Value Bench Press

Be careful what you wish for because you just might get it. During the ’80s, academics and management pundits alike [...]

December 1 1999 by JP Donlon


Be careful what you wish for because you just might get it. During the ’80s, academics and management pundits alike asserted that business suffered mightily from entrenched management. CEOs were too powerful. Their influence, it was alleged, extended deep into the boardroom where few dared to oppose their imperial rule. Yet today, we are witness to regular CEO sackings as institutional shareholders are less willing to sell their shares and are more willing to challenge managers and board directors alike.

What’s interesting is that the mantra of shareholder value was used equally by “Chainsaw” Al Dunlap in explaining his slash-and-burn restructuring tactics as it was by the investors who forced his resignation. Some say the trend began with GM’s Bob Stempel, IBM’s John Akers, and AT&T’s John Allen-no one was too big or too powerful to be immune. The pressure to perform has only become more intense. Just ask Eckhard Pfeiffer.

The trouble starts when not everyone agrees on what is meant exactly by creating shareholder value. In his book, EVA: The Real Key to Creating Wealth, Al Ehrbar acknowledges that in its simplest form economic value is the notion that returns should be large enough to compensate for risk including the capital charge for all committed funds, both debt and equity. Ehrbar and his colleagues at Stern Stewart argue that EVA is “much more than just a measure of performance. It is the framework for a complete financial management that can guide every decision a company makes.”

The late Roberto Goizueta agreed. As CEO of Coca-Cola, he put the company’s operations including its compensation system-on an EVA footing. But even EVA is not the ultimate measure of corporate success. The most reliable measure is “market value added” or MVA. Some describe MVA as EVA on steroids. The mission of a company is not to maximize its market value, or total capitalization, as some would have you believe. Management should aim to maximize the dollar amount by which the company’s market value exceeds the capital supplied by the firm’s investors-hence the name market value added. Simplified, MVA is essentially the difference between a company’s current market value, as determined by its stock price, and its “economic book value.” A company’s economic book value is roughly the amount of capital that shareholders and lenders and all capital providers have committed throughout its existence, including retained earnings.

Beginning on page 46, we rank more than 900 top public companies using this measure developed by the folks at Stern Stewart & Co. A unique refinement enables us to better compare the performances of individual CEOs. Dividing the change in MVA by the amount of capital a company had when the CEO took control adjusts for the relative size of different companies.

This “standardized” version of MVA scales the changes in MVA, providing a way of measuring how each CEO managed the capital at his or her disposal. Will it become the ultimate measure for shareholder value that all sides can agree upon? Too early to tell. There remains a built-in bias favoring those who have been in office long enough to reap gains from a 17-year bull market. But, until something better comes along, it may be the ultimate scorecard as to which CEOs are the heavy value lifters.