vd dissertation

Business School

WELL-BALANCED MANAGEMENT OF KEY FINANCIAL

VALUE DRIVERS THROUGH VALUE CREATION

STRATEGIES AND ITS IMPACT ON SHAREHOLDER VALUE

MAXIMIZATION AND INVESTORS’ APPRECIATION

Teesside University Postgraduate Management (MSc) Dissertation:

H8145246

Ross Novak

AIM:

The purpose of this dissertation is to examine how the key financial value drivers can affect the

shareholder value, what the proper management of these drivers should be implemented in pursuing

value-maximizing goal and to which extend the value-based management is applied within the

current manufacturing industry.

RESEARCH QUESTIONS:

1) Is the shareholder value maximization approach observable from historical performance and

what relationship can be found among the core value drivers?

2) Which metrics can be used in performance targets and performance evaluation?

3) How sensitive to the shareholder value can be a variation of each of value drivers in building

long-term prospect?

4) What factors can cause value destroying and how can the issues defined in ‘Agency Theory’ be

avoided?

5) Can value drivers be used as a benchmark in comparative analysis of strategic position?

6) Do today’s managers use the value-based approach or do they rather focus on enhancing return

on investment?

7) What alternative strategies would improve investors’ anticipation and enhance the shareholder

value added?

8) Which strategy options associated with the key value drivers motivate the greatest corporate

value by selected companies?

1

ABSTRACT:

An appropriate management of financial value drivers is crucial for the enhancement shareholder

value and for that reason, the concept of value-based management, which creates a sustainable

competitive advantage and a consistent ‘value culture’ is the principal element of this study. This

managerial approach is contrasted with the profit maximization view, which encourages under-

investment rather than creates long-term value. This research project deals with shareholder value

analysis, financial value driver management and growth-setting objectives with the central goal of

maximizing discounted future cash flow. In particular the cash generating abilities, expected by

investors, have been expressed via calculated shareholder value added serving as a criterion for

consideration of such strategy options that will lead to the greatest corporate value. Calculation

based on estimated cash flows discounted by cost of capital and derived from a perpetuity method

has been also supported by alternative value-creation metrics (valuation through economic profit and

stock market valuation) resulting to similar conclusions with a value creation bias. The ‘Agency

Theory’ (relating to destroying value), the investment appraisal (based on Threshold margin

calculation) and international differences between stakeholders’ view and shareholders’ concerns

have been also included in this work. The hypothetico-deductive research method with

methodological pluralism has been used in this dissertation combining both descriptive and

correlational study for better understanding of the characteristics of variables influencing a

phenomenon of interest - shareholder value of the company.

ACKNOWLEDGEMENTS

This postgraduate dissertation was completed at Teesside University as part of MSc Management

degree. I would like to thank Alexander Finlayson, for his encouragement and help with regards to

his observations that have contributed to the comprehensive concept and methodology as my

dissertation advisor and my daughter Lenka for being so awesome and supportive.

2

CONTENTS:

Aim, Research Questions…………………………………………………………………………. і

Abstract, Acknowledgements…………………………………………………………………..….ii

List of Figures……………………………………………………………………………….…..viii

List of Tables, List of Graphs……………………………………………………………………….…….ix

1. Rationale………………………………………………………………………………….. 10

2. Theoretical Underpinning……………………………………………………………….. 12

2.1. Two Concepts: Profit Maximization vs. Value Maximization …..12

2.2. International Diversity in Setting Company’s Goal…..13

2.3. Earnings-Based Management…..13

2.3.1. Shareholder Value Approach and SVA…..16

2.3.2. Principles of Valuation…..17

2.3.3. Financial Value Drivers…..19

2.3.4. The Growth Strategy…..21

2.3.5. Capabilities as the Sources for Creation Value…..22

2.3.6. Growth-Setting Objectives…..23

2.3.7. Value-Creation Metrics…..24

2.3.8. Value Management…..26

3. Methodology…………………………………………………………………………………..27

3.1. Research Method…..27

3.2. Research Design…..29

3.3. Sample Design…..30

3.4. Questionnaire Design…..32

3.5. Statistical Analysis of Data…..33

3.6. Empirical Work…..34

3.6.1. Framework in Part 1…..35

3.6.2. Framework in Part 2…..38

4. Interpretation of the Results…………………………………………………………………39

4.1. Evaluation in Part A…..39

4.2. Evaluation in Part B…..51

4.3. Stock Market Indicators…..54

4.4. Value Destroying Analysis…..55

3

4.5. Appreciated Share Price…..57

4.6. Market Position Analysis…..59

4.7. Questionnaire Appraisal…..60

5. Discussion and Conclusion…………………………………………………………………..61

References………………………………………………………………………………………..63

Appendix 1: Tables 1 – 19.11

TABLE 1: Historical secondary data Hamworthy Plc. extracted from FAME

TABLE 2: Identification characteristic value drivers – Hamworthy Plc.

TABLE 3: Assumptions proposed

TABLE 4: Current policy (strategy option ‘zero’) – Hamworthy Plc.

TABLE 5: Value driver management (strategy option 1) – Hamworthy Plc.

TABLE 6: Investing – Threshold Spread

TABLE 7: Management of 3 rd Driver – Investment (strategy options 2,3,4) – Hamworthy Plc.

TABLE 7.1: SVA generated through different investment appraisals – Hamworthy Plc.

TABLE 7.2: Setting objectives (strategy option 5) – Hamworthy Plc.

TABLE 7.3: Setting objectives (strategy option 6) – Hamworthy Plc.

TABLE 7.3.1.: Summary of SVA achieved under different objectives – Hamworthy Plc.

TABLE 7.4: Cutting investment without declining sales growth (strategy 7) – Hamworthy Plc.

TABLE 7.5: Cutting investment with declined sales growth (strategy option 8) – Hamworthy Plc.

TABLE 7.6: Adverse effect of cutting investment (strategy option 9) – Hamworthy Plc.

TABLE 7.7: Rationalization (strategy option 10) – Hamworthy Plc.

TABLE 7.7.1 : Cost reduction alternatives – Hamworthy Plc.

TABLE 7.8: Sensitivity of DCF, NOPAT and SVA (summary) – Hamworthy Plc.

TABLE 8.1: Accounting-led growth (15% cut) – Hamworthy Plc.




TABLE 9.1: SVA maximization - Investment to increase sales growth (25%, 12%, 35%)






TABLE 9.7: SVA maximization - Investment to improve margin (20%, 15%, 35%)

4




TABLE 9.11: SVA maximization - Investment to improve margin (20%, 27%,75%)


TABLE 9.13: SVA maximization – Investment to both drivers (20%,15%,35%)






TABLE 9.19: Summary: Value Maximization – Hamworthy Plc.

TABLE 10: The stock market’s valuation – Hamworthy Plc.

TABLE 11.1: EP-valuation using performance spread method (15%,7%,25%)

TABLE 11.2: EP-valuation using performance spread method (predicted performance)

TABLE 11.3: EP-valuation using the profit less capital charges method

TABLE 11.4: EP-valuation under different drivers (20%,12%,25%)

TABLE 11.5: EP calculated for different driver management– Hamworthy Plc.

TABLE 11.6: Two methods in comparison – Hamworthy Plc.

TABLE 12: Comparative analysis of historical performance of selected companies

TABLE 13.1: Historical value drivers within monitoring period – Hamworthy Plc.

TABLE 13.1.1.: Historical value drivers within pre-monitoring period – Hamworthy Plc

TABLE 13.2: Historical value drivers within monitoring period – Spirax-Sarco Engineering Plc.

TABLE 13.2.1: Historical value drivers within pre-monitoring period – Spirax-Sarco Engineering

TABLE 13.3: Historical value drivers within monitoring period – Weir Group Plc.

TABLE 13.3.1: Historical value drivers within pre-monitoring period – Weir Group Plc.

TABLE 13.4: Historical value drivers within monitoring period – HC Slingsby Plc.

TABLE 13.4.1: Historical value drivers within pre-monitoring period – HC Slingsby Plc.

TABLE 13.5: Historical value drivers within monitoring period – 600 Group Plc.

TABLE 13.5.1: Historical value drivers within pre-monitoring period – 600 Group Plc.

TABLE 13.6: Historical value drivers within monitoring period – Clyde Process Solutions Plc.

TABLE 13.6.1: Historical value drivers within pre-monitoring period – Clyde Process Solutions Plc.

TABLE 13.7: Historical value drivers within monitoring period – Pressure Technologies Plc.

TABLE 13.7.1: Historical value drivers within pre-monitoring period – Pressure Technologies Plc.

TABLE 13.8: Historical value drivers within monitoring period –Mount Engineering Plc.

TABLE 13.8.1: Historical value drivers within pre-monitoring period – Mount Engineering Plc.

5

TABLE 13.9: Historical value drivers within monitoring period – MS International Plc.

TABLE 13.9.1: Historical value drivers within pre-monitoring period – MS International Plc.

TABLE 13.10: Historical value drivers within monitoring period – Gas Turbine Efficiency Plc.

TABLE 13.10.1: Historical value drivers within pre-monitoring period – Gas Turbine Efficiency Plc.

TABLES 14.1-14.10: Value drivers predicted – equilibrium position and confidence limits

TABLES 15.1-15.10: Valuation selected companies using anticipated value drivers

TABLE 16.1-16.10: Stock market’s valuation versus calculated value

TABLE 16.11: Summary

TABLE 17: Value-destroying analysis – 600 Group Plc.

TABLES 18.1-18.2: Positioning – strategic control charge (MBR-size relationship)

TABLE 19.1: Share Prices

TABLES 19.2-19.11: Investors fundamentals

Appendix 2: Graphs 1A – 81A

GRAPH 1A: Earning Performance – Hamworthy Plc.

GRAPH 2A: NOPAT – Hamworthy Plc.

GRAPH 3A: Sales Volumes – Hamworthy Plc.

GRAPH 4A: Changes in Incremental Sales - Hamworthy

GRAPH 5A: Total CF from Operative/Investing Activities - Hamworthy

GRAPH 6A: Investing and ROCE - Hamworthy

GRAPH 7A: Historical/Future NCF - Hamworthy

GRAPH 8A: Cumulative and Continuing PV - Hamworthy

GRAPH 9A: Enterprise Value - Hamworthy

GRAPH 10A: SVA within Forecast Period - Hamworthy

GRAPH 11A: SVA Generated from Different Investments - Hamworthy

GRAPH 12A: Cumulative DCF and PV of Continuing Corporate Value - Hamworthy

GRAPH 13A: Proportion of DCF and CV – Hamworthy (in percent)

GRAPH 14A: SVA Creation within Forecast Period - Hamworthy

GRAPH 15A: Economic Profit and DCF Valuation in Comparison

GRAPH 16A: Economic Profit Calculated for Different Drivers

GRAPH 17A: Operating Profit after Tax in Comparison

GRAPH 18A: Free CF in Comparison

GRAPH 19A: 1st Driver – Sales Growth in Comparison

GRAPH 20A: 2nd Driver – Operating Profit Margin in Comparison

GRAPH 21A: 3rd Driver – Investment in Comparison

GRAPH 22A: Hamworthy – Profit/CF

6

GRAPH 23A: Spirax-Sarco Engineering – Profit/CF

GRAPH 24A: Weir – Profit/CF

GRAPH 25A: HC Slingsby – Profit/CF

GRAPH 26A: 600 Group – Profit/CF

GRAPH 27A: Clyde Process Solution – Profit/CF

GRAPH 28A: Pressure Technologies – Profit/CF

GRAPH 29A: Mount Engineering – Profit/CF

GRAPH 30A: MS International – Profit/CF

GRAPH 31A: Gas Turbine Efficiency – Profit/CF

GRAPH 32A: Hamworthy–Historic Drivers

GRAPH 33A: Spirax Sarco Engineering-Historic Drivers

GRAPH 34A: Weir Group-Historic Drivers

GRAPH 35A: Slingsby-Historic Drivers

GRAPH 36A: 600 Group-Historic Drivers

GRAPH 37A: Clyde Process Solution-Historic Drivers

GRAPH 38A: Pressure Technologies-Historic Drivers

GRAPH 39A: Mount Engineering-Historic Drivers

GRAPH 40A: MS International- Historic Drivers

GRAPH 41A: Gas Turbine Efficiency- Historic Drivers

GRAPH 42A: Hamworthy-‘Strategy Triangles’

GRAPH 43A: Spirax Sarco Engineering-‘Strategy Triangles’

GRAPH 44A: Weir Group-‘Strategy Triangles’

GRAPH 45A: HC Slingsby-‘Strategy Triangles’

GRAPH46A: 600 Group-‘Strategy Triangles’

GRAPH47A: Clyde Process Solution-‘Strategy Triangles’

GRAPH48A: Pressure Technologies-‘Strategy Triangles’

GRAPH49A: Mount Engineering-‘Strategy Triangles’

GRAPH50A: MS International-‘Strategy Triangles’

GRAPH51A: Gas Turbine Efficiency-‘Strategy Triangles’

GRAPH52A: Hamworthy-‘Value Gaps’

GRAPH53A: Spirax Sarco Engineering-‘Value Gaps’

GRAPH54A: Weir Group-‘Value Gaps’

GRAPH55A: HC Slingsby-‘Value Gaps’

GRAPH56A: 600 Group-‘Value Gaps’

GRAPH57A: Clyde Process Solution-‘Value Gaps’

GRAPH58A: Pressure Technologies-‘Value Gaps’

7

GRAPH59A: Mount Engineering-‘Value Gaps’

GRAPH60A: MS International-‘Value Gaps’

GRAPH 61A: Gas Turbine Efficiency-‘Value Gaps’

GRAPH 62A: Stock Market Valuation

GRAPH 63A: MBR-CBR Relationship

GRAPH 64A: 600 Group-Sales Growth

GRAPH 65A: 600 Group-Incremental Increases/Decreases of Sales

GRAPH 66A: 600 Group-Profit Margin

GRAPH 67A: 600 Group-Operating Margin

GRAPH 68A: 600 Group-Investment

GRAPH 69A: 600 Group ROCE (%)

GRAPH 70A: Hamworthy: EPS-Share Price

GRAPH 71A: Spirax-Sarco Engineering: EPS-Share Price

GRAPH 72A: Weir Group: EPS-Share Price

GRAPH 73A: HC Slingsby: EPS-Share Price

GRAPH 74A: 600 Group: EPS-Share Price

GRAPH 75A: Clyde Process Solution: EPS-Share Price

GRAPH 76A: Pressure Technologies: EPS-Share Price

GRAPH 77A: Mount Engineering: EPS-Share Price

GRAPH 78A: MS International: EPS-Share Price

GRAPH 79A: Gas Turbine Efficiency: EPS-Share Price

GRAPH 80A: Strategic Control Charge: MBR-Size

GRAPH 81A: Strategic Control Charge: CBR-Size

Appendix 3: EP – Based Valuation

Appendix 4: Questionnaire Form & Response Analysis

Appendix 5: List of Companies

LIST OF FIGURES

FIGURE 1: Drivers of Value……………………………………………………………………20

FIGURE 2: Two Routes to Value Creation……………………………………………………..22

FIGURE 3: Rappaport’s Free Cash Flow……………………………………………………….25

FIGURE 4: Options Opened to Managers………………………………………………………26

FIGURE 5: Hypothesised Casual Relationships………………………………………………...34

8

LIST OF TABLES:

Table 1: Strategy Options Used in Value-Drivers Management……………………………….36

Table 2: Value Maximization Options………………………………………………………….37

LIST OF GRAPHS:

GRAPH 1: Share Price Movement – Hamworthy………………………………………………40

GRAPH 2: Enterprise Values under Different Strategies………………………………………42

GRAPH 3: Shareholder Value under Different Strategies……………………………………...43

GRAPH 4: DCF Profiles within the Planning Horizon ………………………………………..44

GRAPH 5: NOPAT Profiles within the Planning Horizon………………………………….….45

GRAPH 6: SVA under Proposed Strategic Options – Hamworthy ……………………………46

GRAPH 7: Future CF Generated under Different Rationalizations-Hamworthy………………46

GRAPH 8: SVA under Different Cost Reductions-Hamworthy………………………………..47

GRAPH 9: Value Maximizing Options according to the highest SVA-Hamworthy…………...48

GRAPH 10: Valuation Using Economic Profit-Hamworthy…………………………………….49

GRAPH 11: Valuation Methods in Comparison-Hamworthy……………………………………50

GRAPH 12: ‘Strategy Triangles’-Hamworthy…………………………………………………...52

GRAPH 13: ‘Value Gaps’-Hamworthy…………………………………………………………..53

GRAPH 14: ‘Value Gaps’-Gas Turbine Efficiency………………………………………………54

GRAPH 15: ‘Value Gaps’-600 Group……………………………………………………………55

GRAPH 16: Sales Growth/Shrink-600 Group……………………………………………………56

GRAPH 17: Operating Margin-600 Group……………………………………………………….56

GRAPH 18: Investment-600 Group………………………………………………………………56

GRAPH 19: Historical Share Price (LSE)………………………………………………………..57

GRAPH 20: EPS/Share Price Relationship-Hamworthy…………………………………………58

GRAPH 21: P/E Ratio Comparison………………………………………………………………59

GRAPH 22: Strategic Control Charge: MBR-Size……………………………………………….60

9

1. RATIONALE:

This dissertation is concerned with the shareholder value creation as a paramount goal of a company

that seeks superior competitive position on the market and long-term success ensuring stability even

in such dynamic time as we are experiencing today. Therefore the key financial factors affecting a

company’s value most will be identified and an efficient driver management will be examined.

