Capitalized Earnings Value of the Equity of Stock Corporations (Public Limited Companies)
An Article in the Compendium of Market-Based Social-Ecological Economics
Key issues in view of the neoliberal crisis:
How can we guarantee employment and fair income?
How can we protect the environment effectively?
How should we shape the economic globalization?
What should the economic sciences contribute?
What must be the vital tasks of economic policy?
How can we legitimize economic policy democratically?
Table of Contents
Shareholder value is, on the one hand, the neutral term for the earnings value attributed to the shareholders of stock corporations and, on the other, it is a synonym for a controversial corporate strategy aimed solely at share-price gains on the stock market. Under the conditions of the current neoliberal globalization, this strategy is of no long-term benefit to shareholders, nor does it serve the interests of employees, customers, suppliers and the general public. It should therefore be noted that an equitable balance of interests between the various stakeholders of public limited companies can only be achieved under a market-economy system that aims for social and ecological returns.
2. The Meaning of the Term
Shareholder value literally means the capitalized earnings value of the equity (of the shares) of listed stock corporations that is allocated to the shareholders. The term is also used synonymously for shareholder assets or wealth, market capitalization and enterprise or company value. A characteristic feature of shareholder value is that the value of equity capital on the stock market is not derived retrospectively from the company’s performance of the last reporting period, but from the interpretation of published corporate planning and the assessment of future market and competitive developments by market participants and so-called analysts.
With reference to the development potential of equity capital, the term shareholder value is also used for a so-called value-oriented corporate strategy, in which all measures are aimed at sustainably increasing the value of equity capital in order to meet the shareholders’ claim for a return in line with market interest rates. Shareholders’ interest claims are derived from investments with comparable risks and include dividends, price increases and subscription rights.
3. The Origin of the Shareholder Value Strategy
The strategy was first described in 1986 by US economist Alfred Rappaport in his book Creating Shareholder Value and has since become a globally accepted standard. In the new edition of his book (Creating Shareholder Value: The New Standard for Business Performance) published in 1998, Rappaport expands the strategy and deals with the peculiarities of deregulated markets as they have arisen in the course of the neoliberal globalization. In particular Rappaport offers measures against new threats, for example against the danger of hostile takeovers, which those stock corporations are exposed to whose shareholder value develops worse than the general market and who thus become »cheap« takeover candidates. For the first time, Rappaport also addresses the conflict between the demands of shareholders and those of other stakeholder groups, which include employees, customers, suppliers, lenders, the state, the public and the environment.
In resolving the conflict, Rappaport sees the »elected representatives of the legislature« responsible, i.e. he calls for legal measures to ensure that the value and the increase in value of equity capital of stock corporations to be equally granted to all stakeholder groups. Finally, he describes the preservation and increase of shareholder value as »the only social responsibility« that companies have in a market economy. (By the way, the corporate strategy involving all stakeholder groups is described in the article Stakeholder Value (English)). The fact that Rappaports proposals are contradictory in themselves under the prevailing neoliberal conditions is dealt with in the following section.
4. The Application of the Shareholder Value Strategy
In order to determine the equity capital value as a strategic parameter, economically accepted procedures are required which derive the current equity capital value from the future measures to be defined within the framework of corporate planning. The discounted cash flow method, which focuses on financial solvency and views corporate activities as a series of payments (cash flows), has meanwhile been accepted in the market as a global standard: Accordingly, the equity value is calculated by discounting the cash surpluses forecast for future periods (usually the next 5 to 10 years), the so-called free cash flows, to the present value using a risk-adjusted cost of capital rate and reducing it by the market value of the borrowed capital (e.g. bank liabilities).
If the equity capital value of a company is calculated as described and deviates from the current stock market value without temporary sentiment in the stock market being responsible for it, it must be assumed that the stock market has come to a different assessment with regard to the future development of the company than the discounted cash flow method. Under the assumption that a stock price reflects the intrinsic value of a company, i.e. the present value of all future free cash flows that a company could pay out to its shareholders, or in other words, that the stock market basically »feeds« all foreseeable developments into the stock prices, a new round of corporate planning with correspondingly adjusted measures is madatory.
If a (re-) calculation for a company does not result in any cash surpluses at all, i.e. the return on equity is below the cost of capital, the company must be restructured or sold in line with the shareholder value strategy.
