The authors are partners of VBM Consulting (www.vbm-consulting.com), international firm focusing on corporate value improvement.

The Chief Financial Officer has traditionally served as the company´s shareholder value steward. He was the first to introduce the organization to core value principles. The one who pushed for the resources, methodologies and—most important—management time required to make ‘value´ work, arguing that effective company-wide program returns many times the investment. At heart, the CFO is the numbers person, after all.

As Managing for Value (MFV) has evolved, it has probably been the CFO who has kept pace with the transitions: shift in emphasis from valuation metrics of the early ‘80s to full-scale integrated value process modeling in the early ‘90s. A decade later, transition to systematic action methodologies and tools.

Today it´s MFMV—Managing for Maximum Value. The extra consonant helps differentiate the serious implementer of value best practice from those corporate underperformers which hope that merely chanting ‘value´ rhetoric is enough. It isn´t.

The value-aware CFO knows that step increases in sustainable corporate value are only achieved one action at a time. He knows this because the earliest value improvement initiatives occurred within his own financial function, years ago. 1

Now, management anticipate return to economic resurgence beginning sometime in 2003. The chief financial officer is probably the first to understand that a key to surging ahead in the next Boom is to re-double efforts at achieving company full value potential. 2 Through a balanced program, focusing on at the prime sources of (as yet) dormant value within the company.

How/where to proceed? We point to the following six part agenda, described below and summarized in the table opposite.

1.) First, Stop the Bleeding

Several of the company´s business units, projects, assets and team initiatives were projected as major value contributors in 1999. 3 Today, objective analysis reveals that the opposite is true. Each day that the bleeding continues lowers the company´s valuation a bit further.

This is a common sense starting point for the financial officer´s value agenda, for two reasons.

First, because of necessity. Until the deterioration is neutralized and reversed, nothing else matters. In today´s nanosecond change environment, once-robust leading companies slip effortlessly into laggard status or lower.

Once the bleeding starts, it can prove difficult to prevent from spreading and accelerating. De-staffed procurement departments at client companies provide notice that from now on they will only deal with the top two providers. For the provider-company, this means that sustaining the marginal, value-draining No. 3 (or lower) operation becomes the corporate equivalent of picking the pockets of the shareholders.

A lethal combination of forces confront management of the company who cannot or will not stop the value bleeding: downgrades by rating agencies, soaring debt servicing burden (in part caused by those downgrades). Not so benign neglect from valuation-shaping analysts. Understated whisper campaigns by marketplace rivals. Bankers suddenly re-scrutinize company credit lines, exactly when extra reserves are needed to prepare for value-based growth in 2003 and later.

In valuation terms, the pummeling intensifies if the financial community´s value-setters even begin to suspect that there are other bleeding wounds which are hidden or even worse, which management may not even be aware of yet.

Completeness, effectiveness and speed of the company´s initiatives to Stop the Bleeding emerge as key means for communicating to the financial community that the situation is under control. That the firm does command a potent value-building strategy.

Reason Two has to do with momentum. Many of the cessation options (‘Stop-Its´) comprising the Stop the Bleeding action list are far easier to effect than other methods for fundamental value reform, thus providing early momentum in the value improvement battle. Along with concrete evidence that the CFO-lead value resurgence works.

Company value is suppressed by delays in implementing long overdue improvements that everyone knows must be addressed sooner rather than later. There´s that pet business venture of the senior executive that plods along, stealing funds from higher value uses.

Some other initiatives started well enough, but mismanagement later transformed those businesses into staggering zombies. Careless expansion, starving the early stage business of its advertising lifeblood, inconsistent leadership—whatever the cause of the value destruction, it is the owners of the company who are asked to pay the bill.

Everyone already knows that the three dozen upper-level managers who stopped rising in the organization are now liabilities, value-wise. Will management do what the financial community already knows is necessary, or play ostrich for fear of offending golfing buddies?

The same names tend to arise in the lower one-third of the direct sales force, even after territories have been rotated, obliterating that excuse. Will that hidden source of bleeding be addressed? And what about the oversized strategy and HR departments that reduce value until stripped of superfluous activities, reports and costs?