Hence, according to this the firm’s aim, hence, must be wealth maximization through financial value

drivers which will ensure the maximal possible total share return in performance. For that reason,

investors could be interested in such study in particular; however executives should be also

concerned since they must handle the value drivers a day-to-day basis. Based on an assumption that

many companies are driven by profit and short-run ‘effects’ rather than by long-term sustainability,

this work emphasises managers’ own interest in the ‘always the best results’ approach and

recognises profit maximization under short-term strategies in companies operating in real business

environment. Furthermore, some managers’ conviction that maximizing profitability under earnings-

based approaches pursues maximizing shareholder value is supposed by the researcher to be as quite

often a conjecture that should be tested, proved and explained. The importance of this research area

is great since managers could realise through dissertation findings that although their actions are

evaluated on the base of annual performance the investors’ value anticipation will finally determine

the success achieved by these managers. Thus they should be focusing on consequences arriving

from their decisions in a longer than annual period. The useful demonstrations of value driver

handling containing in this project can be beneficial to them as guidance in decision making. On the

other hand, shareholders’ benefit for shareholders from this project can be seen in helping to

understand and appreciate the ‘real’ performance of their investment related to stock price. In

particular the shareholder approach to strategy will be investigated in this essay by seeking the

historical performance of selected companies and predicting companies’ capabilities to govern such

value drivers that may generate future net cash flow (NCF) and maximize the profit over the long

term. However, creating value is more than just an acceptance of value maximization as the

organizational objective. This is the corporate scorecard that managers use to assess a success or

failure of the company. It must, in any case, be complemented by a corporate vision and strategy.

This project is based on the researcher’s conviction that an organization can only maximize value if

its managers do not ignore the interest of its shareholders.

10

Like the rest of us, corporate managers have many personal goals and ambitions, only

one of which is to get rich. The way they try to run their companies reflects these

personal goals. Shareholders in contrast, deprived of the pleasures of running the

company, only care about getting rich from the stock they own. Hence, when managers

ignore profits to keep up traditional lines of business, conflicts are bound to arise. Where

other checks on management failed, hostile takeovers could now wrest control from

managers who ignored the interests of their shareholders. More so than ever before, fear

of such disciplinary takeovers has forced managers to listen to shareholder wishes.

Ironically, making acquisitions is often just the quickest and easiest way for managers to

expand the scope of their control by directing the firm’s cash flows into new ventures.

Shleifer and Vishny (1988, p. 7)

This dissertation provides the clarification what is the proper link is between value drivers related to

the value added and how to deal with them to maximize shareholder value in an efficient way. This

is done through proposals of strategic options designed by researcher and via the value-based

management (VBM) aiming to achieve a maximal shareholder value. This framework will allow

managers to understand how their activities are directly linked to company’s cash flows and how

these cash flows, in turn, determine the long term value of the company appreciated by investors.

VBM combines financial and strategic management techniques to create sustainable competitive

advantage based on corporate capabilities and consistent ‘value culture’ with singular focus on

value. The ‘know-how’ acquired from dissertation findings can be useful in making future decisions

related to the proposed strategy options and in comparative analyses of value indicators. The

solution leading to an investors’ satisfaction should be in encouraging of managers to find the best

VBM by using measures of the value drivers effectively and by an ability to foresee those drivers

that will affect the future business operations and value anticipation.

Many companies now acclaim the virtues of maximizing shareholder value in their

mission statements, annual reports, and investor communications but fail to fully exploit

the potential wealth creation from a value-based perspective. Many fail to see any direct

connection between their businesses. Understanding the relationship between strategy,

finance, and company value is the key to making consistent value-enhancing decisions.

Morin and Jarrell ( 2001)

11

Nevertheless, the main challenger is a ‘stakeholder theory’, which argues that a corporation exists

for benefit not only investors but all its major constituencies—employees, customers, suppliers, the

local community, and the government, as well as shareholders. The success of a corporation under

VBM could be assessed simply by its long-run return to shareholders, whereas under stakeholder

theory a company's success would be judged by taking into account of its contributions to all its

stakeholders (Wallace, 2005). Various measures of corporate success in satisfying non-investor

stakeholders can be investigated by future research as an extension to this dissertation as well as an

investigation whether a broader focus on multiple stakeholders is necessarily inconsistent with the

pursuit of long-term shareholder value. Cassidy reminds that in order to rebuild the trust of the

individual shareholders, employees, and the public, corporations must focus less on maximizing

shareholder value in the short-term and more on optimizing shareholder value through building

strong relationships with all the stakeholders avoiding to sacrifice them. The critical relationships

with employees, customers, suppliers and the community involved in its business will only destroy

the long-term shareholder value (2003). Also, this work may be a complementary work to a previous

study "Corporate governance, managerial strategies and shareholder wealth maximization: a study

of large European companies" undertaken by Dockey and Herbert, who refer to research on

managerial attitudes for maximizing shareholder value and pressures to align the interests of

directors and shareholders. It reports a survey of executives in 175 large firms in seven EU countries

and it analyses their strategies (2000).

2. THEORETICAL UNDERPINNING:

Grant states that business is about creating value that can be created by the physical transformation

of products and commerce creates value by repositioning them in space and time. He also explains

that the difference between value of a firm’s output and the cost of its inputs is value added which is

then distributed among stakeholders - owners, lenders, employees, government (2002). This is the

first issue, with which a successful management will have to deal in order to balance the interest of

the different stakeholders. The stakeholder approach, which tries to balance often conflicting

interests of multiple groups, can be found, for example, in continental Europe (Germany, France).

This approach sees the firm as a social institution. However, in Anglo-Saxon countries (UK, US) the

shareholder approach prevails differing in companies’ legal obligations – management is required to

act exclusively in the interest of company’s owners.

2.1. Two Concepts: Profit Maximization vs. Value Maximization

Firstly, a clear explanations of the shareholder value (SV) concept, value creation mechanism and

especially a fundamental difference between two distinctive strategies pursued by managers

12

(maximizing profitability under earnings-based management and maximizing shareholder value

implemented by value-based managerial approach) is necessary. Value-based management is

founded on the assumption that investors value shares according to the strategy of the firm, its

organizational capabilities and its financial functions (Arnold, 2008). The share price starts to rise as

investors perceive a greater shareholder value focus. Hence the primary objective should be long-

term value maximization (consequently leading to shareholder wealth maximization), focusing on

identifying growth opportunities and building competitive advantage. (Doyle, 2000). It should be

pointed out that shareholders are interested in the flow of dividends over a long time horizon and not

necessarily in a quick payback. Retaining profit within the business invested in firm’s development

via, for example R&D programme, will produce higher dividends associated with a long-term

perspective. In contrast the short-term attitude of maximizing profitability is aimed at cutting costs

and reducing assets to produce quick improvements in earnings, which fails to invest and erodes a

company’s long-term competitiveness and destroys its economic value (2000).

2.2. International Diversities in Setting the Company’s Goal:

The key role of an effective management is to balance the interest of different groups involved in a

business. According to the stakeholder approach the goal of a firm should be based on the

recognition that the company pursues the interest of multiple parties. In some countries such as

Japan, France, or Germany, the notion of corporations balancing the multiple interests has a long

tradition (Grant, 2002). The differences between stakeholder view and the shareholder approach are

reflected in international issues and firms’ legal obligations. Grand further demonstrates that

executives in UK or US are required to act in the interest of shareholders, French boards are required

to pursue the national interest, and successful German managers are required to include

representatives of main parties, shareholders and employees (38). Wheeler argues two forms of

power sharing developed in North American and European board rooms. The first is the growth of

non-executive directorship ensuring the accountability of the executive to the investors. The second

form of formal power sharing, according to Wheeler, inclines the balance away from the shareholder

control model through the development of supervisory councils – most notably in Germany. The

continental European Supervisory Council model is made more powerful by including not only

representatives of workers and trade unions, but also the banks. In Scandinavian corporations there

will be a unitary board rather than a separation of executive and supervisory functions where

directors sit on boards alongside nonexecutives from outside the company (1997).

2.3. Earnings-Based Management

The ambiguity of the maximizing-accounting-profit concept is apparent immediately after a

consideration of what kind of profit should be used in calculations, and how it is to be measured – to

13

maximize total profit, margin on sales (profit as a ratio), return on assets, or return on equity.

Ranking of companies by performance depends on how profitability is measured. The goal to

maximize total profit may encourage investment in activities that are profitable but returns usually

fall below the cost of capital (Grant). Maximizing the rate of profit, on the other hand, encourages a

reduction of assets focusing only on a few profitable activities. A company must also consider

several issues before profit can be measured with regards to which items it expenses and which it

capitalizes, the depreciation methods uses, how it values its assets, and how it deals with

extraordinary items (2002). Arnold cites that reasons why accounting profit may not represent the

shareholder wealth and why it cannot be a sufficient benchmark for comparative analyses. He argues

that the profit figures fail to reflect the potential of the firm and that stock market will give a higher

share value to the company which will show the greater future growth outlook. A company’s

prospect must be at the forefront of managerial decisions over short-term approaches causing

sacrificed long-term prospect. Organizations may report identical historic profit figures, although

they can have both different future prospects anticipated through share price and the same

accounting returns. A company’s performance can indicate the volatile profit figures which are

subject to much greater risk than steady returns. Investors are likely to value the firm with stable

income flows more highly than volatile one (2008). A big issue is, according to Arnold, that earnings

are arbitrary and easily manipulated by management and thereby profit can vary depending on

multitude of judgements resulting in completely different ‘bottom line’ figures. These results then

provide distorted views of the potential of the firm. For instance earning per share as an indicator of

success fails since the investment needed to generate the growth is excluded from the calculation.

The additional debtors and inventory are included as an asset in the balance sheet yet not as a cost in

the profit and loss account. The time value of money is also excluded from the calculation and even

growth in earnings can destroy the value if the rate of return earned on additional investment is less

than the required rate. Managers should not forget that money has a opportunity cost and that

investors will always value shares by the estimation of discounted cash flows. What shareholders

want is a return greater than the return available elsewhere for the same level of risk (2008). Focus

entirely on earnings fails because of another aspect - a risk that is ignored in calculations. Some

business activities that generate growth in earnings are subject to higher level of risk requiring a

higher discount rate. For investors these risky strategies are worth less than safe ones (less-earning

based). The Financial Time’s Lex column interpreted a view about the measure of earning per share

(EPS):

“ EPS is the main valuation yardstick used by investors……but EPS is not a holy grail in

determining how well a company is performing….it is because EPS growth says little about

14

whether a company is investing well and managing its assets effectively….but unless the

return on investment exceeds the cost of capital, a company will be destroying value”.

Financial Times (1996, Lex column)

The column has also expressed the major problem with using return on capital employed within

metrics of performance when the profit figure are combined with balance sheet asset figures:

“The figures for return on capital employed that can be derived from a company’s

accounts are virtually useless. Here the biggest problem is not so much the reported

operating profit as the figures for capital employed contained in the balance sheet. Not

only are assets typically booked at historic cost, meaning they can be undervalued if

inflation has been high since they were acquired; the capital employed is also often

deflated by write offs.

Financial Times (1996, Lex column)

A further problem, according to Arnold, is the way of capitalization, when an item of expenditure

(for instance spending on R&D) can be written off against profit as an expense or taken on to the

balance sheet and capitalised as an asset. Finally, he has concluded that it is not true that

shareholders do focus on EPS because they are primarily interested in the long-term cash flows

returns in the future (2008, 632). He also stated that over two-thirds of the value of a company’s

share is determined by income to be received in a couple years hence and he even stated that many

of the quoted companies are not expecting any positive earnings in the next a few years yet they are

highly valued in the market (634). If investors examine the cash flow they are able to recognize

whether shareholder value is created. Doyle says: “Profits are an opinion, cash is a fact” (2000, 26).

He continues that none of the manipulations and adjustments made in accountant procedures has any

effect on the company’s cash flow or economic value, which is the discounted value of the

anticipated cash flows. Shareholder value, therefore, will increase only if return on investment will

exceed the cost of capital used in the discounted process (2000). Unfortunately, despite this,

managers still erroneously believe that if they focus on enhancing return on investment (ROI) and

return on equity (ROE) the share price will automatically increase its value. Nevertheless, it is wrong

to concentrate exclusively on profits producing a short-term view ignoring the future implications in

sense of boosting current earnings. This approach will consequently erode market share, future

earnings and the company’s prospect entirely. Finally, this managerial attitude finally discourages

growth-oriented strategies that may increase long-term competitiveness. ROA is not correlated with

value and ROE has yet another one problem when it is calculated as the proportion of assets

financed by debt rather than equity (28). Managers are familiar more with accounting earnings since

15

they are easy to calculate, however all valuation measures based on earnings data (EPS, P-E,

margins) and performance standards (ROCE, ROA, ROE) have fundamental weaknesses, according

to Doyle. Their measurement is then subjective and conceptually inappropriate because they do not

measure changes in value taking in the account results from past activities. Value changes are

principally based on future activities with predicted cash flows.

2.3.1. Shareholder Value Approach and SVA

When a company pursues a strategy that will build a sustainable competitive advantage, the

investors will appreciate it and the firm’s value will rise. The stock market value of corporation’s

shares is based on investors’ expectations of the cash generating abilities and a judgement on the

expected financial performance is reflected on its market-to-book ratio (MBR). This ratio measures

how successful management has been in maximizing shareholder value. Value is created when the

market value of the shares exceeds its book value stated in the balance sheet. Doyle explains that the

main determinant of market value is the ability of managing profitable investment opportunities

(2000). When a weak MBR indicates a ‘value gap’ (difference between the appreciated value and

current value) the existing management is not doing well and requires alteration. Lowell suggests

that companies can be categorized into four groups: the vulnerable group (with small amounts of

financial capital and generating low returns), the complete control group (generating high returns

and with high market shares), the group with limited control through performance (high returns from

relatively small amounts of invested capital), and the group with limited control through size (large

companies producing low returns on capital, but difficult to acquire) (1998). Shareholder value

analyses (SVAs) allow the determination of which strategy is more likely to increase the market

capitalization and help explore where a particular strategy lies on the strategic vulnerability map.

The issue is whether a planned strategy moves the firm towards the area of ‘complete control’ or

increased ‘vulnerability’. SVAs are becoming the new standard as opposed to a short-term view of

accountant-based management encouraging an under-investment, and ignoring intangible assets. It

provides an effective tool for investigating shareholder value added from given value drivers:

growth, profit margin and investment. The core of SVA is the principle that economic value is

created purely when operations earn a return on investment that exceeds its cost of capital (Doyle,

2000). SVA is future oriented with a tendency to encourage the long-term effects of investment

projections. Maximization of shareholder value means maximization of future net cash flow and

minimization of cost of capital. Discounting reflects that money has a time value and also allows for

risk that is reflected in the cost of capital. The current share price reflects both the values derived

from past decisions (profit in time before plan period) and shareholders’ expectations (predicted cash

flow from future activities). Grant said that the key merit of the shareholder value approach is its

consistency (2002, 48).

