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Shareholder Value Article Critique

Shareholder Value Article Critique.

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pages: 10

Topic:

Business Article Critique, add/edit

Type of paper:

Essay (any type)

Discipline:

Business and Management

Format or citation style:

APA

Instructions:

This assignment requires you to critically analyze the given article in a way that is more than just summarizing or providing your opinions.  A good quality critical analysis should contain citations from relevant research resources to support your opinions with authority. Synthesizing credible research resources is an excellent way to critically analyze a variety of arguments.

Analyze the validity of finance and value creation arguments.

What are the facts and data upon which those arguments rest?

How do these facts validate or invalidate the author’s arguments?

Assess the use of financial persuasion to support the arguments.

What financial persuasion elements were present?

Were any financial data or facts omitted?

Analyze the financial implications of the author’s arguments.

What does this mean for the organization?

Are there implications for constituents and interested parties?

Synthesize your analysis of the article and your observation of the finance function at your workplace, or a major publicly rated corporation.

What new or deeper understandings do you have about the finance function?

What other insights do you have about the finance function? Use the arguments, facts, data, and financial persuasion elements from the article to support your understanding of the finance function.

Shareholder Value Article Critique

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This is an article critique of Alfred Rappaport’s “10 ways to create shareholder value”. It will analyze the finance and value creation arguments as presented by Alfred. It will analyze the facts and data that validate or invalidate the arguments, assess the financial persuasions that support the arguments and the financial implications of the discussed arguments towards the company applying them. The financial function of this author’s arguments will be discussed to establish their relevance and application in a workplace setting.  The author’s arguments will be analyzed thoroughly to establish any data omission along the way. Finally a general conclusion will be given to bring every aspect in the discussion together.

Shareholder value is the value enjoyed by persons who possess shares in a company once the management is able to grow earnings, sales and free cash flow over time. Simply it is the value delivered by the company to the shareholder. It is made up of the present value of cash flows during the value growth period and the long-term, residual value of the business at the end of the value growth period (Srivastava, Shervani, & Fahey, 1998).

The number of shareholders vary with the size of the company. Their roles in the company include financing, governance and business operations.  Therefore, it is any company’s priority to create and increase the shareholder value to cultivate the success of the business.  It is crucial for the management team to mind the shareholders interest during company’s decision making to such that they influence the value positively.  

High shareholder value imply better management and progressive company. In order to realize the high values, the management is expected to make efficient decisions that increase profits/earnings which leads to increased shareholder value. Faulty decision making process might involve actions that might damage the shareholder value to end up in decline. In other words, shareholder value a technique to determine if a company is or is not creating more wealth for the owners and if the management is putting up policies and making decisions that work towards this goal.

The shareholder value is accrued when the company returns are above the cost of capital generating them. Whenever a company sustains returns on capital above its cost of capital then value is created for its shareholders (Institute of Management Accountants). Usually, an increase in shareholder value will increase stockholders entity amount as listed in the financial statements. The executive officers and top management not only include the duties of running the company but also paying attention on the market expectations of the produced goods and services. Every decision taken should work towards improving the status of the company both in the short term and the long term.  The current article address how companies can rectify their approach on shareholder value.

The creation and improvement of shareholder value is imperative to the success of an institution. Rappaport describes, with deep insight, 10 principles that organizations can incorporate in their operations to create and increase shareholder value. Author Rappaport gives detailed formation on how the principles can affect the organizations in a positive way when an organization takes them up and how they can affect the institutions that fail to apply them (Rappaport, 2006). He has used simple techniques together with real life examples effectively to help identify the crucial areas can be restructured by the company to help create or improve stakeholder value. The author has presented the article in a clear, simple and concise manner such that the readability is easy and high.  

Rappaport main argument is that the ten basic performance principles will lay a better foundation for every company in its business model towards the creation of shareholder value. According to him, very few companies implement ten principles he has laid down and even those that have attempted to implement them, they still hold back a number of the principles. The application of the explained principles is set to serve the long term interests as far as the shareholders are concerned. The author points out that the actual benefit that the company gains is as a result of the enhancements made to the long term growth strategy by the share-holder value orientation. He implies that most companies focus on short termed goals and gains in order to realize the targeted quarterly earnings. He points out that laying focus on the short-term performance measures will in most cases fail to deliver value creating growth. The concentration on the short term gains denies the company the opportunity to develop long term growth as it is forced to pay more attention on the existing operations.