It is never enough merely to undertake those ‘Stop-It´ actions that everyone knows about already and nothing more. In order to be valued as a company that manages for maximum shareholder worth, the CFO-led company resurgence must go much further: all the way to anticipating those potential value black holes that elude ready detection.

The start: reducing dependency on tomorrow´s non-creditworthy customers, even before payment data provides overt signals. Radical corrective surgery to those areas in the company that are value black holes in other organizations: promotions, new merchandising initiatives, new product development. Changes in staff, need for which is confirmed by the fact that few competitors want to poach the company´s leading people anymore.

2.) This Time, Value´s for Real

Once, the company might become perceived as ‘managing for value´ through self-declaration backed by slick financial PR alone. But that was before Enron, Tyco and the popped tech bubble. One thing´s for sure: in the coming expansion, no one will be treated as a value-maximizer without proof, first.

Throw away the TV make-up. Discontinue those lessons about how to deliver hollow ‘value´ bromides unconsciously and in the most convincing manner.

After years of operating at 30% below the performance-based value of competitors and fifty percent-plus below that company´s own potential, the last thing that the financial community wants is further value destructive waste in terms of outlays to a bunch of corporate Rasputins. 4

The PR bluff never worked, even though these spinners are unusually talented at preventing anything as mundane as facts from getting their way. Faced with a valuation 70% below its peak, one investor relations-type proclaimed with a straight face that without him, the plunge would have been even deeper.

The serious Value Champion CFO begins by throwing off the literally bankrupt practices of decades past, both metrics myopia of the 1980s and the grand but unimplementable ‘full company integrated processes´ that followed.

The path ahead is clear. Taking value serious means a full scope, covering all five of the sources of value within the corporation. Serious means the single best value solution for each of those fundamental reforms, rather than whatever pedestrian guess just came out of an advisors cranium. Finally, serious means risk management and execution equal to the CFO´s challenge of value leadership.

3. ) End of Looking for Value in all the Wrong Places

This might sound like a Mickey Gilley song, but it isn´t. The CFO´s corporate value improvement agenda is dead even before it has started when management isn´t even looking at the right targets of opportunity.

Wrong target? In the underperforming performance improvement program, there are as many excuses for the causes of the company´s ills as there are separate power centers.

Mostly, the value agenda is dominated by the present activities list, whether or not that´s where the opportunities for improvement reside. In the Scott Adams Dilbert comic, the consultant advises the manager to simply preface whatever he happens to be doing today with the phrase ‘We achieve maximum shareholder value by…´.

An exaggeration, but not by much. There´s the superfluous gaggle of administrators that claims to generate value because their own subjective analysis says (surprise) that their costs are slightly lower than comparable operations elsewhere. Then there´s the sales group that expropriates whatever definition for ´value maximizing´ is in fashion that season to ensure that the bottom 20% of the sales force always avoid the cut. Shareholders be damned. Next, members of the development group who have been so thoroughly brainwashed in the erroneous belief that value only comes from growth that they repeatedly pursue value-destroying initiatives.

You get the picture. There isn´t enough space here to list all the ways that these and other partial value actions diminish shareholder wealth. What does work is a value scope that covers all five of the potential sources of missing shareholder wealth.

Value-creating growth. Fundamental expense structure reform and new efficiencies. Value-optimal capital structure, financing and business portfolio strategy. Risk management. Guiding perceptions of the emerging new group of value-influencers who have emerged after The Bubble, when businesses were forced to forget the fluff and focus on what works in all aspects of business. Including management´s paramount responsibility, to maximize shareholder value on a continuing basis.

None of the five sources of value is enough all on its own. Overrely on one value source to the exclusion of the other four, and errors of partial value arise. But when all five prime value sources are examined effectively and pursued aggressively, the company has the beginning of a powerful corporate value improvement agenda.

4 ) Single Best Value Solution

"We create value." Problem with this standard shareholder value mantra is that it doesn´t address the related question, "How much?".

When the performance question is (incorrectly) phrased too broadly as, "Do you create value?", disappointment is assured. Almost any mediocre approach might be massaged to somehow be seen as creating at least some additional value.

At the company that manages for maximum value, that isn´t enough. The proven Value Champion is obsessed with discovering and implementing the single best value solution. That´s the solution generating the greatest incremental value, over the shortest period of time.