16

2.3.2. Principles of Valuation

Most companies pay only a fraction of net profits (or none) in dividends. According to Grant,

shareholders are concerned more with the total return on their share (dividends plus stock market

valuation). The major part of shareholder return is the appreciation on the market value of those

shares. Hence, shareholders are more interested in maximizing the stock market value than in annual

payment of dividends (2002, 44). The shareholder return provides an indicator of the success of the

management effort in increasing the discounted cash flow and valuation is strongly influenced by

perceptions, ‘market psychology’ and market dynamics. ROCE (or alternative ROA, ROI) remains

the predominant measure of the past performance and cash flow rather than profit being the relevant

performance measure. Valuing companies by discounting economic profit, in practice, should give

the same result as by discounting net cash flow. The difference only consists of the treatment of the

capital consumed (seen in economic profit calculation presented in Appendix 3). Discounting cash

flow methods are the most satisfactory approach to pursuing shareholder value maximization,

although expected cash flow far into the future may be difficult to estimate for inexperienced

managers. The most feasible approach is to recognize and understand the factors that determine a

firm’s future cash flow in order to select the strategy that offers the best prospect of maximizing

shareholder wealth (Grant, 2002). The central concept of valuation of companies, according to

Doyle, is in the determination of a company’s share price as the sum of all its anticipated future cash

flows, adjusted by the cost of capital. If generating more cash is expected due, for example, to a new

growth strategy, its share price will increase. Doyle remains that the crucial task of management is to

maximize the sum of these future cash flows for generating new assets. The cost of capital is the rate

of return expected to be received by investors if they invested elsewhere in assets of similar risk

(2000). The sum of the cash flows discounted by cost of capital is called present value (PV) which is

calculated as:

PV(DCF) =∑ Ct / (1+r)t …………t – years within cash flow occurs (33)

r – discount rate

Ct – expected cash flow occurring in particular year

The net present value (NPV) is the present value (PV) plus the initial investment (C o) to acquire the

asset and is usually negative because it is cash out.

NPV=Co + ∑ Ct / (1+r)t (33)

17

Doyle has also explained why the cash flows are discounted. There are two reasons: first, cash today

is worth more than tomorrow, and second, more risky returns are penalised by a higher discount rate.

He concludes that investors should only invest in assets with positive NPV and that investors’

anticipation of cash flow will be mainly based on their views on the effectiveness of the future

strategies. The shareholders return comes normally in two forms, first as dividend payment (DIV)

and second, as value of share appreciated. The share price (Po) is essentially the discounted value of

forecast dividends, and dividends per share are the same as cash flow per share. Therefore it may be

possible to value shares by using forecast of per share revenues, costs and investments:

Po=∑DIVt / (1+r) t = ∑ (CF per share) t / (1+r) t (36)

This formula calculates implied share value (if the actual share price is below the implied value than

the ‘buy’ recommendation should be made). This demonstrates that stock market is not short-term

oriented since the value of shares is determined by forecasting dividends, and short-term earnings do

not have much impact on the share price (Doyle, 2000). However, a failure in delivering the

expected earnings may lead investors to reconsider their long-term forecast of company’s prospect,

hence short-term earnings are an important source of information for investors, but shareholder value

is not determined by it. The total value is called enterprise value and consists of both shareholders’

debt and shareholder value (equity):

Enterprise value (EV) = Debt + Shareholder Value (37)

The valuation of enterprise value is divided into two parts: valuation within a forecast period where

the predicted cash flows from operations are discounted to the PV, and a calculation of the

continuing value where the PV of cash flows generated after the planning period must be derived.

The investment, as a third component, may be also added to the enterprise value. Doyle explains that

cash inflows are a function of sales and the operating profit margin. On the other hand, cash

outflows are a function of taxes and additional investments on incremental sales that will inevitably

be required by the growth strategy. The management should estimate an additional working capital

(debtor, cash, stock less creditors) and capital expenditures (fixed capital investment) as a percentage

of sales that will grow in the future activities. The continuing value can be estimated via the

perpetuity method, assuming that after the planning period competition will force the return down to

the cost of capital with the implication that further investments do not change its value (2000). As a

result the cash flow generated after the forecast period will be treated as an infinitive stream of

identical CF.

18

Continuing value (CV) = NOPAT / Cost of Capital (42)

Then the enterprise value:

Enterprise value = ∑ CF t / (1+r)t + CV t / (1+r)t (41)

An alternative method of valuation, according to Doyle, is the market-to-book ratio (M/B)

measurement where a value is given by multiplying the projected book value of assets by an average

M/B ratio for similar companies. Nevertheless, this method is criticized since the book value is a

poor measure of the company’s real value (2000). However, the perpetuity value calculation depends

on judgement and alternative methods enable testing the validity of more scientific methods of

valuation.

The continuing value figure is a very significant element of company’s value in SVA since it is

the largest part of a company’s total value, especially for growing businesses with only little profit in

the early years. They absorb cash flow rather than generate it by aggressive strategies, but they are

creating enormous value, which is reflected in the high figure for the continuing value and share

price. In contrast, mature businesses create high profits and levels of cash flow within the planning

period, where management is more concerned with reducing costs, working capital expenditure and

fixed investment. Its continuing value will then be than only a small proportion of the entire

company’s value, recognizing that the future competitive position will not be strong with a relevant

investors’ appreciation (Doyle, 2000).

2.3.3. Financial Value Drivers

The value-based management starts with establishing a primary financial goal to increase the

economic value and the recognition that free cash flow and economic profit are better indicators of

the firm’s efforts to create shareholder value than accounting profit. The basis for strategy

formulation and the first step in applying a suitable strategy to pursue the shareholder-oriented

mission is to identify the financial value drivers that will determine the estimated cash flow

associated with the strategy (Doyle). Also, if the business performance is unsatisfactory the sources

of poor results need to be diagnosed, focusing on the fundamental value drivers. The financial

drivers are the objectives of the business and achieving growth depends largely on the strategy of

how to manage four key financial factors: level of cash flow, timing of cash flow, sustainability of

cash flow and risk of future cash flow (2000, 48). There are three key financial drivers that

executives need to manage: sales growth, operating profit after tax and investment requirements.

This is important to realize that in achieving faster sales growth, higher profit margin and good

19

investment we need to manage all financial drivers, marketing drivers, and organizational drivers

(core capabilities) need to be managed. This is essential to gain a required financial performance

(FIGURE 1).

Figure 1: Drivers of Value (Source: Doyle, 2000, p.38)

The most fundamental determinant of SV, anticipated level of cash flow, is generated through sales

growth, which is used to calculate additional cash flow by subtracting it by additional cost and

investment:

Additional CF = Sales Growth – Added (Costs+ Investment) (48)

Therefore, increasing cash flow without sales growth by cutting costs and investment is possible in

the short run, but, as Doyle explains, it leads to a decline in cash flow in the consequent years.

Improving net operation profit margin (NOPAT) has a positive impact on SV and there are three

ways how it can be improved: first, through higher prices applied without loosing significant

volume; second, cost reduction through a more effective use of resources or reengineering, and third,

a volume growth improving the operating margin since overhead costs do not increase

proportionately (49). Although reducing investment produces sharp increase in cash flow in the

short-term, in the long-term it could be very counterproductive. Namely, investments namely may

Financial Value Drivers

SHAREHOLDER VALUE(Capital growth and dividends)

Sales growth

Operating margin

Investment Risk

Duration

Timing

Level of CF

20

increase the long-run growth and the level of NPV of the cash flow, which creates the shareholder

value in future. Nevertheless, executives have to avoid wasteful investment that could be value

destroying equally as the avoidance to invest sufficiently in profitable opportunities. Therefore, it is

useful to calculate the Threshold margin (TM) evaluating the relationship between the three drivers

of cash flow. It is the minimum pre-tax profit margin on additional sales that is necessary to finance

value-creating growth.

TM = (Incr. Investment Rate) x (WACC) / (1 + WACC) x (1-Tax Rate) (51)

The key rule is if the actual operating margin on the additional growth exceeds the TM, the growth

will add value for shareholders. The higher incremental capital invested for financing growth, the

higher the cost of capital, the higher the tax rate and the higher the minimum operating margin which

is required on additional sales (102). The difference between actual margin and TM is Threshold

Spread (TS). Investors give extraordinary high valuations to high-growth companies. Nevertheless,

they have to be aware of excessive investment and negative sales-earning Threshold Spread, which

would be value destroying. TM is in any case a key determinant of value creation.

SVA = (Incr. Sales in period t) x (TS in t) x (1-Tax Rate) / (WACC) x (1+WACC) t-1 (52)

Timing is also crucial to manage since the faster high positive cash flow occurs the greater the

shareholder value. It can be achieved, for example, by faster a new product development, or an

acceleration of market penetration. Sustainability of cash flow means that the more lasting the CFs

are, the greater value is created. Investors’ appreciation attributes to the continuing value of the firm.

It depends upon their perception of sustainability of the company’s differential advantage and its

ability to innovate. The last factor, riskiness attached to the future CFs, is seen as a difficult

prediction of the cash flow because of the volatility and vulnerability which are penalised by a

higher discount rate (52). Therefore, growth can also create SV by reducing the volatility of cash

flow and so cutting the cost of capital based upon a growing score of satisfied customers (103).

2.3.4. The Growth Strategy

The primary determinant of future cash flow is profitable sales hence growth has a clear effect on the

SV in terms of long-term perspectives (Doyle, 2000). In spite of this, some managers still believe

that there is an alternative to market growth strategy for a value enhancement. They frequently apply

a strategy of rationalization focusing on cutting costs, reducing working capital, rising prices and

divestment. They are often motivated by managerial incentives subjected to short-term targets.

Unfortunately rationalization and growth strategies have different impacts on future cash flow.

21

Cutting either costs or investments immediately affects increases in profit and cash flow. In

contrast, building a profitable growth is costly in present time and usually takes years before the

positive outcomes. Doyle adds that it is easy to implement the rationalisation strategy since it is

about reconfiguring the firm’s internal resources, and because this strategy can be directed from the

top. On the other hand, a success in the growth strategy is determined externally due to the need to

convince customers of its superior value as opposed to the competitors, reinforcing of loyalty and

developing new businesses via new distribution channels or extensions to international markets. This

requires having necessary capabilities for the creation of competitive advantage and investing in

product, skill, marketing etc. [FIGURE 2]. Management should take into consideration growth

opportunities that match its organizational capabilities and the firm’s unique competencies. Thus

having identified the sources of poor performance that might destroy shareholder wealth they should

look into the changes in market positioning, resource deployment, and operational policies (Grant,

2002). Rationalization sacrifices long-term investment for shot-term improvements in profitability

and cash flow. However, Doyle maintains that, if sales are declining, no amount of cost cutting or

price increases will prevent a decline in the future cash flow (2000, 107).

Figure 2: Two Routes to Value Creation (Source: Doyle, 2000, p.106)

2.3.5. Capabilities as the Sources for Creation Value

Grant cites that the value added is derived from two sources: from location within an attractive

industry and from competitive advantage over rivals that the company possesses. Due to

internationalization deregulation and other forces, the competitive pressure has been increased hence

development and deployment of resources and capabilities have become the most important goal for

Rationalise

Creatingshareholdervalue

Growth

Cut costsCut investment

Cut costs

New productsNew customers New

businesses

22

strategy-following value-based approach. He regards the resource-based view as emphasising the

uniqueness of each company, suggesting that the key to success is through doing rather through

exploiting differences and unique capabilities (2002). Unfortunately, the balance sheet provides only

a limited view of a firm’s resources and it is focused merely on financial and physical resources.

Further, he emphasises that resource analysis is not simply the valuation of a company’s assets

recorded in balance sheet, since intangible assets are undervalued or even excluded. This

circumstance is a major reason for the large difference between balance sheet valuations (‘book

value’) and stock market valuation (‘market value’). Nevertheless, the key, according to Grant, is not

only the identification of unique resources but also leveraging its resources into capabilities. “Why

has Sonny, with a much smaller research budget than Philips, produced so many more successful

innovations?”(2002, 151). Finally, he concludes that a successful company has recognized what it

can do well and has its strategy based on it. “One reason for lack of success is not an absence of

distinctive capabilities, but a failure to recognize what they are and to design strategy to use them

most effectively” (161). The main concern is to reveal a resources’ potential to establish sustainable

competitive advantage. The appraisal of company’s capabilities twill then provide the basis for

reconsidering of the strategy aiming to maximize the shareholder value via deployment and use its

strength to its maximum advantage. Managers should be encouraged to focus on a company’s major

strengths in resources and avoid the risk included in calculation of cost of capital. The key to

creating value, according to Grant, is the ability to share company’s resources and transfer

capabilities more efficiently, where the additional costs do not outweigh the value created (451). He

explains that growth is usually pursued by managers at the expense of profitability since the

company size is more closely linked with management bonuses than profitability (453). It implicates

a tendency to invest at a greater rate than is consistent with a shareholder value, because such

overinvestment reduces the associated market value. Risk reduction is the second purpose of the

diversification strategy that avoids cyclical fluctuations of profits, leading to stability in the cash

flow and it may reinforce independence from external capital markets. Hence financing investment

internally is better than resourcing to external capital markets. Grant finally evaluated diversification

as a strategy that is likely to destroy rather than create shareholder value because of the divergence

between managerial and shareholder goals. Due to many competitors appearing within industry and

the internationalisation of businesses it exerts the pressure for cost reduction, divesting poorly

performing assets, organizational changes to eliminate inefficiencies and applying rigorous financial

targets and control. Managers need to look behind the cost accounting data and be able to identify

cost drivers for each firm’s activity, seek opportunities for innovation, and exploit new sources of

dynamic efficiency (2002, 337).

2.3.6. Growth-Setting Objectives

23

The planning process must start with growth-objectives settings especially margin improvements

achieving higher productivity, incremental investments to support sales growth, and the level of

sales growth. Managers should understand that the growth of the equity value depends on strategies

to improve present value of future cash flows. Arnold discuses the objectives, such as maximum

sales, market share and customer service excellence, and concludes that these are not the company’s

true objectives although they are important in helping to achieve the maximum of shareholder

wealth. He states that only the goal of maximizing discounted future cash flow creating shareholder

value is a company’s actual objective (2008, 649). Each project appraisal should be carried out using

discounted cash flow techniques and budgeting should not rely solely on accounting background but

it should have value-based metrics a enabling view from ‘other perspectives’. Strategic analysis,

Arnold cites, is having three steps: the first step is a strategic assessment of external environment

and internal resources to find the key influences on the value-creating potential. Also, as Arnold

adds, there are also three strategic determinants of value creation that have to be identified: industry

attractiveness, the strength of unique resources and life-cycle stages of value potential responsible

for the longevity of the competitive advantage. The second step of strategic analysis is the strategic

choices after strategic options are developed, based on cash flow valuation methods. The objective

is, according to Arnold, to find a competitive advantage within attractive markets yielding positive

performance spreads. Finally, as Arnold concludes, the third step is strategic implementation.

2.3.7. Value-Creation Metrics

Executives need to know how value drivers should be managed for creating growth and long-term

success and how to establish strategy for future actions aiming to increase an enterprise’s value. The

reliable measures of value need to be used in order to be able to consider projected alternatives such

as the optimal levels of working capital investment, or percentage of targeted margins. The metrics

quantify the plan, desired targets and incentives to encourage high performance and also they are

used in the judgement of valuation processes of the entire firm. There are three basic value-creation

metrics, according to Arnold: discounted cash flow method (DCF) to measure value, Rappaport’s

shareholder value analysis (SVA) for strategy valuation and performance targeting, and the

measurement of economic profit, which enables managers to review a firm’s performance (2008).

