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Shareholder value and Financialization: consultancy promises, management moves Julie Froud , Colin Haslam , Sukhdev Johal & Karel Williams Published online: 02 Dec 2010.

To cite this article: Julie Froud , Colin Haslam , Sukhdev Johal & Karel Williams (2000) Shareholder value and Financialization: consultancy promises, management moves, Economy and Society, 29:1, 80-110

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Shareholder value and Ž nancialization: consultancy promises, management moves

Julie Froud, Colin Haslam, Sukhdev Johal and

Karel Williams

Abstract In the pages of the daily Ž nancial press, ‘shareholder value’ is a loose rhetoric. For business consultants who sell Ž nancial metrics and implementation, shareholder value is also a product and a promise that purposive management action will be rewarded. This paper begins by considering the consultant’s promise and the more guarded aca- demic responses. It then presents empirics on micro performance and the meso limits to shareholder value and argues that most corporate managements cannot easily deliver what consultants promise and the capital markets demand. The paper ends by taking a broader view of value-based management as part of a process of Ž nancializa- tion. If the results are contradictory and disappointing, a persistent gap between expectations and outcomes can nevertheless drive management behaviours, which change the world.

Keywords: shareholder value; Ž nancialization; restructuring; consultants; corporate management.

Copyright © 2000 Taylor & Francis Ltd 0308-5147

Economy and Society Volume 29 Number 1 February 2000: 80–110

Julie Froud, School of Accounting and Finance, Crawford House, University of Manchester, Manchester M13 9PL. julie.froud@man.ac.uk; Colin Haslam and Sukhdev Johal, The Management School, Royal Holloway, University of London, Egham, Surrey TW20 0EX. c.haslam@rhbnc.ac.uk, s.johal@rhbnc.ac.uk; Karel Williams, Graduate School of Social Sciences, Williamson Building, University of Manchester, Manchester M13 9PL. karel.williams@man.ac.uk.

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Introduction

It is difficult to avoid confusion and ambiguity if we begin by asking what, when or where is shareholder value (SV). For SV is not so much a precisely deŽ ned concept with a stable place in one discourse or politico-economic system, as a rhetoric which circulates widely and a thematic which can be variably invoked as cause, consequence or justiŽ cation. Rhetoric can bridge any gap between expec- tations of value and results, just as thematics can migrate effortlessly from one form of capitalism to another. From this point of view, it may seem pedantic and irrelevant to ask directly whence SV came, where it goes or what it portends; hence also, the hugely different verdicts on shareholder value which has been variously characterized as epochal revolution or mere fad and quite possibly is both.

To clarify these confusions and ambiguities, this article begins by exploring the discursive and structural limits around some of the Anglo-Saxon social actors who use the language of SV, before turning to issues of more general signiŽ cance. It starts in the Ž rst section by examining the offer of a group of key intermediaries, consultancy Ž rms, for whom shareholder value is a product because value-based management is what they sell to corporate managers struggling to meet stock-market expectations. It then considers, in the second section, the academic responses to SV as a development that can be endorsed or resisted. The inconclusiveness of this response is set in context by an argument in the third section about micro performance and meso limits and the real gap between what corporate management can deliver, what consultants promise and the capital markets both require and create. This argument draws on, and is empirically illustrated with, data on UK companies and sectors. On this basis of argument and evidence, the Ž nal section of this article offers a broad but nuanced interpretation: if management can deliver less than the consultants promise, the contradictory processes of Ž nancialization do change the work of management under late capitalism.

Consultancy metrics and promises

If shareholder value has become the business cliché and social mantra of the 1990s, it began life as a consultancy product of the 1980s. LEK/Alcar’s one- time principal Alfred Rappaport and Stern Stewart’s co-founder Bennett Stewart were the leading boosters, through quasi-academic business texts like Rappaport’s Creating Shareholder Value (1986) and Stewart’s The Quest for Value (1991). The product has several elements that we can consider separately and in turn: the metrics including registered trademarks; the implementation and incentive packages; the guides to action and the promise that purposive manage- ment action will be rewarded.