All other approaches are assessed relative to the optimal. A new, simple working definition for value destruction emerges: anything less the single best value solution. Take the recurring challenge of adjusting the company´s business unit portfolio to eliminate those parts that savage the company´s value.

First (and to no one´s surprise), company officials finally pull the plug on divisions/subsidiaries that have been drowning for years (´Stop the Bleeding´, above). The cycle is complete: the unit originally described as the savior of the corporation is downgraded to ‘revitalized´ and then to ‘restructured´ and then dumped or discontinued. Company value increases, but only by a modest amount. 5

To increase value improvement to Level 2, management expands their scope. They begin to address some of the embedded value underperformance in parts of the company that are not immediately apparent to outsiders.

There´s the marginally profitable fourth-in-segment struggling unit facing a dilemma between a fundamental change in its business model or sales of assets while they still have some value. Punch card equipment in the early ‘80s, personal computers today, 3G (third generation cellular phone) sets tomorrow?

At first, apologists contend that so long as cashflow is still positive, a case can be made for holding on and hoping for better days. There´s a freeze on further spending (something about ‘throwing good money after bad´) but the return ratios can be improved through reduction in the level of investment.

But postponing the inevitable in this manner merely deepens and extends the value damage from this source. A credible turnaround approach doesn´t exist, so the only way is down. Even with temporary positive cashflow, the operation/project/unit/team is still value-destructive based on the working definition.

Next, at Improvement Level 3 are the bold strokes that catch almost everyone by surprise, thereby enhancing the opportunity for enduring valuation improvement. These are the actions that prompt the comment a few months later that no one can understand why this wasn´t done years ago.

The actions involve both serious revenue enhancement and further efficiencies. Both risk management and improvements in the transparency of information available to the outside. In the case of the latter, goal is to foster the perception among value-setters that here is a company that is actually making itself easier to be understood, as the future direction is positive and there´s nothing to hide.

5 ) Zero Tolerance of Value Destruction

Talking the value talk is easy. Walking the value walk is far more difficult. Latter is achieved by very few, including scores of companies that spew value propaganda. How to separate the serious Value Champions from the rest? Outside evaluators look consider the completeness and rigor of the company´s actions to root out value destruction on a continuing basis.

Look again at that tonnage of charts, formulas and full paragraph technical definitions that characterize the ‘value´ programs in name only. Thos stale bromides and other material are literally boxed away, never to be applied to practical business issues.

One of the fastest ways to reveal the Company´s much-ballyhooed ‘value´ effort as a fraud is to tolerate or worse, encourage value destruction. The most damaging lapse of Zero Tolerance of Value Destruction occurs when the breakdown occurs within the executive office. 6

With grand fanfare, top management proclaimed that managing for value is ‘How we do business´. But daily behavior contradicts the carefully devised PR. Instead, actions by senior management communicate that the company is merely using ‘value´ as a cover for bad old business-as-usual.

Management´s impulsive, subjective guesses are merely repackaged by in-house lackies as ‘value-based analysis´ through spin and manipulated spreadsheet analyses that wilt under tough, objective examination. 7 Crony administrative departments destroy value because of embedded budget fat that persists each quarter, unreformed and untouched.

Eight layers persist in the organizational structure, even though the same company in fully lean mode could thrive with just four. Deadwood are kicked upstairs to expensive but ceremonial vice chairman positions, where they sometimes multiply their value destruction by involving themselves in still-prosperous parts of the business.

Money-draining projects and acquisitions continue to be supported, years after those initiatives stopped being value-creating. After all, we can´t have any of the top guys losing face, because they authorized these turkeys way back when. Promotions, R&D and business development initiatives are padded with value-deteriorating extras: extra expenses, non-productive people, money losing initiatives that bleed value but are not terminated.

Think that the company is being managed to achieve maximum appreciation of shareholders´ ongoing wealth? Think again. Every major action by senior management communicates the opposite to those in the financial community who shape future shareholder wealth.

Value-setters in the financial community fear either that (1) management selective applies ‘value´ only when it doesn´t impede freedom to continue to ‘wing-it´ or worse, (2) that top-most management lacks a clear understanding of the critical actions and characteristics that distinguish the Value Champion from the pretenders.