They are all based on estimated cash flows discounted by opportunity cost of capital. For instance,

the value of an investment-encouraging sales growth is related to the sum of cash flow discounted to

its present value. If this investment, for example used for promoting sales growth, produces a rate of

return greater than the finance provider’s cost of capital then value added exists. In the calculations

there are forecasted profit figures estimated based on both the firm’s historical performance and its

capability to exploit its resources. Also the number of adjustments are included amending the cash

flow figures. We need to know how to extract the net (free) cash flow figures (NCF). They represent

24

the amount which is available to pay out to the company’s stakeholders without affecting any future

operating cash flow (2008). When an item is depreciated profit is reduced but no cash is lost. Hence

to move toward to cash flow we have to add depreciation that was deducted in the calculation of the

future profit figures. Also the accountant does not recognize in profit figures the cash expenditure

when inventory or debtors are increased. The analyst of cash flow identifies cash being used for

these items and can amend the profit figures when deriving the cash flows figures. Similarly, the

cash flow analyst needs to make adjustments in the cases where the supplier sends input goods for

payment on ‘cash on delivery terms’ or ‘credit terms’. The accountant treats this as an expense and

deducts it from the profit and loss account in the year of delivery. The adjustment must be made by

cash flow analysts since the amount of expense may not yet have been paid out in cash yet. We also

need to return back the interest charged to profit since the discount rate already includes an

allowance for return to lenders (670). The total of discounted cash flows represents a value of a firm,

and managers can be judged on the basis of performance targets embodied in cash flow terms.

During strategy valuation the current strategy expressed in the value term could be compared with

new alternatives embracing different predicted value drivers or marketing schemes.

Rappaport has established a basic concept of a simplifying method of shareholder-value

analysis. It assumes a relatively smooth change in the various factors correlated with the cash flow

float and with the sales level. He introduced seven key factors that determine value as follows: sales

growth rate, operating profit margin, tax rate, fixed capital investment, working capital investment,

the forecast horizon and the required rate of return (1998). He calls them value drivers and he

assumes that both have a constant percentage rate of growth in sales and the same percentage of

profit margin. Fixed capital and working capital investments are related to the additional sales and

these are called the incremental (additional) investment. Thus free cash flow, as Arnold defines, is

the operating cash flow after both incremental fixed and incremental working capital investment,

coming from the operations and it excludes cash flows arising from the sales of shares and payments

of dividends (FIGURE 3). Nevertheless, the disadvantage of using SVA lies in simplified

assumptions that may lack realism (2008, 682).

Figure 3: Rappaport’s Free Cash Flow (Source: Arnold, 2008, p.677)

25

Nevertheless, Doyle quotes that the SVA is superior to conventional accounting approaches in that it

avoids the short-termism in targeting earnings and not focusing to a book value. On the other hand,

managers need to be aware of the assumptions and approximations correlated with forecasts of

prospective cash flows depending on the right judgement, and appraising the weighted average cost

of debt and equity. This is not particularly easy to do since it depends on the estimation of business

risk exposure and the amount of debt. However, SVA becomes the most effective method for

evidencing effectiveness of a company’s strategy as well as for evaluating alternative repositioning

strategies (2000, 66).

2.3.8. Value Management

Arnold also discusses third value driver stating that the value is created when an investment

produces a rate of return greater than required for the time of money and, where the level of risk is

linked to the business activities. According to him, shareholder value is driven, according to him, by

four factors: the first is the amount of capital invested; the second is the actual rate of return; the

third is the required rate of return; and the last one is the planning period. The difference between the

actual rate and the requested rate of return is called the performance spread and is measured as the

percentage spread above or below the required rate of return.

Annual Value Creation = Investment x (Actual Return % – Required Return %) (635)

Value destruction occurs when the performance spread becomes negative and indicates the necessity

to take an action to prevent the incurred losses. Otherwise, bad growth arises if the focus is purely on

sales and earnings growth (operations do not produce a return sufficient to justify its additional

investment) - FIGURE 4

Figure 4: Options opened to managers (Source: Arnold, 2008, p.637)

Operating costsSALES

Tax

Incr. investment in FC

Incr. investment in WC Free CFfrom

operations

less

Operating profit

26

The incremental investment to the business is a crucial value driver necessary for initiating sales

growth. Arnold notices that at the corporate level the knowledge of potential good and bad growth

investment can assist in an appropriate allocation of resources and a selection of portfolio of

businesses helping to find out which unit becomes a value destroyer due to its negative return spread

occurred by overinvestment (or bad investment). Finally, he introduces five modes of action

available to enhance the corporate value: the first is to increase the return on existing capital by

improving the efficiency of the operations. The second is raising investments in a unit, which

performs a positive spread. For the third action, Arnold suggests to divest assets of units showing

negative spread and thereby to release capital for more productive operations. Also, there is a

possibility, as the fourth action, to extend the planning horizon over a longer period than expected.

The last action can be applied through reducing business risk lowering the required rate of return

(even by shifting to a higher proportion of debt). Arnold also observes that some companies are

financing its business entirely through its shareholders’ equity trying to reduce the risk and avoiding

financial distress. In the end, he concludes that managers can become too cautious and sacrifice the

opportunity of lowering the cost of capital by not using a higher proportion of cheaper debt finance.

3. METHODOLOGY:

3.1. Research Method

The aim of this study is to examine the trends in managerial approaches prevailing within industrial

companies and operating in the recession period we experience today. Taking into account the

shareholder wealth maximization the investigation was aimed to focus to find out how the key

financial drivers should be managed by executives, what impact they have on the company valuation

and what strategy options could be applied to maximize shareholder value added. Correlation

between value drivers and other various factors related to the company’s value and long-term

strategies has been showed on samples of selected enterprises. The historical data have been

Value creation Value opportunity forgone

Value destruction

Value creation

Positive performancespread

Negative performancespread

Growth

27

Shrink

obtained from the public corporate documentation, company reports, Financial Times business

newspaper and by accessing the London Stock Exchange website. However, the major source of

secondary data is provided from the FAME database available on the Teesside University’s network

containing comprehensive relevant information about past performances of UK-based organizations.

These and other empirical data have formed the basis of this project and been used to test the

linkages to the observable phenomena. Propositions have been made to assess relationships of

identified variables and commonalities within a predetermined sample size representing the entire

population of the interest. This research has been designed above all to test specific hypothesized

predictions using a hypothetico-deductive method, and mostly a scientific approach based on a

collection of facts and observable phenomena. However, strategic options proposed are based on

predicted financial drivers, which need to be evaluated and considered using a qualitative analysis. A

deductive approach to the relationship between theory and data relies on what is already known

about a particular field and after a consideration it deduces hypotheses which must be subjected to

empirical scrutiny (Bryman, 2007). Cooper explains that deduction is the process by which we test

whether the hypothesis is capable of explaining the fact. It is associated with a quantitative research

approach (2008). There is known presumption that financial value drivers are sensitive factors

affecting a company’s value and that they should be managed to achieve long-term benefits

appreciated by investors. There are the hypotheses which have been all subjected to testing through

large analyses provided by this study:

The hypothesis about the current trend of short-termism spread over many recent businesses

which operate within selected industry sector

The hypothesis that some businesses changes its strategies in order to offset their

performance declined due to recent adverse economic situation or increased competition

The hypothesis that current businesses do not invest efficiently to increase future cash flows

The hypothesis that some financial outcomes can be manipulated in order to impress

shareholders (‘Agency Theory’)

The hypothesis that some managers simply prefer the accounting-based measurement over

NCF methods

The hypothesis related to a need to keep balance in value driver management in order to

achieve the value enhancement

The hypothesis that too rigorous cost management will lead to a value destruction

The hypothesis which confirms investors’ anticipation of share price with a long-term

strategy options which encourage CF generating in the future regardless current profitability

28

In line with positivism, the researcher intended to produce a general implication that can be used to

predict certain circumstances avoiding unfavourable business outcomes in terms of shareholder

wealth and draw attention to the managers, who maintain and develop financial tools to create the

value added for shareholder benefit. Also, a case study has been included in the project, where more

extensive study of a single organization has been examined (Hamworthy Plc). This model has been

used not to generate theory but rather to test a theory to see if it occurs and applies in the current

business environment. A specific company’s policy and performance has been related to other

companies’ financial results by a simplification and generalization of some external and internal

business environments. The methodological pluralism has then been then included to combine

quantitative and qualitative techniques that will add credibility to the study by providing a cross-

checking tool - triangulation. According to Bryman, triangulation entails using more than one

method of source of data in a study, which improves the reliability and validity of the study (2007).

There is a multi-step process involved in this research, where the results obtained in the study

should help the researcher to logically deduce or conclude his findings. It stands for that researcher

having begun with the observation of broad a problem area to focus on real success of companies

and managerial manners in industrial business environment affected by a recession period. The large

literature review has been surveyed in the preliminary data collection stage to acquire a sufficient

background for a later theory formulation. Data, such as published records, have been provided to

having secondary data available and information to know more about what researcher observed.

Then the problem has been defined and explained with proposals how it can be solved. The next

step, the theory formulation, has been deducted from earlier stages and formed into the framework

how to find the correlations among the variables identified as important to the problem. From this

conceptual model the testable hypothesis has been developed to see whether the theory formulated is

valid. The hypotheses, such as that declining sales growth strongly affects a company’s created value

and thereby investors’ anticipation and that trend of short-term actions boosting profitability will

hugely destroy shareholder wealth, are derived from situations especially present in the recent

adverse environment. The hypothesized relationships have been tested through descriptive statistical

analysis - relationships of both the criterion variables and the predictor variables. Then the research

design needed to be done as well as sampling design, data collection and establishment of measure

methods and analysing techniques to test the hypotheses. Also, a questionnaire has been compiled to

survey attitudes and opinions of managers referred to the aspects associated with the company’s

value, an evaluation of performance and managerial trends. The data generated from the

administered survey has been used as primary supportive data. The phenomenalist element has been

implemented by interpreting and explaining the questionnaire’s responses and the findings have been

used to support or reject hypotheses resulted from quantitative analyses.

29

3.2. Research Design

This dissertation is designed as a descriptive study aiming to understand the characteristics of

variables and to describe relevant aspects of the phenomena of interest, when the characteristics (the

key value drivers) are known to exist and the researcher wanted to describe them better (Sekaran,

1992). This research is also a correlational study where shareholder value (a phenomenon of interest

to the shareholders) has been found to be sensitively influenced by such variables as sales growth,

operational profit margin and an incremental investment and even more factors and managerial

attitudes (100). There are three major stages in this study. The first stage is an exploration in which

hypotheses have been formulated, in the second stage data were collected, and the third stage is

analysing of results that are discussed and evaluated. ‘A research design is the strategy for a study

and the plan by which the strategy is to be carried out. It specifies the methods and procedures for

the collection, measurement, and analysis of data’ (Cooper, 2008, 156). The project has identified

important variables changing phenomenon (the value drivers), proved impact on this phenomenon (a

different valuation and decision making process) and tried to explain relationships among both these

variables and other ones. In seeking the reliable and representative results the researcher expected

both an identification of potential trends and a proving the hypotheses by using diverse models of

research methodology. Triangulation has been achieved by combining methods together via a variety

of approaches such as quantitative and qualitative techniques of data collection and by mixing of

explicatory method, concerning issues in the past in order to understand the present and predict the

future-making judgements based on findings (Jankowicz, 2005) and comparative case study method.

A case study method has been used when the researcher’s thesis has been focused on a set of issues

in a single organization (Hamworthy Plc.), and the factors involved in this base-case have been

identified. The investigated outcomes from the case study have been consequently compared with

relevant results and examined in analysis of other companies (ten selected companies). Although the

case study looks at only one example, it is essential that its context and background are described in

order to provide a full picture of the situation under investigation (White, 2002). In the case study

the researcher has achieved the results through a comparison of the company with others in a

systematic way, exploring different possible stances to the issues, or examining different levels of

the variables involved. In contrast from the historical review, a survey method (also used in the

study) derives most of its data from the present when a survey is conducted in order to establish

respondents’ views of what they think, believe, or value. The administered questionnaire has

surveyed opinions of managers about a particular aspect associated with the change.

3.3. Sample Design:

30

Jankovicz said that empirical work is only worth doing if the findings are organized in such a way

that they can be generalised and used by other companies. He defines the sample as a deliberate

choice of a number of units providing the researcher with data from which conclusions about some

larger group (population) can be drawn (2005, 202). The sample has been selected and designed to

be as truly representative as possible. Before the researcher has selected the sample the population of

interest has been defined, the sampling frame identified and also the sampling size determined

through appropriate sampling methods. The population of interest of this study is defined as all

middle and large-size companies from manufacturing industry sector listed on the stock market and

the sample frame has been compiled based on ‘SIC(2003)’ codes of FAME database (Bureau van

Dijk Electronic Publishing, database of listed companies available as university’s facilitates)-

http:// www.fame.bvdep.com/version-2010608/cgi/template.dll . The sampling frame includes 86,283

companies that have been derived from the database through fives codes related to the specific

manufacturing field of industry (SIC codes with first two numbers have been opted for: 28-

manufacturing of fabricated metal products, 29- manufacturing of machinery and equipment, 33-

manufacturing of precision and optical instruments, 34-manufacturing of motor vehicles and trailers,

35-manufacturing of other transport equipments). An accurate sampling frame is very important,

according to White (61) since it helps to reduce bias, and ensures that the used sample truly

represents the population from which it is taken. For the purpose to determine the sample size, a

non-probability sampling technique with purposive sampling method, has been used. Also, a ‘dual’

sampling technique has been applied when the researcher combined two samples sizes using

triangulation method. The first group of sample units has been designed to find out the companies’

values and proposing strategy options. For the comparative purpose ten enterprises under SIC Code

in FAME beginning 28xx, 29xx have been chosen. They represent a standard peer group of

companies operating in manufacture of fabricated metal products and manufacture of machinery and

equipment. As a selection criteria before the final determination of the sample units the researcher

had to opt for industry sector (28 code represents fabricated metal products, and 29 code represents

machinery and equipment), ‘active only’ status and ‘public quoted’ legal form criterion. After these

preferences 86 companies have been generated from the original 68, 520 - firm before search criteria

selection. This size served for an individual judgemental selection of the case study, ‘master’

company, and next 9 enterprises for comparative analysis. The second sampling method has been

decided for investigation in qualitative research via the questionnaire engaged in individual

managers’ attitudes in the handling of the current firms. A purposive homogeneous sampling, also

called judgemental sampling, has been used for a decision about the sample size. This method is

used, according to White (2002), when the researcher needs to examine one issue in detail, and then

search for samples that are more or less the same. The sample size decided for survey of managers’

views has been designed through the London Stock Exchange database published on actual official

31

website 30th April 2010 (http://www.londonstockexchange.com/exchange/prices-and-news/stocks). It

has indicated list of 2747 listed companies of all industry sectors. After selected the required criteria,

the ‘industrial engineering’ and the sub-sector ‘industrial machinery’, 57 companies have been

displayed. When sampling the researcher has decided to exclude for sampling corporations

performing market capitalization under £ 5 million and PSM companies (Professional Security

Market). Consequently, 49 enterprises generated from UK Main Market and AIM (Alternative

Investment Market) have been left as a sample size designed for purpose of the survey.

3.4. Questionnaire Design and Analysis Responses:

A fully structured e-mail questionnaire has been used in the project to test out hypotheses when a

content, question sequence and answer format have been determined in advance. The main

advantage of the e-mail questionnaire is, as Sekaran explains, that a wide geographical area can be

covered in the survey over a short time period (1992). Although sample units represent the

population of corporations listed on the UK market, they have mostly subsidiaries operating abroad

thus this technique of collection data is very suitable. However, it can be difficult to ensure

anonymity and another disadvantage can be found that any doubts the respondents might not be able

to be clarified. For improving the rate of responses a covering note has been enclosed, containing the

researcher’s name and the purpose of the questionnaire, a possible benefit to the respondent and a

brief description of the confidentiality and security arrangements. Also simple wording of the

questions and keeping the questionnaire as short as possible will help to increase return rates as well

as sequencing of questions where early questions have been simple, constructed with a high interest

value first (questions 1, 2 in questionnaire). More technical questions succeeded in the middle

(questions 3, 4) demanding for higher expertise and the last two questions (questions 5, 6) have

again had a high interest value. The inquiries have been designed as semi-closed type questions

helping to respondents to make a quick decision by making a choice among the given alternatives in

multiple-choice format where respondents have been asked to choose a single alternative from a list

of four which have been provided in each question (Jankowicz, 2005). The suggested ‘other, please

specify’ option has been added as an opportunity to make additional comments. The simple

instruction how to complete the questionnaire has been provided for the respondent starts the reading

of questions (an explanation: insert marks “x” to grey boxes). The questionnaire and its analysis

have been included in the Appendix 4. The ethical goal of in this research is to guarantee that no

participant is harmed or suffers adverse consequences from research activities. Cooper identified

several ethical considerations to be balanced: to protect the rights of the participant, to follow

ethical standards when designing research, to protect the safety of the researcher and team and to

32

ensure the research team follows the design (2008, 51). This research is designed so that the

participant (respondent in questionnaire) does not suffer discomfort, embarrassment, or loss of

privacy. The researcher will progress according to ‘UK Data Protection Act 1998 Chapter 29’.

