Importance of Shareholder Value in Improving Firm’s Performance

The firm’s ability to accurately establish and measure shareholder value (SHV) is crucial for assessing financial performance and moving the firm toward established objectives. Among other strategic objectives, such as profitability, efficiency, market share, and growth, shareholder value is the most important measure to evaluate a corporation’s long-run financial performance.

The discounted cash flow (DCF) method definition of shareholder value is the present value of the firm’s future cash flows (FCFs) discounted at its weighted average cost of capital (WACC), add to this initial cash, marketable securities, and other investments, and subtract the value of debt. This approach makes sense that because a company can only make an economic profit only after it has repaid the cost of capital. Investors are interested in not only knowing how the company performed in the past but also, more importantly, how it is likely to perform in the long-run (say, 3 to 10-year period). This long-run focus of investors connects to a firm’s strategy that lies at the core of any enterprise’s success. The FCF term in shareholder value definition also makes SHV focus on long-term value creation, and therefore it is easily integrated into the strategic management process. In the strategic management process, a performance measurement system is used to monitor, evaluate, and control performance measures. It is said that if you cannot measure, you cannot control. By establishing meaningful and measurable shareholder value objectives (from pro forma models) in the strategy formulation process and finally monitoring, evaluating, and controlling the financial results will ensure that an organization is aiming at its strategies to achieve its overall goals and objectives. Therefore, the shareholder value (SHV) management system plays a vital role in every organization, as it offers key tools for performance measurement systems and provides forward-looking indicators to assist management in predicting and controlling the company’s economic performance.

Traditional accounting measures such as earning per share (EPS), return on investment (ROI), and return on assets (ROE) are also used by corporations and analysts to assess corporate performance. The drawback of these approaches is that they are not forward looking to predict future performance, do not consider the cost of capital in the calculation, and are influenced by accrual-based accounting.

In addition to the SHV model defined above, there are few other important “SHV measures,” which are:

• economic value added (EVA) and market value added (MVA)
• cash flow return on investment (CFROI)
• total business returns (TBR) and total shareholder return (TSR).