Long-term measures of shareholders’ wealth

We’ve looked at ways to measure shareholders’ wealth in the short term. Now let’s turn to measures that focus on long-term value.

Share price movements

A company’s value is reflected in its share price — the market price at which shares are bought and sold.

This is a long-term measure because a share price reflects both:

• short-term performance and news
• long-term expectations about future profits and cash flows

Net present values of projects

Definitions

Net present value (NPV)

A long-term, cash-based (liquidity-based) measure that focuses on actual cash flows rather than accounting profit. The time horizon can extend to 20 years or more. Because profit can be affected by accounting choices, NPV is often seen as a more realistic basis for valuing projects.

Shareholders expect the company to invest in projects that increase shareholder value. Earlier, we looked at profit measures, which usually focus on a period of less than one year.

We’ll explore this in more detail in upcoming chapters.

Stakeholders

Definitions

Stakeholders

Any groups that have an interest (a “stake”) in what the company does or how it operates. Their stake doesn’t have to be large, and they don’t need formal power — having a genuine interest is enough.

So far, the focus has been on shareholders. But other groups also care about how a company performs. These groups are called stakeholders.

Company directors are responsible for considering and meeting stakeholder needs. Stakeholders are often grouped into categories.

Internal stakeholders

Internal stakeholders are closely involved in day-to-day operations because they work inside the company. They include directors, managers, and employees.

The board needs to consider its needs because they run the business. Typical needs include:

• good salaries
• good working conditions
• empowerment
• bonuses
• other benefits

Connected stakeholders

Connected stakeholders are not employees, but they have an ongoing relationship with the company and regular communication. This usually happens through contracts or ongoing transactions.

These include shareholders (mentioned often already), customers, suppliers, and other groups with contractual relationships and regular contact (finance providers).

External stakeholders

External stakeholders are more distant from the company. They usually contact the company only when their interests are affected.

In other words, they are not in regular communication and may not be closely interested in the organization unless it impacts them.

Examples include:

• government (fair trade, regulations, and tax)
• environmental groups (how the company affects nature through its conduct)
• trade unions (treatment of employees)
• others

Stakeholder conflict

It’s almost impossible to keep all stakeholders satisfied all the time. Different groups often want different things, and even people within the same group (such as shareholders) can have different priorities. Examples include:

Shareholders vs. customers

• Shareholders want higher returns, while customers want high-quality products that cost more to produce.
• This creates conflict because higher returns often require lower costs and/or higher prices, which can clash with what customers want.

The director’s vs. shareholder

• Directors may want high salary packages. They may also prefer expansionary policies, which can reduce shareholder returns in the short term.
• Shareholders, on the other hand, are typically most satisfied when the company increases returns.

Environmental groups vs. the company

• Environmental groups may want the company to go beyond profitability and take stronger action to protect the environment.
• The company may argue that this is outside its primary objectives and that it can be costly and time-consuming.

Managing stakeholders

Definitions

Mendelow’s stakeholder matrix

A theory designed to help organizations manage stakeholders by grouping them based on two factors: power and interest.

Mendelow’s stakeholder matrix helps organizations decide how much attention each stakeholder group needs. Not all stakeholders have the same level of influence or concern, so treating them the same would be inefficient. By categorizing stakeholders based on their level of power and interest, businesses can prioritize their efforts, focusing more on those who can impact decisions while still keeping others appropriately informed.

High power — High interest
These stakeholders are deemed key players in the organization’s planning, meaning it will need to satisfy their needs first. They will be central to the organization’s planning. These include employees, shareholders, and suppliers of key resources.

High power — Low interest
For these stakeholders, the organization will need to keep them satisfied because they have more power, which in itself is enough to shut the organization down if they are not satisfied. This is normally the government and perhaps the stock exchange.

Low power — Low interest
The company should give these stakeholders minimum effort since they don’t have more interest or power. These include the general public who may just be interested in the know-how situations.

High interest — Low power
These stakeholders don’t have the power to enforce what they want in our organization, but their level of interest is always high; the organization will need to keep them informed. These may include some social clubs and some different groups holding some sort of interest in what we do.

Principal-agent problem

Definitions

Principal-agent problem

Arises when directors run the company in their own interests rather than in the interests of shareholders (the owners). The principals are the shareholders; the agents are the directors who run the company on their behalf.

We’ve already noted that conflict can exist between directors and shareholders.

Areas of conflict include:

• High salaries that do not match their performance in the organization
• Sacrificing long-term goals for short-term goals
• Self-interest from directors
• Focusing on controlling more market share than being profitable

How are these issues resolved?

Corporate governance

Definitions

Corporate governance

A set of rules or frameworks designed to structure how companies are run and controlled.

In the 80s and 90s, shareholders often had limited power over directors. This sometimes led boards to abuse their powers, with some companies becoming bankrupt and engaging in unnecessary acquisitions.

Most countries now have corporate governance codes/rules to help restore ownership and control to shareholders.

The aim of corporate governance includes:

• Reducing the power of directors
• Increase transparency
• Increase confidence in the corporations
• More disclosures
• And more