Every consultancy Ž rm must have a metric of its own or so it seems. And this rule applies not only to new consultancy Ž rms like Stern Stewart and

Julie Froud et al.: Shareholder value and Ž nancialization 81

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LEK/Alcar which have been built on Ž nancial metrics but also to long- established Ž rms like Boston which were previously identiŽ ed with strategic consultancy but now have a ‘value management practice’ (Myers 1996). So, Stern Stewart’s Economic Value Added (EVA™) and Market Value Added (MVA) contend with LEK/Alcar Consulting Group’s Shareholder Value Added (SVA) and Holt Value Associates’ Cash Flow Return on Investment (CFROI). Not to be outdone, McKinsey has Economic ProŽ t, while Boston Consulting Group has its own version of Cash Flow Return on Investment (CFROI) and Total Shareholder Return (TSR) (see Figure 1). The international accounting Ž rms, such as Price Waterhouse Coopers and Arthur Andersen (1997), have also joined in with their own recipes for measuring and creating shareholder value.

There are differences between the consultants’ shareholder value packages. Some consultants, like Stern Stewart, adopt a ‘one best way’ approach and explicitly promote one metric and its associated implementation package for all clients. Others, such as Boston Consulting Group (BCG), recognize a range of measures and offer to choose appropriate metrics for individual clients (1996a: 11). A memo to BCG consulting staff, which accompanied a booklet in their Shareholder Value Management Series, explained:

You should note that the positioning in Booklet 2 is that BCG understands the entire spectrum of value-based measures and works with clients to estab- lish the most appropriate measurement approach for their culture, appli- cations, and capabilities.

(The Boston Consulting Group 1996b)

Some established Ž rms, such as Price Waterhouse, adopt a more eclectic approach, combining value metrics with other measures and techniques such as scorecards, identiŽ cation of value drivers and value chain management in ‘an approach which energizes a corporation to enhance shareholder wealth’ (Price Waterhouse undated: 2).

The metrics are powerful because they allow a ranking of performance, although, in technical terms, they are relatively straightforward, even banal. The most widely used new metric, EVA™, for example, is a residual income measure which shows whether the Ž rm in one year earns more than its weighted average cost of capital. The relation of EVA™ to MVA is straightforward insofar as it is assumed that the market price incorporates expectations of future earnings and MVA thus becomes the discounted present value of future EVA™. What the con- sultancy Ž rm adds to create a market-leading proprietary product is a series of adjustments to accounting measures of earnings and capital and an acronym. Stern Stewart, for example, capitalize research and development expenditure and goodwill which has the effect of in ating the value of the company’s capital base and thereby reducing the lump of EVA™. Practically, the Ž ve to ten key adjustments which Stern Stewart would make in the typical case are important because they increase the proprietary element: although any corporate Ž nance director can calculate residual income, only Stern Stewart can make the adjust- ments which produce EVA™.

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Julie Froud et al.: Shareholder value and Ž nancialization 83

CFROI: `HOLT calculates the CFROI (cash  ow return on investment) in two steps. First HOLT measures the in ation-adjusted (current dollar) cash  ows available to all capital owners in the company and compares that to the in ation-adjusted (current dollar) gross investment made by those capital owners. Next, HOLT translates the ratio of gross cash  ow to gross investments into an Internal Rate of Return (IRR) . . . the CFROI is directly comparable to the shareholder return investors expect to receive, i.e., their cost of capital or discount rate’ (HOLT Value Associates undated: 4).

EVAª : `EVA™ is deŽ ned as the net operating proŽ ts after tax, minus the required rate of return on capital employed’ (Corporate Finance 1991: 34). ‘Companies have a clear directive with EVA™ to improve returns earned on existing capital, to invest in projects that earn returns above the cost of capital and to sell assets that are worth more to others’ (Milano and Schwartz 1998).

MVA: `Market Value Added (MVA) [is] the difference between the current value of a company and the total invested capital. MVA reveals how well each company has performed over the long term in using its resources to create value. . . . But it is hard to manage for MVA because of share price volatility, the difficulty in seeing the impact of decisions on MVA and the inability to measure MVA deŽ nitively at various levels within a company. That is why Stern Stewart invented EVA™’ (Milano and Schwartz 1998).