Antidote is simple and direct: Impose a regime of Zero Based Tolerance as complete and all embracing as exists in the private sector. No instance of value destruction is permitted, in any part of the business. The theory: failure to ruthlessly eliminate value destruction spreads the plague like wildfire.

Overt, visible instances of value destruction are straightforward. Shutting down or radically restructuring the losing subsidiary, division, unit, promotions/business development group or sales team is a fairly direct matter. If implementing management bluffs at meaningful cost and performance reform instead of doing the job right, then they are part of the problem rather than the solution.

Hidden sources of value destruction are more difficult to see, and thus more difficult to eradicate. At any one time, the top three layers of management tend to be distracted by a dozen-odd distractions, all of which claim to be mandatory but almost none of which have any direct impact on enduring shareholder value.

Cut them out, along with the wasted staff and budgets. In fast-changing times, inertia can quickly change the identity of the project/asset/employee from value-creating to value-diminishing. There is no in-between position.

Fail to keep up, and the company falls behind the competition and eventually succumbs. Yes, Welch´s Number-One-or-Number-Two rule still applies. Not surprisingly, the survivor-champion is also the company that exhibits zero tolerance for value destruction throughout the organization.

6.) Fixing the Value Incentives Structure

Substantial value improvement can never be achieved and sustained across the corporation without major changes in senior management behavior.

Initially, value rhetoric and the accompanying circus atmosphere generates its own momentum. 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.

The list includes 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.

The start of the value journey is the easy part. Sustaining upward value improvement momentum is far more difficult. Not only does the method have to be equal to the challenge, but incentives must also be linked to value creation. Balance of this part deals with the second issue.

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.

Getting the stretch goals part right is far more challenging. 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. 8 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. 9

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 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 of a one year heist may become irresistible.

Notes:

1

Those activities within the financial function/department include (1) value creation by changing the company´s debt-equity capital mix (thereby changing the firm´s Weighed Average Cost of Capital, WACC), (2) using a WACC-based financial qualifier or ‘hurdle´ for making capital allocation and funding decisions, and (3) use of discounted cashflow and Cost of Capital analysis to make fundamental decisions concerning priorities in the business mix. Stated another way,(3) is the answer to the question, “Where does most of our value come from?”

2

Anticipating changes in business cycle direction is precarious at best, but one fact persists as a guide for planning. Ever since serious step were first taken by the Volcker Federal Reserve in the early ‘80s to begin to tame structural inflation in the US economy, the expansion/retreat pattern has evolved towards 8 years of market expansion, followed by 2-3 years of retrenchment and consolidation.

3

As referred to here, “value contribution” refers simply to an increase in the present value of future anticipated cashflows, net of all investment and costs, objectively and fully calculated. Two important caveats: (1) the primary analysis period (t) should be no greater than the underlying economic life of the related product bor service, typically not longer than 5-7 years, (2) terminal value (value ascribed to the initiative following the primary analysis period) cannot exceed 65% of the primary period value. Without both of these two limits, skilled numbers crunchers can easily devise an illusion that the value-destroying initiative instead creates value.

4

Beginning of Ch. 1 in The Value Mandate (“Your company is underperforming in value terms by 50 percent. In value terms, on a continuing basis.”) reflects the fact that the sources of value reform are both visible and available. Missing the correct value targets (No. 3, ‘Looking for Value in All the Wrong Places´, herein) comprises up to half of that gap. Incomplete and or inadequate solutions (No. 4, ‘Single Best Value Solution´) and execution comprise the balance.

5

The value improvement level is modest at this stage because the long-overdue corrective measures are already ‘in the market´, that is, anticipated by the financial community and reflected in valuation. The improvement that does occur largely reflects value-determiners´ relief that company management are starting to deal with money- and value-losing operations, activities and projects, rather than being in denial.

6

“Zero tolerance” is a phrase that is widely attributed to William J. Bratton, former chief of police of New York City and at this writing, the recently-appointed police chief of Los Angeles.

7

Refer to Note 3, above. The fact that few if any value spreadsheets are checked for accuracy years later says it all. In the ‘talk the talk´ MFV mirage company, overly-optimistic analysis is used to sustain management-by-budget, instead of management for maximum shareholder value improvement.

8

Net Value, 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).

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.

9

The Value Mandate, pp. 98-100.
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