Defentions and Financial Mesures Essay Example | Topics and Well Written Essays - 1750 words

Defentions and Financial Mesures - Essay Example Focus on shareholder value started gaining prominence in the 1980s and by the start of 21st century had become a key element in corporate governance in the US, UK, and most of leading European nations like Germany, France and Sweden; so much so that the OECD, in their document released in 1999, emphasised that firms be run first and foremost in the interest of shareholders. They further reinforced this thought in their 2004 release of OECD principles of corporate governance (OECD 2004). As the fad of focus on shareholder value began spreading, the understanding of the concept seemed to have started to erode somewhat as many executives began to focus on quarterly earnings as a key driver of their stock prices. The concept of shareholder value does not, however, imply that companies should target a short-term â€Å"never-before† high stock price at any cost. A company targeting only short-term stock price gains is likely to suffer in the long-term as it would be subject to makin g decisions that may seem beneficial in the short-term but could likely produce a negative long-term effect. Instead, the concept of shareholder value means that if a company builds value, its stock price will trace it; the objective for a firm’s management is then â€Å"to build value and let the stock price reflect this value† (Mauboussin, 2011). And, the value creation of a company is reflected in its ability to secure and increase its long-term cash flow. It is thus essential to understand how to and, more importantly, how not to create shareholder value. Creating shareholder value is not just about getting the numbers right in the short-term but more about taking the right decisions that create sustainable long-term value for the firm. For example, in order to â€Å"increase the shareholder value†, a firm could cut its cost on pollution abatement and lead to environmental damage; such actions, however, are not sustainable in the long-term and when the time comes to take corrective measures in the long-term, the associated costs could be several times higher. Another very recent example is how banks and other lenders blindly lent money to create the housing bubble in the US. From short-term perspective, the sub-prime lending seemed extremely attractive for creating value and seeing the stock prices skyrocket but it was probably not the best decision from long-term cash flow perspective. Thus, from the long-term perspective and in retrospection, the overlooking of fundamentals of lending without considering the ability of people to repay and the short-term focus on numbers was probably not the best strategy for creating value. This ideology of focussing on short-term was even criticised by Jack Welch, former CEO of GE, and a chief proponent of the idea of â€Å"shareholder value†. In an article on Financial times, Welch called the short-term focus on share price as an indicator of shareholder value as â€Å"the dumbest idea† (Guerrera, 2009). He said that rather than setting share price as their objective, managers should focus on aligning their short-term profits with an increase in the long-term value. It is therefore important to understand that the principle of shareholder value is the right one only as long as it is understood properly and in the right sense; that is constantly focussing on the long-term and