According to Bryman, reliability of measurement refers to the consistency of measures. Therefore,

for example questions designed in the questionnaire, should be clear with no ambiguity, so that the

respondent immediately recognises the researcher’s intention. The researcher was also concerned

with the maximum possibility to generalize the findings, so that the sample would be as

representative as possible (2007).

The measurement of the variables and the analysis of its findings to test the hypotheses have

been done through a descriptive statistical analysis. Each research question has been subjected to its

own analysis when a relationship among variables has been described, and decision making criteria

have been stated. Both the criterion variables (dependent) and the predictor variables (independent),

which influence the dependent variables, have been introduced in the analysis as well as the

preliminary analytical steps of editing and coding. Coding is the technical procedure, by which data

are transformed into symbols that are often numerals, because they can be tabulated and counted

more easily. The information extracted from the questionnaire in form of ticks in boxes has been

transposed into numbers. Each set of the six questions contains four plus one alternatives from which

only one option purely matches with shareholder value approach. The numerical symbol 1 is

allocated to the ‘hidden right option’ whereas other alternatives indicate a zero code (obviously it is

not visible to the respondents). After respondent provided his/her opinions through marking

applicable preferences (x into box), the simple tabulation has been created with a single variable and

the distribution of feedback has been visualized through a histogram and frequency polygon. This

quantitative analysis has been combined with qualitative technique where all opinions replied in the

questionnaire have been surveyed and explained regarding to diverse approaches used in replied

answers.

3.5. Statistical Analysis of Data

Descriptive statistics involve describing and displaying numerical results in the form of tables

and diagrams. Arithmetical calculations are also a part of the examination of selected companies

when both the shareholder value added and the economic profit have been computed. Statistical data

processing helps to convert numerical data into tables and graphs, which have been numbered in an

appropriate way and given a self-explanatory title. Most figures have been attached in Appendix 1

and Appendix 2, although, some of them have been included in the main body of the dissertation too.

Tables used to display numbers help reveal trends and patterns and the reader can easily identify

particular values. Diagrams are not as precise as tables, but they do have a more visual impact when

they display data. The number of graphs used in this study visualise the numerical data in a tabular

33

form to indicate the relationship between variables and the consequences of their variation. The

independent variables are usually plotted on the horizontal axis with regular intervals (mostly an

annual scale), while the dependent variable has been plotted on the vertical axis with more irregular

intervals.

Easterby claims that if there is an association between two variables, then knowing how someone

responds to changes of one variable can carry information that may help to predict their response to

the other. The association between variables can be tested through a Chi-square test (χ 2) or through a

correlation coefficient (Pearson correlation, Kendal correlation) (2008, 261). However, an effect of

interrelated influences is not always easy to measure and multivariate analysis dealing with many

interrelated variables must, in many cases, be firmly rooted in predictions of relationships rather than

associations as measured by correlations. All predictions of trends, especially for determination of

the cash flow generated in the future, have been estimated rather cautiously since all historical data

have been found as not very reliable and incomplete. The purpose of multivariate analysis has been

to find the reciprocal relationship between variables and suppositions of fundamental factors

affecting the valuation of the business. In section A of the analysis, multivariate statistical methods

have been used to test casual models dealing with many interrelated variables and their relationships

that have been estimated rather than measured through a correlation method. Easterby explains that

statistical methods offer a specific testing method of hypotheses, which helps to the researcher in his

or hers judgement. However, what casual modelling methods cannot do is to prove a hypothesis of a

casual relationship- only disprove or support it (2008). In the case-study section a normative casual

model has been used where the links between the shareholder value maximization and corporate

strategy have been considered. This model states that looking after the interests of shareholders is the

best approach to how the company should be managed and that the strategic goals set by

management is determined by a need to protect and promote the interests of their shareholders (282).

This principle governs how the corporate strategy is formulated, and how the strategy in turn

influences the future financial performance. FIGURE 5 shows the normative model of key variables

to show the hypothesised casual relationships among them.

Figure 5: Hypothesised casual relationships (Source: Esterby, 2008, p. 282)

3.6. Empirical Work

34

Shareholder wealth interest

Corporate strategy Corporate market value and expected financial performance

Historical secondary data has been mostly extracted from the FAME database where the financial

fundamentals are summarized for ten years. An alternative source of information amending missing

figures and verifying uncertain information has also been used (The Financial Times

-http://www.ft.com/markets/company). For example, the missing figures ‘Investing activities’ in the

Hamworthy Plc database (row 223, annual year 2005 and 2006) has been replaced by figures ‘Total

Cash from Investing’ found in section ‘Financials’ – ‘Cash Flow’ stated in The Financial Times. It

has also been revealed that the information presented in The Financial Times is more recent than

figures in the FAME database because of the relatively frequent additional adjustments made in

particular cases. It has been found that, for instance, profit before taxation (row 40, annual year

2006) displayed in FAME for Clyde Process Solution, has been restated from negative 153 thousand

pounds (loss) to positive 711 thousand pounds recorded in The Financial Times (the section

‘Financials’ – ‘Income Statement’). The historical price data movement representing investors’

perception about the company’s value over a few past consequent years has been taken from the

London Stock Exchange (http://www.advfn.com/lse/londonstockexchange.asp) and has been used to

look at interactive share charts.

3.6.1. Framework - Part 1

In the first step of Part A of the analysis chapter the historical performance of the case study

company (‘master’ company) has been recorded in Table 1/Ap1 and exhibited in Graphs 1A – 7A

/Ap 2. The trends and relationships of value drivers have been illustrated in these figures and the

performance profile of the base-case company has been revealed (Hamworthy Plc). The aim of the

eleven-step procedure of analysing in Part A is to identify the historical value drivers and the

company’s capabilities to improve its value, forecast its future performance, and to evaluate the

future value drivers. The predicted value drivers have been then used in calculation of company’s

value. The principle that value drivers are designed from figures extracted from the past performance

(to gain equilibrium of drivers) has also been applied in Part B in the valuation of peers selected for

the comparative analyses. The assessment of the value drivers, based on secondary data, has been

recorded in Table 2/Ap1 (the second step). In the third step a few assumptions have been made such

as determining constant tax rate, discount rate, and incremental investment (Table 3/Ap1). Based on

these preliminary steps and the recognition of the current company’s policy, revealing its typical

percentage of sales growth, the profit margin and the investment, the first calculation the SVA has

been performed (‘strategy option zero’) (Table 4/Ap1) as the fourth step using the cash flow

discounting method. The ‘heart’ of the calculations is the basic model, which employs all three key

value drivers under ‘strategy option 1’ (the fifth step). The predicted sales growth and the requested

margin have been identical as in the case ‘strategy zero’, even though the additional total investment

calculated as a percentage from incremental sales has been proposed at 25 per cent. This level of

35

http://www.advfn.com/lse/londonstockexchange.asp

investment has been assumed to maintain long-term company growth and the percentage has been

decided on the researcher’s judgement. The Table 5/Ap1 contains the figures for calculating the

present value of both forecasted cash flows needed to be discounted (DCF) and the perpetuity value

after the five-year planning horizon. Alternatively, a ten-year forecast horizon has been examined.

The results have been summarised in Tables 5.1/Ap1 - 5.3/Ap1 and visualised via Graphs 8/Ap2 –

10/Ap2. Step six has been focused on the determination of the third value driver – the level of

investment, when the Threshold spread has been investigated (Table 6/ Ap1). A large part of the

empirical work containing, in step seven aims to propose strategic alternatives related to the key

value drivers’ changes and to investigate the effect of these variations on a company’s value. Table

7.1/Ap1 includes the calculation the SVA for different levels of investments and Table 7.1.1/Ap1

reviews the results for ‘strategy options 2,3 and 4’, which are displayed in Graph 11A/Ap2. Further

‘strategy options 5’ deals with setting objectives to accelerate the growth effect through a margin

improvement performed due to either reducing costs or by a productivity enhancement. The level of

investment is identical with the level in the base model (strategy 1), but the sales growth has been

increased by 5 per cent. The difference between ‘strategy option 5’ and ‘strategy option 6’ is the

way of spreading improvements of margins over a forecasting period (Table 7.2/Ap1; 7.3/Ap1). The

summarized results of an enterprise’s values and SVA for diversely proposed drivers against the

current company’s policy have been recorded in Table 7.3.1/Ap1. Following ‘strategic options 7,8

and 9’ both decreases the investment and declines the sales growth (Tables 7.4/Ap1 - 7.6/Ap1).

Next ‘strategy option 10’ proposes to reduce costs which increase the profit margin (14 per cent

estimated average), when this accounting-led rationalisation causes a decline in the sales growth.

(Table 7.7/Ap1; 7.7.1/Ap1). The summarized strategies proposed for the management of value

drivers pursuing maximal SVA have been recorded in Table 1 (Table 7.8/Ap1), and displayed in

Graphs 12A/Ap2; 13A/Ap2.

Table 1: Strategy Options Used in Value-Drivers Management

Strategy Options

Key Value Drivers Growth/Margin/Investment

Index

strategy 1 15%,7%25% Table 5.1

strategy 2 15%,7%,35% Table 7.1



strategy 5 20%,12%(incr.),25% Table 7.2





strategy 10 (5%),14%,0%,(20%) Table 7.7

36

Step eight contains Tables 8.1/Ap1 - 8.4/Ap1 providing analysis of the value sensitivity in the

process rationalization on the SVA. This examination is focused on an investigation of the effect of

the different levels reducing of costs on the future cash flow. However, the most comprehensive

calculation has been undertaken in step nine in seeking the value maximization. The structure of the

calculations has been based on the ‘strategy option 6’ providing maximal SVA with a comparison

with other alternatives (in the previous seven step). The investigation has been split into three phases

in which the researcher was looking for the best value performed by different value driver

management and also under various purposes to invest. In fist part of this investigation the

investment has been assumed to increase sales growth - Tables 9.1/Ap1 – 9.6/Ap1. In second part of

the analyses the incremental investment has been aimed to invest for an improvement of the

operational margin via higher efficiency and an appropriate cost management (Tables 9.7/Ap 1 –

9.12/Ap1). The last stage of this examination has been concerned with both the purposes of the

additional investment-enhancing growth and the improving margin (Tables 9.13/Ap1 – 9.18/Ap1).

The findings of the analysis of the key-financial-driver management seeking value maximization

have been outlined in Table 2 (Table 9.19/Ap1), where the best strategies targeting maximum

shareholder value added, has been identified.

Table 2: Value Maximization Options

Purpose of Investment

Driver Management Index

Increasing

Growth

25%,12%,35% Table 9.1

30%,12%,45% Table 9.2

35%,12%,55% Table 9.3

40%,12%,65% Table 9.4

45%,12%,75% Table 9.5

50%,12%,85% Table 9.6

Improving

Margin

20%,15%,35% Table 9.7

20%,18%,45% Table 9.8

20%,21%,55% Table 9.9

20%,24%,65% Table 9.10

20%,27%.75% Table 9.11

20%,30%,85% Table 9.12

Enhancing25%,15%,35% Table 9.13

30%,18%,45% Table 9.14

37

Both

35%,21%,55% Table 9.15

40%,24%,65% Table 9.16

45%,27%,75% Table 9.17

55%,30%,85% Table 9.18

The evaluation of Hamworthy’s performance and the value created has also been considered through

the 'market-based' measures, using the stock market’s perception of the expected value and the

prospects of the corporations. In step ten the market-to-book ratio (MBR) and market-to-book added

(MVA) have been calculated - Table 10/Ap1. The book value, stated in a company’s balance sheet

(whttp:\\www.hamworthy.com) and market capitalization (derived from London Stock Exchange in

the section A Company Profile generated on 08-Apr-2010 at 12:25 from

http://www.londonstockexchange.com/exchange/prices-and-news/stocks/) have been the key

determinant of the company’s valuation. Finally, in step eleven of the analysis section the alternative

valuation using economic profit (EP) has been considered. Table 11.1/Ap1 displays the economic

profit and the value created in the past, whereas Table 11.2/Ap1 shows the projected economic profit

and the value created based on discounted future profits to the present using the spread method in the

valuation. However, Table 11.3/Ap1 includes the results of EP calculation using the profit-less-

capital-charge method. Tables 11.4/Ap 1; 11.5/Ap1 provides the shareholder values for different

value drivers with and without additional investment (16A/Ap2) and the method of valuation, using

the economic profit has then been compared with valuation via the DCF method for the same five-

year forecast period Table 11.6/Ap1; Graph 15A/Ap2.

3.6.2. Framework - Part 2

The comparative analyses in Part B have used the value drivers as a benchmark to compare

diverse ways of value-driver management identified within the ten selected corporations. This

examinations contain eight further steps of the analytic process and starts by contrasting the

Hamworthy Plc with its ‘closest’ competitors the Spirax-Sarco Engineering Plc and the Weir Group

Plc, operating in the similar market sector (in the FAME database they have the same UK SIC code

2912). In the comparative analysis historical performance and value drivers extracted from the

FAME database have been recorded in Table 12/Ap1 as the initial twelfth step. The graphical

illustration of the relative relationships has been drawn in Graphs 17A/Ap2 – 21A/Ap2. In the

following step (step thirteen), the historical data of ten selected enterprises operating within the

same industrial machinery sector have been extracted from the FAME database for the monitoring

period 2004 – 2009 (Table 13.1/Ap1 – 13.10/Ap1). The additional data prior to the monitoring

period (years 2000 – 2003) have been demonstrated in Tables 13.1.1/Ap1 – 13.10.1/Ap1. The

38

evaluation of the characteristic drivers from the historical data and proposing a feasible strategy

through a prediction of future value divers it has been the purpose of step fourteen– Tables 14.1/Ap1

– 14.10/Ap1; Graphs 22A/Ap2 - 41A/Ap2. The predicted value drivers determining the new

projected strategy (with a confidence limit for improving SVA), have then been compared to the

current drivers identified from the historical performance and the comparison of both strategies has

been illustrated by ‘strategic radar - triangles’ - Graphs 42A/Ap2 – 51A/Ap2. Valuation of the

chosen companies via the DFC method has been compiled in step fifteen and the results documented

in Tables 15.1/Ap1 – 15.10/Ap1. The stock market valuation, elaborated in step sixteen, has been set

down in Tables 16.1/Ap1 – 16.10/Ap1 and the ‘value gaps’ have been revealed in Graphs 52A/Ap2 -

61A/Ap2. Table 16.11/Ap1 provides a review of the findings from market-based measures using the

publically available market value (market capitalisation) for all preferred corporations in contrast

with the manually calculated results. The visual illustration of the correlations between the MBR,

MVA, CBR and CVA has been exhibited in Graphs 62A/Ap2; 63A/Ap2. The deeper interpretation

of value destroying has been carried out in step seventeen. Further, the 600 Group Plc has been used

to demonstrate a negative figure in both the MVA and the CVA measure. This has been presumed to

be explained by the historical data provided in Table 17A/Ap1. Graphs 64A/Ap2-69A/Ap2 have

been constructed for this judgement. The succeeding step (step eighteen) concentrates on a strategic

control charge where the mutual positioning of the selected enterprises has been assessed using a

graphical representation of the relationship between the MBR and the company size (Table

18.1/Ap1; Graphs 80A/Ap2). The movement in positioning after the calculated value has been used

can be observed in Graph 81A/Ap2 (Table 18.2/Ap1). In the final step (step nineteen) the

comparison of share prices of all selected companies has been displayed by Table 19.1/Ap1 to

demonstrate the stock market’s judgement on the expected financial performance over the past six

years (2004-2009). The investors’ fundamentals have been in the end summed up in Tables

19.2/Ap1 – 19.11/Ap1, and Graphs 70A/Ap2-79A/Ap2 where the share price-EPS relationship has

been examined.