According to the Alfred, those businesses that take up most of their time on the core businesses end up in situations where there is no time to get into new ventures and opportunities. The article explain principles first introduced by Berkshire Hathaway. He identifies and applauses the attempts made by the company and provide steps that he deem relevant. Just like Hathaway, the decision is to be made with the future implications to the company value rather than the now and current quarter earnings statement (Dial & Murphy, 1995). The author provides financial persuasion elements in the article and displays the negative consequences of delaying the start of a company project for the sake of making the quarterly report look better, not realizing the lost opportunities that can generate.

The article explains how financial persuasion is utilized and financially viable content is created. The above is achieved through statements on how organizations should conduct themselves and progressive comparisons with facts and examples. For instance, the first principle explains that a company simply trying to attain a good looking earnings statement will push accounting to the limit where it can no longer meet investor expectation and crash, since the main principle guideline was a cash flow figure rather than shareholder value (Rappaport, 2006, p. 69).

Another notable statement by Rappaport is the encouragement of a balanced reward system for the management and frontline employees to create a sense of engagement, accountability, and drive for the company. The author goes on to point out the flaws and negatives of some current stock plan reward systems and how the success of one team may benefit another in the company without any engagement and vice versa. A balanced reward system should be in place to encourage and promote the efforts of those who deserve the appreciation (Ward, 1997). The mandatory stock entitlement position by the top management, where the head should be required to keep and receive earnings in the form of company stock and be required to maintain such position motivate them to enforce plans that increase the earnings. This way, according to the author, they are rewarded for success in the business and punished whenever losses are experienced.

Also, Rappaport describes and displays a financial argument in the area of investor reporting. To stay in the spirit of the principle of shareholder value creation, relevant value intrinsic information should be provided. Since the focus is on the value, a figure that represents value should be also the main number to look at for the investor and the way it represents the future benefit in the world of business (Penman, 2007). Towards the end, author provide a summary of the key points and steps he has discussed. He justifies the validity of following the principles truly in regards to value creation versus a blunt dollar figure on a statement. The principles might appear risky but his rweassurance throughtout the article is appealing for any compay.

Analyzing the validity of finance and value creation arguments.

In general cases, the study of Finance focuses on the numbers, statistics, ratios, and estimates. The current article fail to provide guidance on finance specifically. Instead, Rappaport concentrated the paper’s focus on the higher business goal and objectives. These objectives being to seek value creating rather than a specific goal of attaining a number on the balance or income sheets to satisfy those looking for it in their investment overviews.            The underlying principle of Rappaport’s paper conveys the message to the reader and urges business management to succeed in business by firstly attaining a quality service or producing a good, a means of conducting business, and by doing so, the financial figures would, secondly, reflect positively to the effort exerted.

Shifts in shareholder value creation for a company from decision making process that involve low near-term earnings to ones involving long term earnings is a huge step that might face some resistance from manages or shareholders. As stated earlier on, most companies set value on quarterly earnings and short term gains. Going through the ten principles that the author has provided one can derive that it is possible for a company to undergo the shift in order to realize the long term earnings. The shift might be made at the expense of the short term performance leading to low performance and earnings. However the long term earnings outweigh the previous earnings.

Rappaport presents a valid financial argument by promoting the business goal and a valuable overall impact on the customer or consumer which would lead to positive future growth in revenues and profits. He backed up his arguments with clear examples of how decisions made not to apply his ten principles to create shareholder value can adversely affect the company.  It might cause potential misguided goals and achievements for management. Mr. Rappaport has issued several popular businesses in the article to support his ideas and arguments.

The author also supplements this argument and enhances his paper’s objective by touching upon examples of negative financial impacts that are a result of business goals circulating around a monetary figure or number to impress business investors. In the negative example, author re-iterates the negative consequences of un sustained growth that derails the company’s future.

