The Benefits of Managing for Value

Few would argue that achieving the right balance between change and control is one of management's key tasks. But after several years of declining stock prices, conservative modes of corporate governance appear to be in vogue, belying the belief that management's real responsibility is to create — not preserve — long-term value.

To investigate how a focus on maximizing stock-market valuation delivers superior returns over the long term, CFOs from publicly quoted companies based in 19 countries were surveyed. Among the 100 respondents (mainly small-to mid-cap companies along with several major multinationals — all of which managed for value), researchers found that the companies whose stock outperformed the average for their industry sectors in their domestic stock markets (so-called “outperformers”) placed their emphasis on the strategic, the external and change; underperformers focused on the tactical, the internal and control.

This survey, which explored each company's understanding of value, the impact of value on strategy, and approaches to operational implementation and to mergers and acquisitions (M&A), revealed three interrelated characteristics of outperformers: a new approach to M&A, a focus on strategy and an enhanced understanding of risk and value.

Mergers and acquisitions. Outperformers tended to make fewer and larger acquisitions, whereas underperformers employed M&A as a tactical tool and tended to focus on improving the postacquisition integration by creating better-designed compensation targets.

Outperformers did not use M&A to achieve growth at any price: only one-third experienced above-average sales growth, with about half achieving above-average profit growth. However, more than two-thirds of outperformers did attain above-average economic profit growth (that is, profit minus a charge on the capital used by the business), a measure of “good” growth. In this way, outperformers increased their long-term return on capital employed (ROCE), while achieving a modest increase in growth.

In contrast, underperformers were more likely to see a focus on value as a way to build a stable platform. Their sales growth for the three years before and three years after implementing a focus on stock-market valuation was three times that of the outperformers, and they were significantly more likely to justify acquisitions on the basis of growing the top line. Most importantly, however, ROCE declined 4%.

Strategy. Outperformers employed a strategy process that focused on gaining better insight into strategic choices combined with rigorous use of valuation tools. They were significantly more likely to use value drivers to focus employees' efforts, though the total numbers of managers trained or the depth and type of compensation scheme were not noteworthy. To benchmark ongoing business-unit performance, respondents used an average of two metrics, with old-style accounting-related measures (ROCE and return on net assets) being the most common ones.

Outperformers did not relegate planning and strategy formulation to finance or business-development units. Instead, they used a different process to avoid becoming overly focused on costs and short-term earnings. First, they used value to gain a better understanding of the implications of their choices.

Secondly, outperformers combined creative thinking with analytical rigor. A striking observation was that the top one-third of companies in terms of performance used a greater range of valuation tools, with discounted cash flow being the most popular. However, outperformers were twice as likely to use comparable multiples and four times as likely to use real options. Comparable multiples provide an important external dimension, and real options help to model flexibility and the value of information.

Risk and value. Outperformers were significantly more likely to drive their focus on value by implementing a companywide “managing for value” (MFV) program. In other words, a serious attempt to focus on value appeared to work. Perhaps more interestingly, the survey results show that outperformers and underperformers used different approaches to risk management.

Outperformers were more focused on external risks, such as being overtaken by the competition, their position in the value chain or losing a major customer. This strategic thinking appears to have made them better aligned with the capital markets. In contrast, underperformers were more concerned with internal reporting and control. For them, MFV was more a tactical tool whose adoption coincided with a severe decline in corporate performance — implying that it had no impact or had even made things worse.

The 2003 report is “Outperformance: How To Achieve Better Returns in the Long Run” by P. Roeloffs, Rotterdam School of Management, Erasmus University; M.A. Rosellón Cifuentes, Pricewater-houseCoopers Netherlands and Rotterdam School of Management; and B. Savill, PwC Netherlands. Contact Rosellón at miguel.rosellon@nl.pwcglobal.com.