the ‘free cash flow’ should be distributed to shareholders who can then allocate these resources to their most efficient alternative uses” (Lazonick and O’Sullivan, 2000, p28). In all these strategic considerations, management remains solely concerned with the objective of shareholder value maximisation showing less concerns for other stakeholders like customers, employees, suppliers and management. Shareholder value maximisation remains to be the central focus in increasing profitability regardless of provision of value to customers, in acquisition of new technology regardless of its impact on environment and in quitting less profitable operations in favour of new projects with high profit prospects with less concern to its impact on the economic status of employees. Shareholder Value Maximisation: The proposition that the management should solely serve the interest of shareholders and drive the efforts of whole organisation towards maximisation of shareholder value does not hold good enough in the contemporary business and investment environment. Mintzberg, Simons and Basu propound that “in the modern economy, with instantaneous information, global access to capital and Internet-based stock trading, fewer and fewer shareholders are in any way committed to the businesses they “own” (2002, p70). It has now become a widely accepted fact that shareholders or owners, for whom the corporations endeavour to maximise value, are mostly involved in maximising capital gains. Most of the shareholders today are daily traders or arbitrageurs interested in short term capital gains rather than investing in company’s long-term profitability. Although managers are true owners of a company, the other stakeholders, for example the employees and customers have long-term interest in the company’s current and future affairs. Employees and managers are the stakeholders within the company that are the creators of economic benefits for the shareholders. The point here is that while maximising shareholder value, the interest of employees should never be ignored. An emphasis on shareholder value ignores the stakeholders who are the most important drivers of economic performance of a company. Mintzberg, Simons and Basu assert that “shareholder value thus drives a wedge between those who create the economic performance and those who harvest its benefits” (2002, p70). Shareholders, being the owners of a company, are reliant on the employees to perform towards the achievement of profit goals; therefore, employees happen to be important stakeholders of a company whose interest cannot be ignored. This recent development has thus shifted the focus of management strategies and decision making from serving stakeholder interests as a whole to that of the shareholders specifically. In their effort to maximise the value for shareholders mostly in the form of increased profitability and stock price growth, the management most ignores the aspect of social responsibility of business. Mintzberg, Simons and Basu “…corporations have been urged to ignore broader social responsibilities in favour of narrow shareholder value; chief executives have been regarded as if they alone create economic performance” (2002, p67). The quest for shareholder value maximisation keeps management striving for profitability with the sole concern for the impact of their decisions and strategies on shareholders while even sacrificing the interests of society, employees and customers. For instance, in a drive for the enhancement of shareholder value, management would most likely opt to shut down any of its business operations or stop the production of a product that is not reaping the desired profits, regardless of its impact on the employees’ economic well being and customer value. It is however not to suggest that management should not strive to maximise shareholder value, rather it is to put forward that the corporations should not keep aside the interest of other stakeholders while solely concentrating on investors’ interests. Cassidy propounds that “all businesses must discard the simple concept of maximising shareholder value and instead focus on the optimisation of shareholder value by satisfying the legitimate but evolutionary needs of its stakeholders” (2003, p33). In other words, it is a fact that management could not be able to maximise shareholder value in the truest sense unless it gives the interest of other stakeholders an equal considerations. Furthermore, in the name of shareholder value maximisation, there has been significant misconduct on the part of corporations in recent times. Managers and executives participating in options or share schemes have been noticed to be misguiding the shareholders by artificially increasing the stock price in order to benefit from capital gains. Shareholder value maximisation is a notion that could be easily exploited by the corporations. A company should always strive to enhance the value by employing the investors’ funds in the best possible ways so as to maximise stakeholder value i.e. serving the interests of all the important parties associated with the corporation. Pitman, “…despite the high profile examples of mismanagement and greed, sustained value growth is still the best long-term measure of a company’s performance and health.” (2003, p46) Conclusion This report presents an insightful study on the concept of shareholder value maximisation and the efforts that are undertaken by management to achieve it. It demonstrates that in an effort to enhance shareholder value the management generally puts behind the importance of serving the interest of other stakeholders like employees, customers, suppliers and society that share a long-term association with the company. However, protection of interests of these stakeholders is important to ensure the maximisation of shareholder value. This report, therefore, concludes that in order to accomplish the objective of shareholder value maximisation in an effective manner, the management should also strive to serve the interests of other stakeholders. Reference List Ballow, J.J., Burgman, R. and Molnar, M.J. (2004), “Managing for Shareholder Value: Intangibles, Future Value and Investment Decisions,” Journal of Business Strategy, 25(3), pp. 26-34 Cassidy, D. (2003), “Maximizing Shareholder Value: The Risks to Employees, Customers and the Community,” Corporate Governance, 3(2), pp. 32-37 Hart, S.L. and Milstein, M.B. (2003), “Creating Sustainable Value,” Academy of Management Executive, 17(2), pp. 56-67 Lazonick, W. and O’Sullivan, M. (2000), “Maximizing Shareholder Value: A New Ideology for Corporate Governance,” Economy and Society, February, 29(1), pp. 13-35 Mintzberg, H., Simons, R. & Basu, K. (2002), “Beyond Selfishness,” MIT Sloan Management Review, Fall, 44(1), pp. 67-74 Pitman, B. (2003), “Leading for Value,” Harvard Business Review, April, 81(4), pp. 41–46 Read More