Very similar principle and concept also exist in financial journals, Journal of Organizational Science, which also sees the financial potential of business’s goal with the emphasis of value creating and value focus as the primary means to guide the financial future growth force. According to Freeman, Wicks, & Parmar (2004), “values are necessarily and explicitly a part of doing business.

Assessing the use of financial persuasion elements to support the arguments.

Rappaport follows up the business value creating with supporting examples of positive business results, such as that of Berkshire Hathaway, and the negatives elements of financial downfall such as diluting the bad news, delaying the deployment of a business project venture to show a better balancing figures for that quarter, acquisitions that don’t have much value and don’t contribute the future of the company, some such historical examples are Enron, WorldCom, and Nortel Networks.

It is not enough to just deliver a personal point of view; the opinions have to be enhanced with evidence and examples in the real business world situation. As Chen, Yao, & Kotha, (2009), put it: “a study that consistently showed that preparedness, not passion, positively impacted decisions to fund ventures” (p. 199). Rappaport provides practical examples and their implications on the success of the business, utilization of unused cash, as well as go over the importance of an effective reward system for CEO, management, and stakeholders in the company.

To further improve on the persuasive factor with supporting arguments, the author may provide more concrete examples or examples of a specific situation. Reason for that is that Rappaport assumes the reader is already aware, business rounded and familiar with such negative examples as Enron, but there are many examples of successful companies which may have had a more short-sighted approach to their business model prior to changing the outlook for a value-oriented path. For instance, the changes that Yahoo Inc. underwent to change its course from failure to value creation view and provide a solution where the customer demand was met (Morris, Schindehutte, & Allen, 2005).

Analyzing the financial implications of an author’s arguments.

There are high financial consequences to the principles that Rappaport is sharing in the article, as they touch on the core strategic business resolve. A company might spend significant time and capital to implement the principles in the business but according to the author, the outcomes are appealing. According to Narver & Slater, (1990), “for an organization to achieve consistently above-normal market performance, it must create a sustainable competitive advantage. That is, it must create sustainable superior value for its customers“(pp. 20-21). This principle isn’t just creates positive figures, and ratio’s on the balance sheets, it lets the business survive and prosper above others, securing its future existence.

Furthermore, Narver & Slater, (1990), states “if a business rewards every functional area for contributing to creating superior value for customers, self-interest will lead each area to participate fully” (p. 22). Similar to the Rappaport’s principle recommendation in awarding for valiant performance in order to succeed in business goals, this point is necessary for continuous future growth and a healthy financial outlook of the company, as would be expected of a level 10 venture. As the employees strive to attain the rewards, they work hard to improve the earnings such that they benefit both the company and themselves. It is in the verge of shareholder value creation that profitability is experienced by the company (Atiyet, 2012).

Similarly, not having the value principle in place would lead the business to customer value disconnect and would translate into a negate future financial impact displayed by the lack of new customers, profit loss, business downsize, high pressure to perform, desperation, and failure (Godfrey, 2005). Most companies prefer laying their focus on the short term gains as they seem higher given the time period. Those that have implemented the ten principles to increase the shareholder value eventually ends up with higher earnings. Therefore the companies that seek to shift their operation to the long term mindset are set to increase their financial returns.

Synthesizing an analysis of the article and observations of the finance function at a workplace.

Rappaport’s article touches on a much larger subject, the goal hierarchy in a business sense must be valued, and from that everything else will follow. As the author mentions that the first principle would be considered the most pertinent one and that finances are there to support the business goal, and fulfill the company’s objective, it is not the goal but the means of achievement. The company might have great finances at hand but still encounter low earnings. Goals might have been instituted by a company but the labor force in the company is crucial in their realization. Appreciating and reprimanding the workforce whenever the situation requires one to do so help streamline them and improve output in the long run.

Applying such a principle in a workplace environment would enable one to view the financial bookkeeping and monetary organization as a support vehicle for the business’s main role of contributing a value that is demanded and needed by the end client who is willing to compensate for the return of good or service. Understanding that it is not the financial statement the all the operations revolve around, but rather a required, accepted by all, and expected extension to the higher role of the company substantiating its deed to those requesting it in exchange for monetary value. As Jensen (2010) puts it: “managers should attempt to balance the interests of all corporate stakeholders, including not only financial claimants…top management must provide a corporate vision, strategy, and tactics that will unite all the firm’s constituencies in its efforts to compete and add value for investors” (p. 32).