4. INTERPRETATION OF THE RESULTS

The evaluation of the results, comments and deductions has been undertaken consequentially.

Deduction is the process of arriving at a conclusion by interpreting the meanings of the analysed

results (Sekaran, 1992) and based on this, the researcher has made a recommendation on how way

the value drivers should be managed and what future approach managers should adopt in their firms.

Because this research has produced a lot of results the amount of material collected including

calculations and graphs have been presented in the appendices of this work. White also claims that

39

description does not quote to interpretation and that interpretation shows how the results fit (or not),

with the theory and the background of the subject investigated. It is the strength of the researcher’s

argument that is important. Irrespective of whether the researcher used one method or another, his

judgement as an independent researcher is important (2002, 139).

4.1. Evaluation - Part A

The performance profile of the case study company has been presented in Part A through the

historical price performance estimated on the London Stock Market. The share price, however, does

not tell us thoroughly whether its movement can result in only a good or poor value-driver

management. Any other external and internal factors and circumstances may influence the

investors’ appreciation. Nevertheless, the share price is an appreciated view about the company’s

capabilities to generate the future cash flow and a company’s perspective to sustain the expected

growth. Therefore the price performance (relating to the future) is a valuable indicator of proper

handling long-term investments, sufficient growth sales, and effective operational methods in

gaining the expected profit margin. Hamworthy Plc has a declining bias of the price over the past

years 2007-2009. The bottom of price figures in 2008 when economic recession started is clear from

Graph 1. However, since the second half of year 2009 the price has been slowly increasing again.

Graph 1 - Share price (Hamworthy Plc.)

0

100

200

300

400

500

600

700

Oct

-08-

2004

Jul-2

2-20

05

May

-05-

2006

Feb-

16-2

007

Sep-

07-2

007

Nov

-05-

2007

Jan-

04-2

008

Mar

-03-

2008

Apr-3

0-20

08

Jun-

30-2

008

Aug-

27-2

008

Oct

-23-

2008

Dec

-19-

2008

Feb-

18-2

009

Apr-1

7-20

09

Jun-

17-2

009

Aug-

13-2

009

Oct

-12-

2009

Dec

-08-

2009

Feb-

08-2

010

Apr-0

8-20

10

Clo

sing

Pric

e (p

)

As we can see from Table 1/Ap1 and Graphs 1A/Ap 2,2A/Ap2, the earnings have risen gradually

and consistently throughout the monitored period, although the return on capital had been declining

until 2008. In this case, it could be caused by this time, by higher investment levels that have

probably been reduced in 2008. Sales volumes have been boosted as well (Graph 3A/Ap2).

40

However, in 2008 and 2009 the sales growth clearly slowed down from almost 40 per cent in 2007

to amount nine per cent in 2009 as seen in the Graph 4A/Ap2. Two key value drivers have been

observed as having a positive increasing bias. Nevertheless, the third driver, incremental investment,

is much more unrecognisable and difficult to determine. There is no valid figure in the financial

statement about the precise amount of the additional investment, which enables to predict its future

trend. Therefore the researcher has had to deduct this driver using his own judgement. For this

purpose the net cash flow from investing activities figures (FAME, row 23) has been used to

estimate the company’s willingness to invest to its business. Graph 5A/Ap2 reveals the constant

positive total cash flow throughout within the monitored period and the trends in both increasing

investing activities and declining return on capital represented by linear regressive lines drawn in

Graph 6A/Ap2. It shows the long-term targets exerted by the Hamworthy for achieving long-term

success regardless to an adverse external environment. This is a crucial assumption that the

investment activities are sufficient as the sales and earnings are being boosted. Based on this

indicator the researcher could identify shareholder value creation in Hamworthy Plc that is

contrasting with the some companies focusing rather on cost management and short-term profit

maximization. Historical and anticipated level of operating cash flow, the most fundamental

determinant of shareholder wealth, has been illustrated in Graph 7A/Ap2. It is obvious from the

curve that within the whole planning period the cash flow level does not reach the average level of

cash flow based on historical figures. However, this average has been reached in the last planning

year when it was already producing around eight-million-pound positive cash flow. These cash flows

have to be then discounted to the present levels in respect of the cost of capital.

After the several assumptions stated in Table 3/Ap1 where, for example, a depreciation

misinterpreting the profit figures has been ignored from the calculations and discounted rate has

been determined as twelve per cent, the first shareholder value created has been computed. The

predicted sales growth has been fixed at 15 per cent and margin at 7 per cent in accordance with the

historical results (Table 2/Ap1). The cumulative present values of predicted cash flows and

perpetuity value has then been worked out using the discounted cash flow method which has resulted

in the shareholder value added (SVA) - bottom line figures in Table 4/Ap1. This calculation has

been called as the ‘strategy option zero’ when the researcher did include no investment. Such a

strategy is, however, unlikely to sustain since sales growth needs to be maintained by appropriate

investment level to both tangible and intangible assets. There is the gold rule that the return on the

new investment exceeds the cost of capital in order to create the shareholder value and that

investment creates value if the net present value of the cash flow is positive. For following

proposals of a value drivers’ set some level of investment has been always assumed, except the value

destroying ‘strategy option ten’. The basic ‘master’ model of driver management called the ‘strategy

option 1’ gives us the SVA for proposed 15 per cent growth, 7 per cent margin and 25 per cent

41

additional total investment. In this model referred to Table 5/Ap1, an incremental investment is

employed to allow the growth and the SVA figures to be found lower (total SVA 36,947) against

result under strategy zero (total SVA 81,605) because of net cash out flow (investment activities).

However it is a more realistic parameter set managing drivers to increase future cash flow. The

cumulative present value of the forecasted cash flow in the end of the five-year planning horizon is

then displayed in the last column in Graph 8A/Ap2 together with continuing value calculated after

the forecast period. By combining these figures the company value is given in total. The comparison

of the results is shown for both five and ten year’s period in Graph 9A/Ap2. The SVA has been

increased by 26 per cent in contrast with the original policy and the annual SVA have mostly an

increasing bias (Graph 10A/Ap2).

Since the third driver investment has not been judged on the basis of historical data, the

estimated percentage of additional sales has to be verified through a Threshold margin calculation.

As shown in Table 6/Ap1, because of the positive Threshold spread of 3.17, this strategy (‘option 1’)

increases the shareholder value. Managers need to avoid wasteful investment and therefore the

investigation of the maximal investment level has revealed that 45 per cent of the incremental

investment still has a positive Threshold spread of 0.11. Also, the second column of the table

contains an examination of the minimum pre-tax operating profit necessary to finance value-creating

growth (Threshold margin 3.83 equals expected profit margin). Based on these findings the

valuation of the company operating under the different ‘strategic options 2,3 and 4’ with diverse

investment levels has been compiled in Table 7/Ap1 and summarised in Table 7.1/Ap1. There, the

SVA has been found lower with higher investments, which can be explained by the higher cash out

flow level and either the insufficient sales growth or the inefficient operations generating poor

earnings. The results for the SVA can be seen in Graph 11A/Ap2 where the negative Threshold

spread has been verified by negative SVA calculated for the investment appraisal of 55 per cent. In

order to find out how the SV will be changed by the accelerating growth effect through profit margin

improvement that allows achieving quicker growth, further calculations have been carried out. The

value found in Table 7.2/Ap1 and calculated with the annual gradual margin improvement by 1 per

cent a year (‘strategy option 5’) would be three times greater against the current company’s value

(the value 103,241 before accelerating growth has been increased to 295,472). Table 7.3/Ap1 uses

requested annual margin at 12 per cent equally each year within the forecasted horizon and the SVA

is found to be even higher (‘strategy option 6’). Tables 7.3.1/Ap1 summarizes the basic ‘strategy 1‘

and ‘strategy 5’ in comparison with the current ‘strategy of doing nothing’ illustrated in Graph 2.

42

295472

140188

103241

Graph 2: Enterprise values after under different strategies (Hamworthy Plc.)

strategy 0

strategy 1

strategy 5

It is clear that sustainable leveraging of value drivers will lead to an increase in the enterprise’s value

substantially. The SVA created in the growth ‘strategy 5’ is 192,231, which is by 65 per cent greater

than the SVA (amounted 103,241) under current management. The effect of a growth increase on the

shareholder value is then significant. Graph 3 transparently visualises the gained SV after a

deduction of debts from the enterprise value for each strategy option.

261789

106505

69558

Graph 3: Shareholder value after under different strategies (Hamworthy Plc.)

strategy 0

strategy 1

strategy 5

The next investigation has been concerned about diminishing the third driver when ‘new’ investment

rates are decreased whilst growth is kept on the former level. This circumstance can be maintained

only in a short transitional period when managers are using the ‘high-effect’ approach, and they are

43

‘adjusting’ their performance related to their rewards. Reducing long-term investment easily affects

the fluctuating positive cash flow as can be seen in the performance under the ‘strategy option 7’

(Table 7.4/Ap1) in comparison with the ‘strategy option 1’ (Table 5.1/Ap1). The cumulative

discounted cash flow in this strategy which reduces investment rate by 10 to 15 per cent has been

amounted 40,311 against 22,448 of SVA achieved in ‘option 1’ (almost twice as high). This

confirms the sensitivity of this particular driver. Also, the total SVA under this policy has been

found greater (54,810). Nevertheless, this cannot be a sustainable driver management because the

growth must be fostered through financing investment activities permanently. A more common

situation is when sales decline due to an insufficient investment level (Table 7.5/Ap1). In this

‘strategy option 8’, the total SVA (amounted 33,404) has been found lower than the SVA

accomplished using the basic ‘strategy 1’, despite the cash flow level being twice as high. The

reason lies in the lower continuing value calculated via the perpetuity method in contrast to the basic

strategy (reckoned 94,275). The ‘strategy option 9’ represents a deeper impact of reducing

investments on sales when they have been declined to only 5 per cent. (Table 7.6/Ap1). In this case

the SVA indicates only 50 per cent of the SVA achieved in the basic strategy. The extreme the

‘strategy option 10’ has revealed value destroying in the last four years within the planning period. It

has been caused by reducing costs (such as overheads and start up costs) and the marketing spend

(R&D costs) cut by 20 per cent. This increases the profit margin to 14 per cent of the average.

Unfortunately, this rationalization policy is typical for many firms using this tactic in the recent

adverse economic background. Thus, it only demonstrates short-run interests that are not consistent

with the shareholders’ benefit. The second driver - margin - has been extracted from Table

7.7.1/Ap1 after total expenses, which have been taken from the FAME database and an assumption

that the expenses discounted by 20 per cent will stay the same over all of the planning period has

been made. The margin has been calculated for each year and than set as an average at 14 per cent.

The comprehensive Table 7.8/Ap1 finally summarises all proposed alternatives of the value-driver

management with the DCF and profit figures, continuing values and the SVA performed under given

strategies. We can find, in the SVA column, that most valuable strategy to shareholders is the

‘strategy option 6’ that generates 212,601 SVA. The value destroying alternative, according to the

table, is the ‘strategy option 4’ with a negative figure, which caused an overinvestment of 55 per

cent. Also the rationalisation ‘strategy 10’ and the ‘strategy 3’ with inappropriate levels of

investment activities are not recommended to executives since they offer the lowest performed

positive SVA. This table can be compared to Graphs 12A/Ap2-14A/Ap2. Graph 4, indicating the

anticipated cash flows during the monitored period for each driver management strategy, is very

useful. Although the ‘strategy option 10’ ((5%),14%,0%,[20%]) performs the highest total cash flow

in first three years from all proposed schemes and it does not imply any negative cash flow, its very

steep decline cannot guarantee a long-term value creation. On the other hand, the ‘strategy 5’

44

Graph 4 - DCF profiles within a planning horizon under proposed strategic options (Hamworthy Plc.)

4256

869 38

83

1147

0

7643 87

83 9923

3373

3

4368

892

6190

1228

4

7844

8623

9299

2340

7

4488

917

8814

1316

9

8059

8473

8723

1522

4

4610

942

1178

2

1411

6

8278

8326

8181

8773

4726

965

1510

1

1510

1

8487

8165

7658

3735

-590

4

-251

7

-606

0

-258

4

-622

6

-265

5

-639

5

-272

7

-655

7

-279

6

Strat 1 Strat 2 Strat 3 Strat 4 Strat 5 Strat 6 Strat 7 Strat 8 Strat 9 Strat 10

2010 2011 2012 2013 2014

(20%,12%(incr.),25%) and ‘strategy 6’ (20%,12%,25%) generate the greatest SVA figures having a

positive trend.

The Graph 5, displaying profit profiles for the same strategy options as in previous examination can

be useful to visualise that profit figures only are very poor measures of the company’s value. For

example, the ‘strategy 3’ (15%,7%,45%) and the ‘strategy 4’ (15%,7%,55%) presenting a negative

DCF, have an almost identical profit profile with the ‘strategy 1’ (15%,7%25%) and the ‘strategy 2’

(15%,7%,35%) that are generating positive DCF and a satisfactory SVA. Also, misinterpreted high

earnings in the first two years under ‘strategy 10’ in contrast with the most value creating the

‘strategies 5 and 6’, can influence distorted managers’ view and an adverse impact on investors’

anticipation. This graph also illustrates the observed rule that more steeping profiles in positive way

the greater value created and therefore the better management of key value drivers performed. This

is illustrated in the graphs by columns representing the ‘strategy 7’ (15%,7%,15%), the ‘strategy 8’

(10%,7%,15%) , and the ‘strategy option 9’ (5%,7%,15%).

45

Graph 5 - NOPAT profiles within a planning horizon under proposed strategic options (Hamworthy Plc)

0

10000

20000

30000

40000

50000

60000


2010 2011 2012 2013 2014

The Graph 12A/Ap2 shows the DCF and the perpetuity value separate for an each strategy option.

The influence of the investment level on the DCF is obvious from the first four alternatives, whereas

the continuation value has not been affected. Moreover, a very interesting insight can be examined

by observing the ‘strategy 10’ – this is only option generates a greater DCF than the perpetuity

value. The mutual proportion of the present values expressed as percentages and provided with

relevant figures is interpreted in Graph 13A/Ap2. The total SVA has also been reviewed in Graph 6

where the ‘strategies 1, 5, 6, 7 and 8’ could serve as a guide to the management of the key financial

value drivers in the sense of creating value for shareholders.


3694719084 1221

-16643

192232212601

5481033404

15254 10763

Graph 6 - SVA under proposed strategic options (Hamworthy Plc.)

46

The frequently used accounting-led growth approach has also been investigated, in more detail,

when values have been calculated based on various cost reductions. The rationalisation seeking

above all the short-term targets within a year’s budget has been examined in this study through a set

of costs reductions, proposed by researcher at 25, 15, 10 and 5 per cent. The future cash flow

generated under each rationalization-strategy option has been provided in (Table 8.1/Ap1 – 8.4Ap1).

We can clearly see from Graph 7 that if the costs are reduced, the cash flow immediately escalate in

the first year and than slowly decrease over rest of the forecast horizon. Also, it has been found that

the higher cost reductions (25 and 20 per cent) maintain a positive cash flow over all of the planning

period.

Graph 7 - Future CFs generated under different rationalisations (Hamworthy Plc.)

-20000

-10000

0

10000

20000

30000

40000

50000

2009 2010 2011 2012 2013 2014

costs -25%

costs -20%

costs -15%

costs -10%

costs -5%

The findings of cutting cost creating value have been summed up in Graph 8. The initial ‘success’

of the rigorous cost management techniques when the earnings and cash flow are boosted quickly is

obvious, however, it will rather lead to value destruction as shown in the graph exposing negative

cones due to cost reduction strategies at a lower rate ( at 15, 10, and 5 per cent).

47

78631

10763

-57106

-124974

-192843

costs -25% costs -20% costs -15% costs -10% costs -5%

Graph 8 - SVA under different cost reductions (Hamworthy Plc.)

The reason why the first two strategies create the SVA can be easily explained. The cumulative

discount cash flow performed at 25 per cent of cutting costs (Table 8.4/Ap1) has been several times

greater than in the other rationalization strategies (achieved 183 864) because of boosting profits .

