What does “value creation” mean? How can companies prevent value enhancement plans from culminating in value destruction? The answers lie in Value Based Management, a framework designed to manage internal corporate processes in order to maximize the value created.

Why do value improvement plans often fail to impact the company’s market value? Is it an undervaluation problem? How can managers change the market assessment? The answers lie in Active Shareholder Management, a framework designed to identify target investors through segmentation and develop a strategy that, in line with value creation plans, allows a company to optimize its market value. and for the shareholders.

Below is a comprehensive view of value creation, from an internal point of view, Value-Based Management, and from an external point of view, Active Shareholder Management.

What does “value creation” mean?

It is common for management to announce plans to create shareholder value. It’s also common for your financial statements along the line to reveal that value has been destroyed if anything. What went wrong?

It is crucial for managers to realize that “value creation” is a clearly defined and tangible measure, based on personal interpretations or evaluations. There are mathematical formulas that objectively and rigorously verify whether value has really been created, based on financial statements. These formulas are based on the EVA(TM) or Economic Profit concept, which is defined as the difference between the return on invested capital and its cost.

If the return on capital employed is greater than its cost, the company is creating value. Otherwise, you are destroying value.

Once “value creation” is defined, how can it be maximized?

Based on our consulting experience, companies with low value creation tendencies are often plagued by poor management processes. VBM (Value Based Management) is an approach that aims to maximize value creation by effectively leveraging and aligning strategic actions, resource allocation, performance appraisal and management rewards.

VBM has been successfully implemented by a large number of very diverse companies around the world. Some demonstrate the focus in their external communications: for example, check out the section on BASF’s website dedicated to value creation.

Companies may differ in terms of size and business focus, but if they have successfully implemented VBM, they share two elements: an organic approach and a well-designed roadmap.

Implementing VBM means redesigning and aligning all internal processes. Once the value creation indicator is well defined, all the processes, from the strategic plan to the management incentives, must be renewed.

Logically, VBM must begin with the construction of a strategic plan designed to maximize the value creation indicator. The next stage is disciplined execution, which is monitored by a system of Key Performance Indicators. Lastly, the management incentive plan should be set up to focus on value creation.

VBM implementation

The standard VBM framework can be modified based on customer needs and priorities. The timing and characteristics of the implementation may also change.

The key point for a successful VBM program is organic implementation, even if the sequence of projects and actions differs from company to company. The implementation of VBM requires discipline to follow a precise plan of action. Management must have a roadmap that clearly defines all the actions that need to be taken in some key dimensions (value indicators, processes, systems and incentives), and establishes clear milestones.

A medium to long-term range of vision is needed to drive implementation effectively. That’s why CEOs with a “short-term scope” tend not to initiate these types of programs.

VBM is a comprehensive program that requires a strong leader, usually the CEO, to drive its implementation. The introduction of the approach is an opportunity for a significant cultural change and improvement in the company. Within the roadmap, management should also plan times for collective discussions, sharing, and alignment involving the entire management team, in addition to organization-wide communication and training sessions.

VBM is not just something to make the company run better. It is the key methodology to maximize economic benefit and, consequently, the value of the company’s shares. In fact, the market value of the company is directly related to the present value of the company’s future performance, measured as economic profit.
Simply deciding to adopt VBM is not enough. It is common for VBM adopters not to translate improvement plans into higher market value. The mismatch stems from two root causes: unrealistic assumptions about planned future performance, and second, the lack of recognition by the financial community of the company’s fair value.

This article investigates the second problem.

Active investor management

Some managers accuse the market of not being rational enough. We, however, believe that the problem is not a crooked dance floor. The main source of market value misalignment with respect to expected improvements in economic profits lies in management’s inability to adequately communicate the value of the company to the outside world.

Active Shareholder Management (ASM) is an innovative methodology to improve the market value of the company through the management of key financial investors. ASM’s primary goal is to develop a strategy that, given internal plans and results, maximizes shareholder value.

The ASM approach is based on Investor Segmentation, a tool to identify and understand the main investors and, consequently, manage them. Investor segmentation exploits the breadth of information channels increasingly available to provide CEOs and CFOs with the tools they need to target new investors and define an active and effective financial communication strategy.

Investor segmentation is based on a coordinated analytical effort. It can be carried out through various data collection methods and market intelligence sources. Focused interviews are conducted with investors to delineate management styles and behaviors. Documentary research allows investigating the different strategies of investors and grouping them in a homogeneous way.

Particular attention should be paid to investors who have significant assets in similar companies, which identifies the most relevant shareholders, including those who do not currently hold positions and could be explored further.

With the identification of key investors in hand, managers are equipped to envision the actions required to enhance shareholder value. In fact, under the ASM approach, managers can “test” their potential stocks by simulating investor reactions with the help of mathematical models, and thus can predict the impact on stock value.

The future behavior of investors is a relevant input for the commercial, financial and communication strategy.

Consider the dividend strategy. Some investors do not “appreciate” dividends, many for tax reasons. Others like them, for example, shareholders in low tax brackets who need cash from dividend payments or tax-exempt institutions that need periodic cash. Many investors are simply used to receiving dividends from a given company and would frown on any reduction.

There are also investors who prefer companies that do not pay dividends and funnel the money into ambitious “growth stock” strategies. Other investors prefer more stable behaviors, typically “value stock” companies, where dividends tend to be fairly high and steady.

These preferences are often public knowledge and can greatly influence the actual portfolio strategy of fund managers. Knowing this information can help managers better understand which investors would be attracted to their strategies.

Share buybacks and splits, common tools to increase the market value of companies, should also be planned with key investors in mind, taking into account their needs and foreseeable reactions. Share buybacks can send a strong signal of management confidence in future performance. Following buyback announcements, financial analysts frequently revise their earnings forecast estimates upwards. An empirical study showed an abnormal average stock return of 3.42%.

Managers have to develop ad hoc approaches for each identified investor segment. For example, investors who rely on analysis based on “strategic” issues would prefer information on industry trends, competitive strengths, and new “growth stories.” Meanwhile, “finance-oriented” investors prefer data related to cash flow, operating profitability and returns on working capital. Communication actions, such as preferred channels and meeting frequency, should be adapted accordingly.

ASM Implementation

The management methodology of ASM has not yet caught up with the popularity of VBM, mainly because managing investors is often restricted to the Investor Relations team, but needs to be an organization-wide process.

Many companies, including large corporations, manage investors with a very qualitative approach, based on personal relationships. Analytics are rarely and poorly used, which is a striking difference compared to standard sales and marketing activities and tools, which essentially help a business sell a product or service to someone (a customer, not a customer). investor).

To create momentum for ASM implementation, a clear benefit case must be built. In addition to the advantages already described, another key benefit of ASM is the opportunity for senior managers to use their valuable and expensive time more accurately. In-depth knowledge of target investors improves focus: management can attend only the “right” events and meet only with the “right” investors.

In conclusion, value creation can and should be measured analytically. It is an objective quantity, not a qualitative interpretation. The Best Practices apply Value-Based Management as a tool to manage internal processes with the aim of increasing the value created for shareholders.

When improvements are not reflected in market value, management must work on communication strategies. Active shareholder management can be leveraged to influence market sentiment by delivering the right messages to the right investors, in a way they can hear loud and clear.