SVA: Arthur Andersen calculate Shareholder Value Added as ‘net operating proŽ t after tax (NOPAT) less a capital charge. . . . SVA can be enhanced by focusing on its four components: revenue and expenses (NOPAT), capital (value of assets), and cost of capital (adjusted for risk)’ (1997: 5). ‘The true power of SVA-based management is that it provides a single focal point for strategic decisions, resource allocations, and performance management’ (1997: 3).

SVA: According to Alfred Rappaport, a principal of LEK/Alcar, Shareholder Value Added (SVA) is ‘the amount of value created by the forecasted scenario. While SV characterises the absolute economic value resulting from the forecasted scenario, SVA addresses the change in value over the forecast period. Recall that value creation results from corporate investment at rates in excess of the cost of capital rate required by the capital market’ (1998: 49).

TSR: `The individual investor’s and professional fund manager’s scorecard is the total shareholder return (TSR) of their portfolio. TSR is the combined capital gain and dividend yield of the stocks held in the portfolio and is usually judged in relation to the return of similar portfolios’ (BCG 1996c: 1). ‘TSR is the most useful summary measure of value creation’ (BCG 1996c: 2)

ROI, ROE, ROA, ROCE and RONA: `Return on investment is a generic term referring to the efficiency of a business in producing income (or cash  ow) in relation to its capital employed. Common accounting ROI measures include return on equity, which is net divided by owner’s equity; return on assets, or net income divided by total assets; return on capital employed, or earnings divided by book capital; and return on net assets, or net income divided by net assets’ (Myers 1996).

Note: this list is not exhaustive.

Figure 1 Consultancy metrics for shareholder value

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Considerable effort is put into boosting one Ž rm’s measure and knocking others as part of the process of differentiating (basically similar) products in a battle of the acronyms:

CFROIs are ideally suited to displaying long term track records, whereas a Stern Stewart-type EVA™ is in millions of dollars, heavily in uenced by asset size, and unadjusted for in ation-induced biases.

(Holt Value Associates Partner, Bentley J. Madden, in Myers 1996: 1)

[CFROI is] a technology in search of a problem, as opposed to a system designed to be integrated into a company’s culture in the way real people make business decisions.

(Stern Stewart partner and co-founder, G. Bennett Stewart III in Myers 1996: 1)

Cynical managers suspect the differences are exaggerated, although that too may be functional because insecure corporate managers hire more than one con- sultant to make sure they do not miss out: Monsanto hired Boston and Stern Stewart, using CFROI and EVA™ at different levels in the business (Myers 1996: 4).

All the consultants insist that they offer much more than a metric because implementation of value-based management with appropriate incentive pack- ages is presented as the key to success. This is certainly what creates the product and makes the money for the consultancy Ž rms because this emphasis on implementation allows them to charge out lots of hours. If the product were a metric it would be cheap; as long as the product is implementation it must be expensive because implementation requires continuous assistance by consultants over a period of time.

There are new elements in the implementation packages, particularly the emphasis on incentive packages for senior mangers and others in the Ž rm as well as the insistence on using value as a universal language throughout the Ž rm:

EVA™ . . . is not just a performance measure. When fully implemented, it is the centrepiece of an integrated Ž nancial management system that encom- passes the full range of corporate Ž nancial decision-making – everything from capital budgeting, acquisition pricing, and the setting of corporate goals to shareholder communication and management incentive compensation. By putting all Ž nancial and operating functions on the same basis, an EVA™

system effectively provides a common language for employees across all cor- porate functions, linking strategic planning with the operating divisions, and the corporate treasury staff with investor relations and human resources.

(Stern et al. 1995: 33)

But, if we turn from this vision of a Ž nancialized management system, to actions and the speciŽ cs about what management can do to improve Ž nancial results, then we Ž nd a fairly traditional concept of operations and a puzzlingly empty concept of strategic moves. Traditional modes of thinking are most

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obvious at LEK/Alcar which works hard to reconcile the old and the new con- sultancy so that it is sometimes difficult to distinguish between the prescriptions of the new Ž nancial metric consultancies and those of their precursors a gener- ation or more ago. Thus, LEK/Alcar advises management to focus on the value drivers in operations by analysing the major components of cost and identifying the controllable elements, much as consultants have been doing for the past thirty years (LEK/Alcar 1997: vol. I). And, on strategy, the second edition of Rappaport’s book is promoted by LEK/Alcar with the claim that it shows ‘why competitive advantage and shareholder value should be regarded as synergistic rather than competing objectives’ (LEK/Alcar 1997: vol. V).

