There are two schools of thought about the topic of shareholder value (SV). One school, led by Hugh Davidson, argues that it leads to short-termism. The other school, to which I belong, argues that short termism has been endemic in Western economies for decades and that this has little to do with SV.

During a 20 year period, up to 2000, every high performing company in the FTSE top ten in terms of ROI subsequently either went bankrupt or was acquired. The reason isn’t hard to fathom. As Collis said in a Harvard Business Review article in 2008, most Directors don’t even know what the components of a strategy are, whilst Christensen said, also in HBR, of 30,000 new product failures in 2006, most were caused by poor marketing.

But to single out SV as a major cause of this is ingenuous in the extreme, for it is MANAGERS who are short term in their behaviour, not the financial investment community. It also reveals a common misunderstanding about what SV really is and how stock markets around and world work.

This article explains how the investment community works and why SV is good not only for marketing, but also for KAM.

The Central Role of Risk Assessment in Value Creation

Let’s first look at the concept of risk. For most companies, the current share price already reflects some expected future growth in profits. Thus, these current investors and, even more particularly, potential future shareholders, are trying to assess whether the proposed business strategies of the company will produce sufficient growth in sales revenues and profits, both to support the current share price and existing dividend payments and to drive the capital growth that they want to see in the future. At the same time they also need a method of assessing the risks associated with these proposed strategies as,obviously, these will have a direct link to their required rate of return. This is where marketing should play a role. As Figure 1 shows, the perceived risk profile of the investment drives the level of return required by investors in each particular investment.

Figure 1 Risk-adjusted required rate of return

Logically, therefore, a normal, rational, risk-averse investor requires an increase in expected future return from any more risky investment in order to compensate for any potential volatility. Figure 2 illustrates this cause-and-effect relationship.

Figure 2 Risk and Return

No amount of discussions will alter this inarguable fact of life. It was ever thus and certainly long before Rappaport proposed EVA (the antecedent of SV).

In most government-backed debt investments investors know in advance exactly what their return will be (i.e. the interest rate payable is stated on the debt offering). However this is clearly not the case with most equity risk perceptions and hence required rates of return. Further, if the historical track record of a company’s shares shows significant volatility in share prices and even dividend payments, investors will require much higher returns from the company as they extrapolate from this past performance to the future likely performance of the company’s shares. Thus, life is much more challenging for a highly volatile company, caused by shareholders’ natural dislike for risk.

The new opportunity for KAM from SV

In the best companies, senior managers carry out proper due diligence on declared future business strategies, taking into account the associated risks, the time value of money and the cost of capital. New strategies have significantly different impacts on risk, which may change their potential for creating shareholder value.

Optimal business strategies seek to increase returns whilst reducing associated risk levels and it is these that will create SV. Remember, investors are interested in SUSTAINABLE shareholder value, as it is this which impacts the capital value of shares, not results in a single year manipulated by short termism on the part of managers.

Whether we like it or not, SV will persist as the most logical method of measuring corporate performance, for unless it is created, all stakeholders will suffer. This provides an unprecedented opportunity for key account directors to show the true worth of their work, especially as today intangible assets, (which of course include relationships with customers) now account for about 70% of all corporate value in the UK.

Figures 3 and 4 set out a very clear methodology for calculating whether KAM strategies create or destroy shareholder value. It is this level of sophistication that will get the undivided attention of the boardroom. Figure3.

Figure 4

Measurable benefits to the business

With legislation around the world placing more and more emphasis on control procedures and corporate governance, and with the increasing potential penalties on individual directors, the need for an objective, recognised and well-structured review and approval process should be obvious.