The principles integrates all the entities and the business setting from the lowest level holder to the highest. The top management shares the business risks as it is considered as part of the shareholders. Therefore, every decision that it makes will be for the best of the company in the long run as it expect to gain from the shareholder value. The rewarding and recognition of every business entity from the junior employee to the chief executive officers motivate them to perform their duties in a way to maximize returns as outlined in the article. Eventually, incorporating the principle in a work place setting create a sense of responsibility in the attainment of the long term perspective set by the management in its aim to increase the shareholder value be it through new acquisition or any other proposed way.

The function of the finance should not be to hinder the progress or goals of a business but to better it instead. Rappaport makes it evident in the article in nearly all the principles by letting the reader know that financial function is to sustain, maintain, and help grow the venture and not to postpone, slow down a project, or hinder the business. The proposed manner might decline short term return but if correctly effectively it might benefit the company in the long run. The author purposely present some businesses that have actually reaped the benefits of the institution of the principles. So if the principle have worked in the discussed businesses they can work in other work place setting.

Conclusion

Rappaport provides a viable financial guideline in the ten ways a company may hold the principles true to the value of the entity and shareholders. The main principle of not merely displaying numbers that look good, but the usefulness of the company in the future and the value it may bring to shareholders and others. The article might not be a perfect and flawless guide. However, it shows what a level 10 company is and the how it operates from within. Rappaport shows valid financial arguments by pointing out the need for a balanced reward system for the CEO, management, and employees such that they all feel part of the last outcome and their efforts are appreciated. He points how a company can have all its entities fully committed to the company’s cause, without being too much conservative, in taking any necessary risk to push the business forward. The article has provided convincing support for its arguments by providing existing and known business that have either implemented the principles or failed to implement them.

References

Atiyet, B. A. (2012). The impact of financing decision on the shareholder value creation. Journal of Business Studies Quarterly, 4(1), 44.

Chen, X. P., Yao, X., & Kotha, S. (2009). Entrepreneur passion and preparedness in business plan presentations: a persuasion analysis of venture capitalists’ funding decisions. Academy of Management Journal, 52(1), 199-214.

Dial, J., & Murphy, K. J. (1995). Incentives, downsizing, and value creation at General Dynamics. Journal of Financial Economics, 37(3), 261-314.

Freeman, R. E., Wicks, A. C., & Parmar, B. (2004). Stakeholder theory and “the corporate objective revisited”. Organization Science, 15(3), 364-369.

Godfrey, P. C. (2005). The relationship between corporate philanthropy and shareholder wealth: A risk management perspective. Academy of management review, 30(4), 777-798.

Institute of Management Accountants. “Measuring And Managing Shareholder Value Creation.” Statements on Management Accounting; BUSINESS PERFORMANCE MANAGEMENT. N.p., 1997. Web. 18 Mar. 2018.

Jensen, M. C. (2010). Value maximization, stakeholder theory, and the corporate objective function. Journal of applied corporate finance, 22(1), 32-42.

Morris, M., Schindehutte, M., & Allen, J. (2005). The entrepreneur’s business model: toward a unified perspective. Journal of business research, 58(6), 726-735.

Narver, J. C., & Slater, S. F. (1990). The effect of a market orientation on business profitability. The Journal of marketing, 20-35.

Penman, S. H. (2007). Financial reporting quality: is fair value a plus or a minus?. Accounting and business research, 37(sup1), 33-44.

Rappaport, A. (2006). Ten ways to create shareholder value [Cover story]. Harvard Business Review, 84(9), 66–77.

Srivastava, R. K., Shervani, T. A., & Fahey, L. (1998). Market-based assets and shareholder value: A framework for analysis. The Journal of Marketing, 2-18.

Ward, J. L. (1997). Growing the family business: Special challenges and best practices. Family business review, 10(4), 323-337.

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