Nevertheless, in the long-term view even this strategy will surely have a destroying impact on the

shareholder wealth because of the diminishing bias of cash flow. This issue can be proven by an

extension of the forecasted period in the future research. The bottom line of these analyses is to find

the best value driver strategy leading to the maximal shareholder value. The management of value

drivers provided in step nine has been based on purpose on which additional investment will be

given. In the first strategy option exhibited in Tables 9.1/Ap1 – 9.6/Ap1, for which an increase in

investment is assumed, sales growth will accelerate. Next calculations have been based on a

presumption that investment improves the margin (Tables 9.7/Ap1–12/Ap1) and the last examination

suggests to combine the previous two purposes (Tables 9.13/Ap1-9.18/Ap1). The fundamental

model for projecting value-maximizing strategies is again the ‘strategy option 6’ (20%,12%,25%)

investigated in step seven. The minimum investment rate to encourage growth was estimated as 35

per cent from additional sales. All suggested variations of proposed maximization strategies have

been put into Table 9.19/Ap1 including the SVA results, the total SVA, and the enterprise values.

In Graph 9 the alternative options are ranged by value created (total SVA) and Graph 14A/Ap2

shows an annual development of the SVA created each planning year.

48

50%

,12%

,85%

45%

,12%

,75%

40%

,12%

,65%

25%

,12%

,35%

20%

,15%

,35%

35%

,12%

,55%

30%

,12%

,45%

20%

,18%

,45%

20%

,21%

,55%

25%

,15%

,35%

20%

,24%

,65%

20%

,27%

.75%

20%

,30%

,85%

30%

,18%

,45%

35%

,21%

,55%

40%

,24%

,65%

45%

,27%

,75%

55%

,30%

,85%

1249

542

9394

10

6893

52

4907

43

3359

41

2742

98

2505

23

2267

47

2182

09

2029

71

1791

95

1655

78

1608

16

1554

20

1544

67

1353

06

8339

0

-144

7

growth / margin / investment

Graph 9 - Value maximizing options of value drivers put in order according the highest SVA (Hamworthy Plc.)

It has been found that only supporting sales activities without profit improvements do not create the

expected value (evidenced through all strategies exercising second driver at 12 per cent). Growth

should be always accompanied with a higher efficiency of operations through incentive schemes,

new technology, and improved structure of organization. Investing to improve this brings a higher

value to the shareholders, as can be observed by strategies using a constant growth of 20 percent

with a level of margin higher than 12 per cent. However, the best results of the value creation have

been attained through investing for both purposes – sales growth and improved margin. However,

the higher investment levels must be always balanced by an increased sales volume and profit

enhancement to avoid value destroying due to overinvesting. It should be a general rule that the

investment should not be constrained in the level of rate, only by the appropriateness of investing

associated with the returns and risks involved. Even if the investment initiates a growth of 55 per

cent and a profit of 30 per cent, the incremental investment rate of 85 per cent does not have to be

exaggerated.

The DCF value-creation metrics have also been supplemented in this study by market-based

measures of value performance using the market-to-book ratio (MBR) and the market-value-added

(MVA). The calculation of these figures has been provided in Table 10/Ap1 where it is apparent that

Hamworthy Plc turned every pound into 2.3 pounds in 2009 and the value 81,684 has been created

(the MVA amount is greater than 0). These findings correspond to the result found in the ’strategy

option zero’ where a similar figure of the SVA amounted to 81,605. This may therefore confirm the

validity of these analyses undertaken by the researcher.

The valuations through economic profit (explained in Appendix 3) for comparison with the DCF

valuation method have been done in the last step (step eleven) of the case study. The economic profit

(EP) and a company’s value (capital employed plus economic profit) based on the past performance

49

have been computed using a performance spread method (Table 11.1/Ap1). Then predicted drivers

already operated in the basic ’strategy 1’ have been used (15%,7%,25%) for both a calculation of the

future EPs and projected an annual value within the planning period (Table 11.2/Ap1). The values

recorded in the relevant tables have been then exposed in Graph 10 for including past and future

period where the ascending trend line since 2008 indicates an improvement in the value creation

after the appropriate driver management has been applied.

166854

222494

122521

149499

91427103241

118727136536

157016

180568

207654

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Graph 10 - Valuation using Economic Profit (Hamworthy Plc.)

The profit-less-capital-charge method, used as an alternative technique for the EP calculation, has

validated the calculation, owing to the identical achieved EP figures (Table 11.3/Ap1). The

comparison of the economic profits and the cash flow method, illustrated in Graph 15A/Ap2,

confirms the fact discussed by Doyle’s claim that as a result of the underestimated capital employed

recorded on the balance sheet the EP figures appear unrealistically high. Table 11.4/Ap1 provides

the calculation of the EP and the EP valuation for a higher percentage of drivers (20%, 12%, 25%).

Table 11.5/Ap1 summarises the EP results for variously proposed drivers. These figures identify the

fact that the EP valuation does not recognize investment. This is also obvious from Graph 16A/Ap2

which was constructed for different investment levels. In the end, two diverse techniques used for

finding out a company’s value under the same value drivers (20%,12%,25%) has been compared to

the case study analyses (Table 11.6/Ap1, Graph 11). The disparity between the relevant values of

the different methods has been examined as increasing each year within the planning horizon.

Therefore, distortions arising from accounting conventions should be considered in the next

perspective study, although increases in the EP are identical to the changes in the value added

50

exposed in the DCF valuation, so we can clearly identified the relative trends revealing anticipated

value.

1032

41

1032

41

1415

87

1303

21 1911

43

1624

14

2548

57

2003

45

3364

11

2446

26

4403

92

2954

72

Graph 11 - Valuation methods in comparison (Hamworthy Plc.)

EP valuation

DCF valuation

Part A of the evaluation of Hamworthy’s abilities to properly manage the financial value drivers

has revealed the sensitivity of these drivers and importance of long-term approach in management

leading to a value creation. Investors’ anticipation of a company’s value and an evaluated potential

for generating future cash flow is expressed in market capitalization (for Hamworthy amounts

144,280) that has been found greater than the book value accounted in the balance sheet (62,596).

This indicates that the value has been added. The enterprise value manually calculated in this work

using the cash-flow method for basic ‘strategy 1’ has amounted 140,188 which is a very similar

figure to the market value. Although the company share price has fallen since the recession in 2008

the investors’ expectations about the future prosperity create more value to the shareholders since the

calculated SVA (26 per cent of the additional value) has been achieved and market value has

exceeded the book value. The comprehensive analysis of how to handle the core value drivers has

been undertaken in this part with the conclusion that a close mutual relationship is necessary

maintain the control over changing factors which could change the future company performance

anticipated in the enterprise’s value. This is an especially responsive issue using the rationalisation

strategy when, rather than creating value for the shareholders, the creation of impression from

boosted cash flows in the short run is aimed for. The reciprocal linkage among the drivers affecting

the company’s value found in this analysis is the key outcome which arrives from this section.

4.2. Evaluation - Part B

51

Part B of the empirical work deals with the comparative analyses seeking such a characteristic

mixture of value drivers (used by selected companies) that it leads to shareholder value creation.

Both the specific drivers and the enterprise’s values have been aimed to use as a benchmark helping

to asses the companies’ strategy position. Also, this section has tried to verify the hypothesis about

the tendency to manage value drivers through value destroying policies within some of enterprises

operating in a today’s business environment. Either positive or negative ‘value gaps’ have been

identified when the calculated value exceeded (or not) the book value. These gaps have also been

identified by comparing with market value and a consistency with calculated results has been

examined. The technique of valuation in Part B is identical with the method used in Part A when a

historical performance has been judged for estimating characteristic sets of value drivers (an

equilibrium position) that will determine the value added. The comparison of historical drivers for

the three ‘closest’ three competitors within the same peer group (UK SIC code 2912, FAME)

Hamworthy Plc, Spirax-Sarco Engineering Plc, and Weir Group Plc provided by Table 12/Ap1 and

Graphs 17A/Ap2-21A/Ap2 has revealed that Spirax-Sarco’s drivers’ management is the most

appropriate because of the permanently positive free cash flow lead to high sales volumes, and the

highest profit margin over all of the monitored period. Also, the investment level has had an

increasing bias and in both 2007 and 2009 it the highest figures have been found. As the further step,

the historical data of the ten selected companies have been gathered for past five years, and this is

recorded in Tables 13.1/Ap1-13.10/Ap1. Additional figures contained in Tables 13.1.1/Ap1-

13.10.1/Ap1, have been added for the illustration of ten years historical performance. Unfortunately

many of them are available in neither the FAME database, the financial statements, nor in other

sources. This is the reason why the researcher has focused on a shorter five-year monitoring span.

The documented cash flows and earnings for ten selected companies have been then illustrated in

Graphs 22A/Ap2-31A/Ap2. We can recognise through these graphs the financially strong companies

disposed with the stable positive cash flow, such as Hamworthy, Spirax-Sarco Engineering or MS

International, followed with a constant growing profit all the time. On the other hand, Weir Group’s

free cash flow has fluctuated every year from positive to negative figures with increasing earnings.

The historical drivers’ curves exhibiting in Graphs 32A/Ap2-41A/Ap2 for each company show how

these determinants have been treated suggesting the firms’ ability to create value. There is a criterion

for value added that all drivers should be positive figures in the long-run with an increasing bias. It

can be seen, for instance, by Slingsby Plc performing within 2006-2008 period. The impact of

adverse economic conditions can be observed through declined sales volumes in 2008 almost by all

tracked companies. As the next step, the prediction of the future value drivers has to be done as seen

in Tables 14.1/Ap1-14.10/Ap1. The historical performance, an individual judgement about

opportunities in business, risks of investment or various constraints relating to new strategy must be

considered as well as a detailed analysing competitor’s performance. Two strategies constituted via

52

the ‘strategy triangles’ (Graphs 42A/Ap2-51A/Ap2) express the past strategy with drivers assessed

based on an average of the historical data and predicted strategies using historical data only as a

guide in prediction of value drivers. The consideration is based on the researcher’s judgement about

an organization’s capabilities. For this analysis it has been assumed that 25 per cent of the

investment rate is made for all analysed companies. We can easily recognize the mutual position of

‘triangles’ revealing both the company potential to set such value drivers that maximize value and a

capability of the organization to use them efficiently. By comparing the relevant triangles then it is

possible to identify the ‘driver gaps’ showing a degree of inconsistency between what a company

does and what it can do. For example, Hamworthy Plc should increase investment (from its current

insufficient rate of 10 per cent to the suggested 25 per cent) to enhance the operating margin (from 5

to 7 per cent) since the evaluated potential of value drivers is higher than currently used. On the

other hand, current sales growth of 23 per cent does not match with other value-creating factors as

seen in Graph 12. The historical growth figure is greater than the evaluated one and the current

strategy triangle indicates a very asymmetric shape disclosing an excessive rate of sales compared to

the others. The solution to this chronic problem may be to invest more to sustain the high sales and

to manage operations more efficiently.

Graph 12 - 'Strategy Triangles' (Hamworthy PLC)

10

5

23

7

25

15

0.00

5.00

10.00

15.00

20.00

25.00Sales Grow th (%)

Op.margin (%)Investing Activ. %

current

predicted

Spirax-Sarco Engineering Plc and Weir Group Plc should only increase investment activities and

600 Group Plc has to manage all value drivers in a different way to achieve a higher company value.

In some cases, such as Gas Turbine Efficiency Plc, the excessive percentages of some current drivers

must have been lowered to more realistic figures (excessive investment and growth identified).

Unfortunately, in the case of Mount Engineering Plc, the lack of historical data and their

53

inconsistence has made it impossible to predict the future strategy. These ‘strategy triangle’

illustrations can serve as an indication of the tactics in the driver management used by rivals and the

changes through reposition of new strategy triangles that have to be made in order to deploy the full

potential of the company’s drivers. The valuation of the selected companies, based on the predicted

value drivers (Tables 15.1/Ap1-15.10/Ap1) resulting in the SVA for each corporation, has revealed

the disparity compared to the book value (shareholders funds – FAME, row 211). All the book

value, the market value and the calculated value have been documented in Tables

16.1/Ap1-16.10/Ap1 and presented in Graphs 52A/Ap2-61A/Ap2, where the ‘value gaps’ are

transparently visualised. It is evident that Hamworthy Plc, Spirax-Sarco Engineering Plc, Weir

Group Plc, Pressure Technologies Plc and MS International Plc have created value since both the

market value and the calculated value exceeded the book value. For instance, Hamworthy’s

performance has been shown in Graph 13 with very similar performed outcomes of both the market

and the calculated results.

6259

6

1442

80

1401

88

0

20000

40000

60000

80000

100000

120000

140000

160000

[£' 0

00]

Book value Market capitalisation Calculated value(15%,7%,25%)

Graph 13 - 'Value Gaps' (Hamworthy Plc.)

On the opposite side, by 600 Group Plc and Mount Engineering Plc the enterprise value has been

destroyed when accounting value exceeded both the appreciated and the computed values. In three

of the ten cases, Slingsby Plc, Clyde Process Solutions Plc, and Gas Turbine Efficiency Plc (Graph

14) the researcher has found contradictory results since lower market capitalization against the book

value has indicated value destroyed and concurrently much greater value calculated suggests value

creation. These divergences between the market and the calculated value may be caused by an

incorrect prediction of drivers based on the inconsistent historical data available, or the fact that the

calculations do not include intangible assets that are strongly linked to the market value.

54

1985

4

1092

0

3505

2

0

5000

10000

15000

20000

25000

30000

35000

40000[£

' 000

]


Graph 14 - 'Value Gaps' (Gas Turbine Efficiency Plc.)

The proposed strategies relating to the expansion of business operations abroad, an improvement in

distribution channels and other information familiarized by market analysts can enhance the

attractiveness of the company expressing via the market value. It may be the case of Spirax-Sarco

Engineering Plc and Weir Group Plc that the significant lower calculated values are unable to reflect

the ‘speculative’ information. The extensive calculated value, in contrast to market appreciation, can

be explained as a result of overestimated capabilities to create value by fixing up unreal sales

volumes, especially those achieved in today’s economic downturn period. Moreover, overly

enthusiastically settled profit margin and even an overinvestment together with lower earnings might

inaccurately affect the calculated result. However, the manual valuation through the DCF method

used in this work confirmed in seven cases from ten the market analysts’ view in sense of a value

creation consistency (created-created and destroyed-destroyed findings) dispute some

disproportionate results.

4.3. Stock Market Indicators

The stock market value measures, the MBR and the MVA, also recorded in Tables 16.1/Ap1-

16.10/Ap1 imply either value added or value destroyed in the actual year. Both market indicators

displayed in Graph 62A/Ap2, showing high figures for Hamwothy, Spirax-Sarco Engineering and

Weir Group, reveal the enormous increase in the value over the last year. In the other cases, such as

Pressure Technologies, MS International and Mount Engineering, only the MBR ratio indicates

created wealth. Nevertheless, these findings correspond to the results obtained by the discounted-

cash-flow-valuation method. The comparison of the MBR with the calculation-book ratio (CBR)

55

exhibited in Graph 63A/Ap2 suggests an consistency of both measures. It is obvious that in the

Hamworthy’s case the identical ratios has been achieved, justifying a similar appreciation of this

company in contrast to Spirax-Sarco Engineering, where different ratios reveal a big ‘value gap’.

4.4. Value Destroying Analysis

Some cases reveal a greater book value than the market estimation has identified in the previous

examination. This is the reason why the value destroying analysis has been carried out by researcher

focusing on 600 Group Plc where both the market value and the calculated values have a negative

‘value gap’ (destroyed-destroyed result) - Graph 15.

2950

5

1270

0 2415

7

0

5000

10000

15000

20000

25000

30000

[£' 0

00]


Graph 15 - 'Value Gaps' (600 Group Plc)

Similarly, the MVA and the CVA indicators demonstrate a negative number. The historical

determinants of the company’s value monitored over the last ten years (Table 17/Ap1, Graphs

64A/Ap2-69A/Ap2) disclose some from adverse symptoms. For example, the sales growth has been

indicated only in 2006 and 2007 and the overall average in ten years amounts to only 2.02 per cent-

Graph 16. However, the predicted growth has been fixed at 8 per cent, based only on these

successful years. This may explain the twice as high calculated value in contrast with the market

valuation caused by this overestimated driver.