The broader general concepts of management moves are hardly original or imaginative. For example, Stern Stewart’s ‘three principal ways of increasing shareholder value’ are no more than arithmetical possibilities inherent in any proŽ t ratio, which can be changed by increasing the numerator or decreasing the denominator. Thus Ž rms can make existing assets work harder, invest in activi- ties with positive EVA™ and retreat from activities with low return on capital employed (ROCE) (Stern et al. 1998: 482). Rappaport provides a more interest- ing list of the six ways of beating market expectations. These include exploiting a leading brand name; changing the rules of competition, as when Ž rms intro- duce new formats such as discount warehouse; reacting quickly to change; leadership in high tech; effective downsizing as in the case of General Dynam- ics; or skill in acquisitions (Rappaport 1998: 186–7). The problems with his list are obvious. Many or most Ž rms do not have the brand, the intellectual prop- erty rights (IPR), the technical edge or the supply chain power; shuffling the business portfolio, outsourcing or labour stripping may work for some Ž rms but is unlikely to work for all. Reinvention of the business formula usually involves a risk of failure and, while divestment is guaranteed to work, it creates a smaller Ž rm and would typically yield better ratios but a smaller lump of proŽ t.

Other critics have noted (Mouritsen 1998: 467) that the concept of the moves is such that there is a strong element of tautology and circularity about the form of this discourse: shareholder value is identiŽ ed with particular ratios and strat- egy becomes the corollary actions which improve the ratio by acting on numer- ator or denominator.

If the metrics and moves are hardly original, the associations around ‘value creation’ are powerful because they suggest focused, effective management delivering improved performance in the interests of shareholders. There is in all this a quasi-religious element of shareholder fundamentalism. Consultants like Bennett Stewart readily admit that EVA™ does not work if it is misapplied; his list of reasons for failure starts with ‘they don’t make it a way of life’. But this is not so much a concession as part of the consultant’s offer: consultancy is about putting expertise at the service of corporate clients who thereby avoid the mis- takes that others make.

At the same time, the consultants make positive promises which are mainly (often only) illustrated by homiletic examples and parables wherein consultant, metric and implementation save the value-destroying company just as Jesus saves

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the erring sinner. The 1997 Stern Stewart Performance 1000 for the US opens with Ž ve ‘recent success stories’ which all take the religious form, as in the case of HarnischŽ eger Industries of Minneapolis:

The top line was growing, the bottom line was growing, but the stock price was going nowhere [in 1993] . . . EVA™ was Ž rst adopted as a performance measure, then in 1994 some 400 executives were put on a standard EVA™

incentive bonus plan . . . later 3,600 salaried employees were enrolled in a modiŽ ed EVA™ plan. . . .

When the program began, Harnischfeger had a negative EVA™ and a share price of $18. Thereafter, year by year, the company’s EVA™ grew until it was substantially positive in 1996 – the Ž rst year in which all business units posted positive EVA™ – and the stock reached $40 a share. Harnischfeger’s improve- ment over the three years was so rapid that it was number two on Fortune’s list of the fastest growing companies in the US.

(Ross 1998: 117)

The effects of such parables are reinforced when corporate executives them- selves endorse the product in their own words as in LEK/Alcar’s newsletter. Their fourth volume presented ‘three testimonials on the successful application of SVA and LEK/Alcar’s Value Based Management system’ in Q and A form with senior executives from companies like RJR Nabisco answering the ques- tions. The associative chain connects the consultancy Ž rm via metric and implementation with corporate success.

The association is reinforced by reassuring lists of blue-chip corporate clients which constitute a kind of widely circulated appeal to authority. Since its foun- dation in 1982, Stern Stewart has advised 250 corporations whose sales revenues total more than $400 billion; its US client list includes Coca Cola, AT&T, Eli Lilly, Trans America and Georgia PaciŽ c, Briggs and Stratton and Quaker Oats (Myers 1996: 2). Boston similarly claims 100 corporate clients and all the major consultants are having some success with European companies. Stern Stewart has recently opened a London office whose oldest client is the stores group Burton and whose largest client is Siemens (Ross 1998: 120). The list of LEK International Offices shows how value-based consultancy is going global, though encountering some resistance in Asia: this Ž rm has offices in Auckland, Bangkok, Brussels, London, Melbourne, Milan, Munich, Paris and Sydney.

