Initially, value rhetoric and a circus atmosphere generates its own self-fulfilling momentum within the firm, orchestrated in the right manner. With guidance, the company which has never instituted a robust Managing for Maximum Value program (or those who think they did, but got it wrong) might discover the half dozen relatively easy, early actions that can generate early value momentum.

Those actions include: capital structure changes; switch from a single investment funding authorization (‘hurdle’) rate based on that company’s cost of capital to a multiple tier arrangement; and termination of chronic money-losing operations in the business portfolio. 1

The start of the value journey is the easy part. Sustaining value improvement is far more difficult.

Not only does the method have to be equal to the challenge, but incentives must be linked to value creation. The balance of this section deals with the latter issue. 2

Value-performance linkage has been attempted before, with inconsistent effectiveness. In the early Eighties, what passed at the time for a full value approach consisted of three elements: (1), recasting past company performance in terms of an adjustment for reported earnings; (2), to prescribe aspirational ‘stretch’ goals based on target performance improvements; and then (3), to manage against the variance.

The need to ‘recast’ earnings for performance evaluation purposes (1, above) confirms that reported earnings have almost nothing to do with changes in company ongoing share price. But changes in cashflow correlate almost exactly with changes in market capitalization, thus indicating the nature of the required adjustments. 3

Getting the stretch goals right is more difficult. Pressures may be exerted on the developers of the executive incentive program to devise a goal which appears to be far more difficult than it actually is. 4 Techniques to create such fog include (i.) careful selection of peer groups (to avoid any firms that might make the company look especially bad by comparison) and (ii.) creative use of means. Can’t perform at the top of your peer group? Never mind, this particular incentive program calls for full payout if company merely performs somewhere in the middle of the peer group pack. 5

Some of the most chronic pitfalls associated with incentives scheme have become particularly apparent in recent years with corporate ethical lapses. The company that confuses short-term share price gyrations with sustainable shareholder value improvement might be tempted to try price manipulation techniques to create an illusion of achievement.

The bag of tricks include withholding shares from the market (to exaggerate upward price movements), tout-rumors of the company’s prospects to attract enough gullible retail investors to boost share price and perhaps cause an upward price spiral ‘buyers’ panic’ (aided by press) and a relatively recent sham, the Initial Public Offering (IPO) issue that creates a manipulated sense of defying gravity.

But there are also other, less apparent pitfalls, from where the roots of an effective value-incentive structure must be built.

An especially important aspect is the payout provision. When management thinks that there is no penalty at all for destroying shareholder value, but massive one year rewards for causing a perception that value has been created, temptation for a one year heist may become irresistible.

Deal with this underlying problem first, and that company has begun on the path to incentives that truly create value.

Notes:

1

VBM Consulting past and current clients and corporate registrants on the VBM Resource Centre are invited to learn about the full list, directly from Peter J. Clark or Stephen Neill, co-authors of the business bestseller The Value Mandate. To confirm that you qualify for this preliminary briefing, send full and post address, contact phone number to: outperform@vbm-consulting.com.

2

Regarding, the first issue, complete methodology, refer to “Single Best Value Solution”, in separate valueOUTPERFORMER column. Also described in Clark & Neill’s The Value Mandate.

3

Clark & Neill, Net Value (2001, Amacom) Figures 1.5A, B, pp. 18-19. The illustrated correlation between Market Value/Book Value and Discounted Cashflow / Book Value (Fig. 1A), is 94%. By contrast, the correlation between Price-to-Earnings ration and average Reported Earnings per Share (EPS) growth is a mere 2.4% (Fig. 1B).

4

It is reasonable to assume that the potential for conflict of interest increases significantly when the developer of the performance standard also has other commercial relationships with the company. There is rarely an overt warning to the advisor or consultant that the performance goal had better not be made too difficult, or other contracts could be jeopardized. There is no need for such a warning.

5

The Value Mandate, pp. 98-100.
back