56

Graph 16 - Sales Growth/Shrink (600 Group) Plc.

-20,000

-15,000

-10,000

-5,000

5,000

10,000

[£' 0

00]

change -733 -17,499 -12,379 -1,749 359 4,311 7,673

2001 2002 2003 2004 2005 2006 2007

Besides looking at Graph 66A/Ap2 it can be noticed that a low profit margin is generally falling,

which may reveal inefficient operations and a low productivity. Nevertheless, the predicted margin,

as a second driver, has been perhaps too optimistically set at 5 per cent (demonstrated in Graph 17).

Also, the third driver has not been managed in the past years for the benefit of the shareholder value.

The investment activities since 2007 have been reduced and even in 2009 the company experienced

a divestment seen in Graph 18.

57

Graph 17 - Operating margin (600 Group Plc.)

-12.00

-10.00

-8.00

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

[%]

Operating margin

Predicted margin

Linear (Operating margin )

Graph 18 - Investment (600 Group Plc.)

-400

-200

0

200

400

600

800

1000

2006 2007 2008 2009

The return on capital employed recorded in the past performance has been captured by Graph

69A/Ap2, where several investment loses have been identified. A brief conclusion can be cited that

all three drivers have not been handled well in sense of their mutual balance and the company’s

capabilities. Consequently the market takes in an account the last results influencing investors’

perception about company’s capabilities to generate future cash.

4.5. Appreciated Share Price

The value at which the shares are traded on the Stock Exchange depends on the market's

perception of the value and the prospects of the company expressed by the share price. The

comparison between the historical prices and the earnings per share has been summarised in Tables

19.1/Ap1-19.11/Ap1. Graph 19 illustrates the historical prices extracted from ADVFN

(http://www.advfn.com/lse/londonstockexchange.asp). Spirax-Sarco Engineering and HC Slingsby

Plc have been priced as the most successful in the last six years. Weir Group’s performance has also

58


been highly appreciated by the steadily growing price in contrast with Hamworthy’s falling price

since 2007. Furthermore, Pressure Technologies Plc is well assessed by the last stable price over the

last three years. If we link the share price expressing investors’ anticipation to the ‘value gaps’

analysis (Graphs 65A/Ap2-74A/Ap2) similar conclusions can be made. By analysing Spirax-Sarco

Engineering, Weir Group, Hamworthy, Pressure Technologies and MS International a ‘positive

value gap’ has been identified, causing a value-added creation (their effort is appreciated). Although

by Slingsby Plc the value destroying has been found to be related to market capitalization (not to

calculated value) the share price has been valued highly. However, by looking at the figures in more

detail the difference between the book value and the market value is insignificant in comparison with

the other gaps. On the other hand, the researcher has observed that the calculated value corresponds

more with high market price.

Graph 19 - Historical Share Price (LSE)

0.00

200.00

400.00

600.00

800.00

1000.00

1200.00

1400.00

2004 2005 2006 2007 2008 2009

[pen

ce]

HAMWORTHY

SPIRAX-SARCO ENGINEERING

WEIR GROUP

HC SLINGSBY

600 GROUP

CLYDE PROCESS SOLUTIONS

PRESSURE TECHNOLOGIES

MOUNT ENGINEERING

MS INTERNATIONAL

GAS TURBINE EFFICIENCY

Finally, the relationship between earnings per share (EPS) and share price made in Graphs 70A/Ap2-

79A/Ap2 has revealed the disparity of these market indications and that they are not always related

to each other. As an example, Hamworthy’s EPS-Price relation can be demonstrated when the EPS

has increased despite of the falling price since 2007 – Graph 20.

59

Graph 20 - EPS-share price relationship (Hamworthy Plc.)

0.00

100.00

200.00

300.00

400.00

500.00

600.00

2005 2006 2007 2008 2009

[pen

ce]

EPS basic

Share price

A similar contradictory pattern has been found within Clyde Process Solution and MS International

businesses. The last Graph 21 shows an appreciation of company’s value through the P/E ratio

which is a very important stock market ratio indicating the relationship between earnings per share

and the price of the share. The polygons representing the ratio magnitude separately in each annual

year tell us how attractive the company seems to be for the investors in order to pay a multiple of the

company's earnings for a single share. Gas Turbine Efficiency and 600 Group Plc have been

excluded from this comparison because of their negative EPS. In 2009 (green polygon) the shares of

Mount Engineering have been at the most appreciated when investors have been prepared to pay

more than four times of the company’s earnings for a single share, which amounted to £8.2. Also

MS International and Spirax-Sarco Engineering have had a high P/E ratio in contrast with

Hamworthy or Clyde Process Solution Plc. Moreover, because of the highest P/E ratios in

consequent three years Mount Engineering’s shares have become the most attractive to buy out

related to the EPS despite of the fact that both the market and calculated values have been lower than

shareholders funds stated in the balance sheet (the negative gaps identified value destroyed).

Nevertheless, the cause of this contradiction was not included in the scope of this study and the issue

can be subjected to the further investigation in the future.

60

Graph 21 - P/E ratio comparison

0.005.00

10.0015.00

20.0025.0030.0035.00

40.00HAMWORTHY PLC

SPIRAX-SARCO ENGINEERING PLC

WEIR GROUP PLC

HC SLINGSBY P L C

CLYDE PROCESS SOLUTIONS PLC

PRESSURE TECHNOLOGIES PLC

MOUNT ENGINEERING PLC

MS INTERNATIONAL PLC

2005

2006

2007

2008

2009

4.6. Market Position Analysis

Applying the knowledge about market measures extracted from LSE Company Profile

(http://www.advfn.com/lse/londonstockexchange.asp) and using calculated values the strategic

control charge determining the company’s market position can be compiled. This may also evaluate

the extent to which the calculated figures may change this position against market’s appreciated

values. Graph 22 has been constructed through the MBR index and the company size showing the

strong position of Weir Group Plc (circle C) in complete control quadrant (I.) of the map. That

means that this company generates a high return from a large capital base with competitive

advantages that give it a high market share. This type of company tries to protect its position against

new competitors whilst making use of the new opportunities to grow. The companies Spirax-Sarco

Engineering and Hamworthy (circles A,B) are allocated in limited control through performance

quadrant (II.), though Hamworthy is in a more vulnerable position. These companies usually obtain

high returns from a relatively small amount of invested capital. Other organizations have been

distributed in quadrant III of vulnerable companies with small amounts of financial capital and

generating rather low returns. These companies need to either improve their performance through

appropriate value drivers’ management or divest some of their businesses activities and reinvest the

capital to more attractive ones.

61


Graph 22 - Strategic control charge: MBR-Size

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

-100000 0 100000 200000 300000 400000 500000 600000 700000 800000 900000

Size (book equity in billion)

Perf

orm

ance

(MB

R)

AG

I

IV.

Graph 81A/Ap2 shows the changed positions of the allocated companies after the CBR ratio has

been employed in the analyses. Hamworthy keeps the similar place, however, Weir Group and

Spirax-Sarco Engineering have fallen due to the lower manually calculated value against market one.

Weir Group in its new position of limited control (due to size) would produce low returns on capital.

Still despite of its poor performance it would be difficult to acquire this company because of their

large size.

4.7. Questionnaire Appraisal

The questionnaire designed to reveal the lingering inclination of managers to pursue profit figures

rather than cash-flow creating long-term value in the future business has been sent out to 39

corporations operating in the industrial machinery sector (Group 2757 in FAME) that are listed in

London Stock Market. The list of companies involved in the survey has been attached in the

Appendix 5. Depending on the availability of information one hundred direct e-mail address of these

firms have been collected mostly from their web pages or official contacts stated in LSE Company

Profile. The researcher’s aim has been to question one firm through different e-mail address and

different people in order to increase a rate of responses. Unfortunately, only a few questionnaires

have been returned whilst other recipients failed to reply. However, after adding more companies 38

respondents have been involved in this investigation. Total rate of responses related to the addressed

enterprises amounted to 16 per cent (6 responses) and 11 per cent of the positive responses has been

achieved - 4 questionnaires completed (R1 – Clyde Process Solution Plc by director of marketing,

R2 – Charter Plc by marketing manager, R3 – Castings Plc by managing director, and R4 – HS

62

C

III.

II.B

Holdings by group chief executive). The total response rate (subsidiaries, departments, and

headquarters) was 7 per cent from one hundred e-mails. The questionnaires have been sent in May-

26, 27, and 28 and resent again in June-7 to enhance a rate of responses. Three weeks later, the

results have been collected and equated to a ‘model response’ (compared with the questionnaire

answered in advance by the researcher himself who responded in sense of value maximization).

After evaluating respondents’ feedbacks the correctness of hypothesis about earnings emphasising in

current businesses and short-term approaches applying by today’s managers has been identified. The

expected answers to the survey questions pursuing the value-based view have been marked in the

analysis, seen in Appendix 4 (crosses have been hidden in questionnaire sent to participants). The

response frequency to each question the value-based approach (VBA) percentage, the profit-based

approach (PBA) and the VBA/PBA ratio indicates a superiority of the short-term approach primarily

focusing on earnings and sacrificing long run strategies. The total VBA amounts 25 per cent against

75 per cent represents profit maximization. Each question is provided by graph showing the

VBA/PBA ratio (seen in Appendix 4). There has been found straightforward evidence in the

responses to the first question what goal the managers prefer (50 percent VBA, 50 percent PBA). A

similar conclusion can be made from the answers to the second question after an alternative option

has been judged by researcher as identical with the ‘value approach’ option. Even the third question

was surprising by the non-value technique preferred for measuring the company’s success. By all

questions the responses have been mainly expected, however, however, the critique can be expressed

by sixth question when one participant has referred to obscurity of offered options. Also

contradictions have been found among the replies such as a contrasting view by fourth respondent

(R4) who prefers share price enhancement as a financial goal in the first question and then in the

second one the same respondent underlines profit margin as the main driver increasing value. This

inconsistency in responding may result in ambiguity. Further, the low rate of responses lowering the

credibility of the results could cause some uncertainties; however this questionnaire has been aimed

to have only a supporting function for this study, although it may be developed in other studies.

5. DISCUSSION AND CONCLUSSION:

Many issues, regarding to the company valuation, financial value driver management and value

maximization have been examined and discussed in this study project with its outcomes disclosing a

reciprocal linkage among the value drivers, the sensitivity of the value drivers (associated with the

shareholder value), the value-creating strategies (meticulously analysed and based on a characteristic

set of value drivers in the ‘equilibrium position’) and the capability of an organization to use them in

given business climate. The performance profiles of all selected companies have been examined and

the core value drivers have been determined using an individual judgement about the companies’

potential and competencies. Furthermore, the shareholder value added has been derived from the 63

DCF method for a comparative analysis and the results have been confirmed by alternative value-

creation metrics. Because of the assumptions and simplifications made with regards to investors’

anticipation, the examined outcomes could serve as a benchmark to assess any manufacturing

company’s performance. A fundamental part of this investigation has been a comprehensive analysis

of how to control the value drivers in order to encourage value maximization by projecting value-

maximizing strategies, based on the ‘strategy option 6’ investigated in the case study stage. The

conclusion of this analysis is that only stimulating sales activities without profit improvements does

not create value and in order to encourage growth, a company needs to be made more efficient by

applying an appropriate level of investment. In Part B of the examination the ‘strategy triangles’

have been introduced as an original element, invented by the researcher, illustrating both the

equilibrium position of each company and its estimated confidence limit for improving the

shareholder value. The ‘driver gap’ analysis, which enables to recognize insufficiently managed

value drivers, and the position and asymmetry of the ‘strategy-triangle’ shapes, may suggest a new

proposed strategies. Furthermore, the ’value gap’ analysis, which determines a reduction in the value

added has been identified in selected corporations, which either neglect value-creation strategies or

pursue a value-destroying policy. Moreover, this makes the evaluation of the competitors’

performance possible as well as the analysis of the tactics used by the rivals. Value-destroying

factors have consequentially been investigated by the company that performed the greatest ‘negative

value gaps’, associated with the rationalisation. The rationalization-strategy options, provided in the

analysis, have supported the hypothesis about the rigorous-cutting-costs management having value-

destructing consequences in long-term view and thereby causing a decline in the price movement.

Moreover, the value-based thinking by present-day managers was compared to the accounting-based

approach, which continues to exist in some but a few organizations, using a questionnaire, which

resulted in a confirmation of the proposed hypothesis that the short-term view is not the best long-

term solution to the successful management of value drivers.

Nevertheless, this study project confirms the known fact that the present-day financial

management is not concerned with precise numbers, but about what lies behind the numbers. This

dissertation proves that the value-based management is not a mechanical discipline. Managers using

a cash flow-based analysis have to prognosticate realistic numbers for the future plans, in order to

avoid overestimating predicted value drivers, overinvesting and projecting unbalanced drivers. The

value-based management is a process requiring a sensible judgement and a careful consideration of

the results and their sensitivity to the input numbers. It requires the appreciation of the potential

impact of different judgements on the input variables, which are applied to numbers of the

alternative strategic options and therefore strongly affect the shareholder value. This work may help

business managers to alleviate their tendency to take an action in achieving particular short-term

targets at the expense of long-term wealth and the insights provided by this study will hopefully

64

enable managers to uncover driver management issues in dealing with complex factors affecting

their business. Hence the numbers of varied value creating strategies based on the easily affected

relationships between key variables are provided in this work. In the end, the golden rule arising

from this project is that if the firm want to succeed the key value drivers must be managed in the

way that drives them to maintain a consistently superior shareholder value.

REFERENCES:

Books:

Arnold G., (2008), Corporate Financial Management, Harlow-England, Pearson Education Limited

Bryman, A., and Bell, E., (2007), Business Research Methods, Oxford, Oxford University Press

Cassidy, D., (2003) ‘Maximizing shareholder value: the risks to employees, customers and the

community’, Corporate Governance, Vol. 3 Iss: 2, pp.32 – 37, MCB UP Ltd

Cooper, D.R., (2008), Business Research Methods, New York, McGraw-Hill Companies, Inc.

Dockey, E., Herbert, W.E., Taylor, K., (2000) ‘Corporate governance, managerial strategies and

shareholder wealth maximization: a study of large European companies’, Managerial Finance, Vol.

26 Iss: 9, pp.21 – 35, publisher MCB UP Ltd.

Doyle, P., (2000), Value-Based Marketing – Marketing Strategies for Corporate Growth and

Shareholder Value, London, Wiley & Sons, Ltd.

Easterby-Smith, M., Thorpe, R., Jackson, P.R., (2008), Management Research, London, Sage

Publication Ltd.

Financial Times, 7 May 1996, Lex column

Grant, R., (2002), Contemporary Strategy Analysis-Concepts, Techniques, Applications, Oxford

Jankowicz, A.D., (2005), Business Research Projects, London, Thompson Learning

Lowell L., Lyons, T.G., and Rosenthal, J., (1998), Corporate strategy in a globalizing world: the

market capitalization imperative, USA, McKinsey

65

Morin, R.A., and Jarrell, S.L., (2001), Diving Shareholder Value: Value-Building Techniques for

Creating Shareholder Wealth, McGraw-Hill Companies, NY-USA

Shleifer, A. and Vishny, R.W., (1988), ‘Value Maximization and the Acquisition Process’, Journal

of Economic Perspectives-Volume 2, Number 1-Winter, Pages 7-20

Rapport, A., (1998), Creating shareholder value, revised and updated edition, New York: Free Press

Sekaran U., (1992), Research Methods for Business, New York, John Wiley & Sons, Inc

Wallace, J.S., (2005), Value Maximization and Stakeholder Theory : Comparable or Not?, Journal

of Applied Corporate Finance, Volume 15 Issue 3, Pages 120-127, published on line: 11 Apr

Wheeler D., Sillanpaa, M., (1997), The Stakeholder Corporation- A Blueprint for Maximizing

Stakeholder Value, London, Pitman Publishing

White, B., (2002), Writing your Dissertation, London, Continuum

Web Pages:


http://www.ft.com/markets/company

http://www.londonstockexchange.com/exchange/prices-and-news/stocks

http://www.fame.bvdep.com/version-2010608/cgi/template.dll.

whttp://www.hamworthy.com

Other sources:

Interim Report 600 Group Plc., RNC Announcement, released 23 June 2009

66


vd dissertation

Documents