The texts by consultancy principals that boost SV thus combine pages of tech- nicality about metrics with curiously indecisive discussions of business policy and homiletic examples of corporate success. This is set in an interpretative wrap that presents SV as a benign revolution in corporate priorities with entirely ben- eŽ cial consequences for the broader society: SV will align management and shareholder interests to beneŽ t all stakeholders as shareholding is spread ever wider. Some of the consultants present empirics to demonstrate that pursuit of SV (via the appropriate metric, of course) will bring beneŽ ts to all stakeholders (SCA 1996). Similarly, Rappaport (1998: 11) observes that 40 per cent of Ameri- can households own individual stocks or mutual funds and concludes: ‘when we

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realise that the shareholders are not “them” but are “us”, the case for share- holder value becomes even more compelling’.

Academic responses: yes and no

If SV is a consultancy product, it leaves room for a variety of academic responses. Two groups can be distinguished on an intellectual basis: academic endorsers, who assimilate the language of value into their own academic paradigm through which they construct the corresponding real world processes as a positive development; and academic resisters, who reject shareholder value as a partial or inadequate misunderstanding of how markets and Ž rms work. The difference is as much political as discursive: the endorsers are generally much closer to con- sultancy than the resisters. In this section we develop the argument that endorsers are uncritical and the resisters are insufficiently radical.

If we consider the stock-market developments of the 1990s, especially lever- aged buy outs (LBOs) and value-based management, a small group of in uen- tial American corporate Ž nance professors has played a role rather similar to that of the bishops who blessed battleships before World War I, with the ‘market for corporate control’ occupying much the same place in their thought as the ‘just war’ did in the thought of the bishops. Pre-eminent among these Ž gures is Michael Jensen of Harvard who has consistently supported corporate restruc- turing via LBOs, divestment, share buy backs, etc., as a way by which managers can increase the return on their capital, and has also more generally endorsed value-based management.

The market for corporate control is creating large beneŽ ts for shareholders and for the economy as a whole. The corporate control market generates these gains by loosening control over vast amounts of resources and enabling them to move more quickly to their highest-valued use. This is a healthy market in operation, on both the takeover side and the divestiture side.

(Jensen 1998: 352)

This position on theoretical rationale is not of course anything like as vulgar as product endorsement for any Ž rm or any speciŽ c metric, but Jensen does provide intellectual legitimation for management action, under pressure from the capital market, to create value for shareholders. The whole process of value management is also wrapped into a theoretical a priori: as assets are re-allocated between Ž rms, value for shareholders can be enhanced and teams of managers compete to get higher rates of return from bundles of investment projects.

More speciŽ c product endorsement comes from the cross-over hybrids who are consultants in the morning and academics in the afternoon and publish in books and journals, which combine authors of both kinds for an audience of students and corporate managers. If Stern Stewart EVA™ is the best known of the new metrics, that is partly because they have promoted themselves by pub- lishing with academics as well as for academics and their students. Stern and

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Chew (both partners of Stern Stewart) jointly edit a widely used collection of readings that pulls together state of the art thinking in corporate Ž nance. In the second (1992) and third (1998) editions there is an increased emphasis on man- aging for shareholder value: for example, the third edition contains a new section on ‘Corporate Governance’, including a review of EVA™ which explains, among other things, why it ‘is held in such esteem in the corporate world’ (Chew 1998: x). Equally important is the Journal of Applied Corporate Finance, which mixes articles by consultants with testimonials from corporate executives and contri- butions by leading academics.

On this basis it becomes more difficult to separate the consultants from the academics who fall into line around value-based management. Thus, the second edition of Stern and Chew (1992) and Kensinger and Martin (1992) both discuss how shareholder value is and can be enhanced through strategies similar to those envisaged by Stern Stewart and Rappaport in our preceding section. Or, Hite and Owers take a positive view of the challenge to the large and sprawling conglomerate from increasingly activist investors (Stern and Chew 1992: 577). Eminently respectable and independent academics are put into positions where it is difficult to be impolite about value-based management. In an ‘EVA™ Round- table’ reported in Stern and Chew (1998), the accounting academic, Jerold Zimmerman, provides broad support for EVA™ which ‘clearly has the potential to add signiŽ cant value in many corporate circumstances’ (1998: 497). In par- ticular, he endorses the claim that EVA™ helps to integrate internal decision making with maximizing shareholder wealth.

