Shareholder Value Approach

Nowadays shareholder value approach reflects to a modern management philosophy, which implies that an organization measures its success by enriching its shareholders. Shareholders or stockholders are individuals or institutions that owns in a legally form shares of a corporation. They are considered to be a subset of stakeholders, which are all individuals or communities, who have a direct or indirect interest in the business entity (e.g. suppliers, customers, government, competitors etc.).

The philosophy of the shareholder value approach attempts to increase the organization’s value by enhancing firm’s earnings, by increasing the market value of corporation’s shares and by increasing also the frequency or amount of dividend paid. The idea is that shareholder’s money should be used to earn a higher return than it could by investing in other assets with same amount of money and risk. Furthermore according to many business analysts shareholder value approach provides managers with clear mission and it facilitated decision making.

The commitment of an organization among shareholders is not a theoretical future goal of an organization but is very often stated to the company’s mission statement. Usually firms aim at shareholder value creation and maximization when they make claims such us “we create value for our shareholders”, “we want to provide excellent return for our shareholders”, and “we have a responsibility to our shareholders”.

Many academics through the years had an overall perspective that managers should strive to maximize shareholder value and that doing so maximizes social welfare. According to this belief managers should act in the economic interest of their shareholders and that’s the fundamental objective of the shareholders. As the shareholder value is difficult to influence directly by any manager, it is usually broken down in components or value drivers, such us revenue, operating margin, cash tax rate, Investment in Working capital, Cost of capital and competitive advantage period. Though it is important to mention that quick profit doesn’t give return to shareholders; usually competitive advantage takes care of it. If a business choose to sell lower standard products to reduce cost and gain quick profit it may have the danger that its reputation will be destroyed, will lose competitive advantage and the price of its shares will be reduced.

Is the shareholder value maximization a healthy defined target for the organizations?

Nowadays no country, not even the shareholder-friendly USA has a legal requirement that managers act absolutely in shareholder’s advantage and in fact the law makes it legal for directors to consider also other interest. Although firm that are willing to have an openly commitment to shareholders seem to do better in comparison with others, there is no case that make shareholder’s value maximization the society’s most desirable corporate target or that competitive markets for goods, capital and labor pressure managers to seek on that specific goal.

Furthermore, markets are incomplete; meaning that profit maximization is not well defined and possible conflicts of interest cannot be prevented or in many cases resolved. Under this assumption financial researches have shown that stakeholder-oriented firms are usually more successful than shareholder-oriented firms, because market forces are forcing them to do so.

What role do market forces play in the shareholder value maximization?

Competitive markets are playing a significant role to this argument because they can push managers to act on interest of all stakeholders. Usually they are pushing inefficient firms to cut costs and focus on customer needs rather than shareholder’s interest. Managers can survive the challenges of competition even though they do not maximize economic profits; but capital markets have this role.

It seems that capital markets do not leave managers another way but maximizing shareholder’s interest and doing so maximizing company’s welfare. If investors with many shares of an organization feel that share are going more and more down and start losing money, they may try to take action and influence the decision making, which could mean that managers are risking their jobs.

All in all the combination of the different market forces are those, who can affect or even force managers to act in advantage of stakeholders. A mentioned the basic principles of shareholder value maximization are not clearly defined for the market and even if so, are not in many cases reasonable and possible in the real world.

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