It was only at the end of the 1980s and the beginning of the 1990s, with the rise of institutional shareholders, that the discussion on shareholder value arose.
In Germany, the largest economy in Europe, the process began rather late. There are several reasons for this: first, the importance of the German stock market in the world market capital-isation is relatively small compared to the importance of the German gross national product in relation to gross world production; until recently, foreign investors were not very interested in the German stock market; banks in Germany traditionally have always played and are still playing an important, if not a dominant, role in financing trade and industry; self-financing of trade and industry is relatively large; and finally, many German companies - especially the Mittelstand - have used capital raised primarily by their own families.
Italy became familiar with the concept of shareholder value even later which is illustrated by the recent developments involving Olivetti. This family company could no longer appeal to banks for additional financial support so international investors had to be prepared to finance the company and downsizing was promised. When downsizing and the announced management modifications did not materialise - and the profits and the price of the shares decreased - large institutions called the company to account as they saw their shareholder value disappear.
So, what measures can be taken so that the companies’ management create shareholder value? As is shown in the case of Olivetti, often shareholders can only intervene after the damage has already been done. Before then, the freedom of action of the shareholders is limited, because investors themselves do not want to function as managers.
This is the central issue of the unstable relation from which shareholder value has to evolve. Investors want to receive shareholder value without putting in too much effort of their own.
The confidence investors have in listed companies is partly based on regulations requiring the provision of information that is required of these companies. It is also based on the market liquidity. If one investor believes that he will not receive shareholder value and decides to sell his shares to another investor, the buyer of course, will face the same problem. He then will have to ask himself the question of how to convince the management to create shareholder value.
So far, the most important tools that investors have are the regulations set by stock exchanges on information which has to be provided by companies. This information should be adequate and be issued in time so that in-vestors are able to implement their corporate governance tasks.
Information is the main tool investors use to ensure that listed companies create shareholder val-ue. In this re-spect, it is not strange that in-vestors in un-listed companies, venture capitalist or private equity funds, want places on super visory boards - they wish to be as close to the source of information as possible. Such a privilege is not granted in a listed company. In or-der to gain trust and, as a result, liquidity in the market, one in-vestor is not allowed to have more information than another.
So the main tool for the investor to ensure that the company creates shareholder value has limits. Provision of information alone is not enough to structure the unstable relationship between managers and investors in such a way that the process of creating shareholder value will continue.
Information enables investors to measure whether shareholder value is created. To be more precise: to check whether the return of the various actions taken by a company is indeed higher than the cost of capital.
Measuring, however, is done in retrospect. Therefore, the investor who wants a company to create shareholder value will need more tools than this retrospective criterion.
The investor has only two of the oldest management tools at his disposal: one is the carrot” and the other is “the stick”. Though these instruments may be old, they are sometimes still presented as innovations. Recently Daimler Benz implemented their stock option plan for their senior management. Reinstate managers as shareholders, and that will motivate them to create shareholder value. It goes without saying, that this “carrot” is wholeheartedly supported by both investors and managers.
The “stick”, however, encounters more resistance. Shareholders should be able to call the management and supervisory board directors to account, if the increase of shareholder value is not sufficient. It has also been argued that the only possible penalty for this is that shareholders should be able to discharge directors and (a step further) management from their functions.
Although this seems logical, in practice, outside the Anglo-Saxon world, this can be very difficult. The use of the “stick” as a tool to enforce the creation of shareholder value is hampered by a large number of statutory restrictions. Again the unstable relationship is the cause of the problems.
Creating the possibility for investors to discharge and replace management might be seen a bridge too far. The investor himself has no intention of becoming the manager and the first problem he would face is replacing the discharged management.
This dilemma is a problem shareholders will always have to face. Replacement by outsiders is risky, since shareholders rarely understand the intricacies of the company’s business. Replacement of the management should therefore be available within the company. The only alternative is the hostile take-over in-volving another company which - according to the market - has the expertise to replace the management.
But leaving the hostile take-over aside, long-term investors should look into the company’s strategy and management potential in order to secure shareholder value. They can not simply base their investment policy on stock picking, which is based on information provided by analysts, who anyway limit themselves to profit expectations per share in the next year.
The long-term investor in a listed company should, just like the shareholder of an unlisted company, be able to form an opinion on the strategy that is pursued and on the management involved.
In my opinion, shareholder value is merely a new term for a problem as old as human civilisation: how to benefit from the work of others. The fact that the problem does require a new approach, is because the structure of modern listed companies is, from a historical point of view, a new phenomenon. The heart of the problem is one of human nature. Guiding the management by means of adequate and timely information, and by having both the carrot and the stick to rely upon, are necessary.
Han Kleiterp is chairman of ABP Bestuur. This is based on a talk to a Deutsche Bank custody seminar in Frankfurt.