The resisters come from inside and outside corporate Ž nance and we can begin by considering the objections from within which show that many corpor- ate Ž nance specialists have reservations, although these usually relate to the detail of what metrics can do and the evidence on EVA™ and performance.

The residual income concept is not new because it was used by General Motors in the 1920s and General Electric into the 1950s (Bromwich and Walker 1998: 392) and its problems have been extensively discussed. From this per- spective Bromwich and Walker fundamentally question Stewart’s (1991) ‘appealing’ presentation of EVA™ as the reworked residual income measure which connects ex ante valuation with ex post evaluation to create a powerful and unique incentive system for managers (1991: 409). In their view, Stewart ignores the problematic assumptions necessary for this result, assumptions that are con- troverted in the Ž nance literature so that it is, in principle, impossible for EVA™

to represent everything in a single performance/incentive metric in the ways dis- cussed by its promoters. Other Ž nance academics have questioned EVA’s power to explain and have tested its empirical correlates with varying results. For example, Biddle et al. (1997) Ž nds that abnormal returns to shareholders in the US are more strongly associated with conventional accounting earnings than with EVA™. Using UK data, Stark and Thomas (1998), however, provide support for EVA™ when they Ž nd that market values are more strongly associ- ated with residual income-based measures than with earnings. The empirical results so far are probably best described as inconclusive and likely to remain so

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when variables such as earnings and EVA™ can be calculated in different ways such that empirical Ž ndings cannot always be directly compared.

For our purposes, we can note that the end result is likely to be a gentle debate within Ž nance between those who support and those who critique the new per- formance metrics. Both sides of the debate are united by a shared framework which sees shareholder value as a legitimate objective and who broadly accept that performance measures which help reduce agency problems are likely to enhance shareholder wealth. Equally, the parties to this debate share a concept of the Ž rm as a bundle of investment projects and reduce the economy to one micro level, as the sum of the investment projects made by all the Ž rms. In micro terms, the capital market is the more or less exclusive focus of interest with little reference to product or labour markets.

The resisters from outside Ž nance present or imply different, broader (non- Ž nancial) accounts of how Ž rms work, what limits management actions at Ž rm level and how value is generated. Nevertheless, these resisters broadly accept the shareholder wealth objective with their arguments focusing largely on the use- fulness of the shareholder value metrics and/or on whether the approved con- sultancy moves might realize that objective.

The response from business policy or organizational behaviour specialists is different and entirely predictable. In business policy it has been led by Hamel, who made his name with an internal competences account of the Ž rm, which leads to a very different view of the moves managers make. In organizational behaviour, specialists like Useem argue, from a sociological point of view, that it is difficult to mobilize organizations for action to achieve objectives like SV which quickly become political and socially deŽ ned inside and outside the organization.

These critics tend to make one of two major critical points in arguing against the use of simple one-dimensional measures and for more complex models of the Ž rm and wealth creation. Thus, in Fortune in 1997, Hamel argues against the use of a single Ž nancial measure ‘to capture all the dynamics of corporate per- formance’. This point picks up on and relates to the long-standing Harvard- based critique of Ž nancial-based management as likely to produce perverse results such as short-termism, which creates incentives to reduce expenditure on research and development and discourages strategic thinking. Those who resist single Ž nancial measure performance-based systems are likely to prefer alternative multi-dimensional measures like Kaplan’s balanced scorecard which includes market share, quality and other non-Ž nancial indicators.

The most popular alternative model of wealth creation is some variant on human capital theory which implies that the consultants like Stern Stewart are focusing on the wrong kind of capital. In a debate with Al Ehrbar, a senior vice president of Stern Stewart, Hamel takes this line and identiŽ es human capital as the builder of value in companies like Chrysler and Microsoft. Mouritsen’s (1998) critique of EVA™ concentrates on ‘intellectual capital’ and an alternative ‘technology of management’ which would mobilize intellectual resources to create long-term possibilities of growth through the development of new