5. Rappaport’s Selfish-Schizophrenic Claims
Rappaport, who, as the »inventor« of the shareholder value strategy, is one of the trailblazers of the neoliberal globalization, speaks with a forked tongue in the new edition of his book, as quoted above: When he calls for legal measures against social injustice, he does so even though, as an economist, he must be aware that the influence of national legislation is being pushed back more and more, precisely as a result of the deregulation of national markets. And when he calls the shareholder value the only social responsibility that companies have in a market economy, then his statement is doubly dishonest: Firstly, companies can only withstand cost pressure in competition on open global markets by reducing their social and ecological costs to the level lowered by worldwide social and ecological dumping. And secondly, the transactions carried out with dumping prices and aimed at displacing competitors are capitalist excesses which, at the expense of man and nature, only aim at a maximum return on investment and no longer correspond to the ideals of a market economy. See also the article Excesses of Capitalism.
Rappaport conceals the fact that the neoliberal globalization is based on economically unregulated markets, that price formation on these markets does not include social and ecological costs, that the markets develop into lawless battlefields under the unbridled self-interest of the players, and that the neoliberal market mechanism is directed only towards dubious private economic gains instead of sustainable social welfare. It is obvious that neither social justice nor ecological sustainability can be expected from unregulated markets. And therefore, the sole pursuit of shareholder value cannot be expected to produce social and ecological benefits under the prevailing neoliberal economic doctrine,.
6. Shareholder Value and Neoliberal Globalization
Under the influence of deregulated financial markets, the shareholder value strategy has changed fundamentally. Stock corporations are committed to greater transparency through quarterly reports and are therefore exposed to demands for higher returns on equity, especially when their shares are held by powerful institutional investors such as US pension funds. High equity value and high return on equity are indispensable in order to survive in global competition for equity and debt capital as well as for factor and product markets, but also to win the global competition for takeover candidates and, even more crucial, to protect against becoming a takeover candidate oneself. In this environment, there are constraints to increase the equity value through immediate and short-term measures: for example, by focusing on new (and risky) growth markets, through rationalization and job cuts, by selling unprofitable business units and purchasing profitable ones, by relocating production to countries with low wages and standards, or simply by repurchasing own shares.
In addition, it has become common practice to provide incentives for members of the Executive Boards of stock corporations for the implementation of short-term measures by means of in-house stock option plans. The options allow beneficiaries to exploit stock price increases that exceed the issue price for personal profit taking without being exposed to a risk of loss in the event of a price fall. The incentives are co-responsible for erratic management behaviour and correspondingly frequent price fluctuations, which are intensified by institutional investors by means of biased investment recommendations and are immediately used for profitable transactions – always to the detriment of all other shareholders and also to the detriment of all other stakeholders. Since then, the share has had its day as a safe and profitable long-term investment. By the way, the incentives created by stock option plans are one of the causes of the financial market crisis 2008 and the economic crisis it triggered.
7. Summary and Outlook
Since the mid-1990s there has been increasing criticism of the shareholder value strategy because the demands and machinations of institutional investors are becoming increasingly contradictory to the demands of small shareholders and other stakeholders. The cause for this incompatibility is the lack of local focus of the equity capital of stock corporations, i.e. in the global speculative access to equity capital and the associated opportunities to make speculative profits in the short term. In this environment, all advantages lie on the side of globally active large-scale investors who are able to manipulate the stock markets with their transactions and move prices in any desired direction at short notice in order to subsequently realize profit taking – always at the expense of all less wealthy investors.
In order to achieve a balance of interests between all stakeholders, as was still possible in the 1980s of the last century, it is necessary to have autonomous, democratically legitimized economic policy capability and responsibility at the regional and national level, possibly supplemented by supranational rules on revocation. There is a special need for regulated financial markets that do justice to their actual task, namely to supply the real economy with money capital from a broadly diversified multitude of private sources and to grant debtors an appropriate share in productivity progress through interest rates and yields. This requires a real economy based on functioning local, regional and national economic cycles, as well as foreign trade based on bilaterally agreed exchange rates that neutralize price differentials on average between trading partners, so that comparative relative price advantages become identifiable and can be used for international trade and competition to increase prosperity. In addition, trading partners should grant each other autonomy in setting import tariffs and trade quotas in order to constructively integrate foreign trade and foreign competition into domestic competition, so that domestic suppliers are exposed to incentives to bring their productivity up to world standards and become exporters themselves, without being threatened with final exclusion from the market. In terms of technology transfer and worldwide progress, intangible free trade in intellectual property is a complementary option.
Rappaport’s assertion that the unsatisfactory balance of interests between shareholders and other stakeholders could be permanently improved by national economic policy measures under the conditions of the neoliberal globalization without overcoming the systemic, global economic causes is part of the irresponsible indoctrination that neoliberal protagonists selfishly pursue.
Click here for the German-language version: Shareholder Value (deutsch).
Sources and Literature
Rappaport, Alfred (1986, 1998). Shareholder Value: The New Standard for Business Performance. New York: Free Press