Shareholder Wealth Maximisation

Simply put by Arnold (2008) maximising shareholder wealth means maximising the flow of dividends to shareholders through time. However, the question is do companies really aim to maximise shareholder value or are they more concerned with other objectives?

Take for example Tesco; their primary aim is to penetrate as much market share as possible. However, is this strategy maximising shareholder value or just showcasing Tesco’s obsession with market share. Within the last month Tesco’s share price has taken a substantial nose dive knocking £5bn off the company’s value. The reason for this was a profit warning over poor Christmas sales. A week prior to the event Noel Robbins the chief operating officer sold 5% of his shares in the company worth around £200,000. Tesco explain that Mr Robbins was not in hold of any price sensitive information but sold the shares for family expenditure. (bbc.co.uk)

Whatever the case at Tesco clearly the strategy they are enforcing is not serving the best interests of their shareholders. They have possibly become too obsessed with achieving market share and less so about maximising shareholder wealth. In the words of Finkelstein (2003) in his book why smart executives fail Tesco are “Brilliantly fulfilling the wrong vision”.

The standard norm in assessing how a company is doing is to look at their earning per share (EPS). Investors often use this figure when deciding whether to invest in a company or not. However, it can be a misleading figure and cannot be in the interest of maximising shareholder wealth. EPS offers a narrow focus and may reveal relatively little about the true economic performance of a company. The figure can be manipulated easily. Many companies buy back shares purely to boost the EPS and to indicate to shareholders there is nothing wrong with the company. Just recently the Indian oil giant Reliance Industries bought back $2bn of its shares (Financial Times). This was on the back of an unusually weak quarterly posting of its results in January. Share buy backs may in some cases be the result of the company having too much cash. Therefore to maximise shareholder wealth the company buy shares back reducing the risk of using the surplus cash in risky investments. Coincidentally on buying $2bn of its shares back the share price rose by around 2%.

In order to maximise shareholder value we must set targets for senior management. One such target could be return on capital employed. The problem with setting such targets is that they are open to manipulation. Managers tend to manipulate figures in order to achieve a bonus. However, we’d like to think in most cases that management hit targets through sheer hard work. In the news at the moment is the case of Stephen Hester CEO of RBS. After waiving to political and public pressure he has decided not to take his £1m bonus. In his case he hit the targets required of him therefore he should get his bonus. Not so according to the politicians who believe he has hardly achieved a sterling performance.

The problem now in the banking sector is that they are scrutinised by everyone in what has turned into a lynch mob mentality. What does this mean for shareholder wealth? Well, if top management are not given incentives to maximise shareholder wealth then they are not going to work hard to hit the targets. The problem in the sector is that bonus’s have become common place as a reward for mediocre performance.

The brokerage firm ICAP has announced a squeeze on bonuses (Financial Times), due to weaker trading volumes. CEO Michael Spencer explained “Growth rates and compensation clearly ought to have some sort of relationship. This is good for shareholder wealth maximisation because it means top management are rewarded properly for their efforts. Compare this to another story in the news at the minute regarding the CEO of Trinity Mirror.  Sly Bailey has been criticised by the shareholders of the company for the salary she is on. They believe the salary she takes home is not representative of the size of the company she runs. Sarah Wilson CEO of Manifest points out Ms Bailey is on a FTSE 100 package and the company is not even in the FTSE 250! When Sly Bailey took over the company it was worth £1.1bn now it’s worth £119.1m. This is a problem in the sector because in order to retain the best talent wages and bonuses are spiralling out of control. They are not representative of the work done to achieve shareholder wealth maximisation.