Why Value Based Management ValueBased Management Sam PD

Why Value Based Management Value-Based Management Sam PD Anantadjaya BSc, MBA, MM, CFC, CFP, CBA, Dr ethan. eryn@gmail. com 0859 -21 -938 -800

The Background n Organizations serve a special purpose î They exist to deliver CERTAIN VALUES þ remember the birth of organizations. . . l In semester 1 þ reaching economic profitability l CSR “triangle” þ Organizations must be profitable to survive l Earning high returns on shareholders’ equity to build trust ¬ High stock price þ Organizations are networks of parties and people working together @ Sam PD Anantadjaya, July 2017 – 2/15

The Background n Organizations use tremendous amount of time, effort, investments, assets, and resources. î So it makes perfect sense to ensure, manage, measure, monitor, encourage, and support that maximum value is realized @ Sam PD Anantadjaya, July 2017 – 3/15

The Background n Value-Based Management is to realize that organizations are operating and competing in 4 markets; î Markets for products and services î Markets for corporate management and control þ competition on determining who is in-charge of an organization, threat of takeovers, restructuring, and/or leveraged buyouts î Capital markets þ competition for investors’ favors and savings î Employee and managers markets þ competition for company image and ability to attract top talents @ Sam PD Anantadjaya, July 2017 – 4/15

Trends n Since accounting metrics have turned out to be unreliable î Particularly when those accounting metrics are used in solitary î This pushes for new value-based metrics þ Economic Value Added þ CFROI þ Market Value Added @ Sam PD Anantadjaya, July 2017 – 5/15

Economic Value Added n It is a financial performance method to calculate the true economic profit of a corporation n EVA can be calculated as net operating profit after taxes – charge for the opportunity cost of capital investment î Remember the “weighted average cost of capital”? þ wd * kd (1 -tax)/we * ke @ Sam PD Anantadjaya, July 2017 – 6/15

Economic Value Added n EVA is an estimate of the amount by which earnings exceed or fall short of the required minimum rate of return for shareholders or lenders at comparable risk î EVA can be calculated at divisional level (strategic business unit) î EVA is a flow and can be used for performance evaluation over time î EVA is economic and is based on the idea that a business must cover both the operating costs and the capital costs @ Sam PD Anantadjaya, July 2017 – 7/15

Economic Value Added n EVA can be used for the following purposes; î Setting organizational goals î Performance measurements î Determining bonuses î Communication with shareholders and investors î Motivating of managers î Capital budgeting î Corporate valuation î Analyzing equity securities @ Sam PD Anantadjaya, July 2017 – 8/15

Economic Value Added @ Sam PD Anantadjaya, July 2017 – 9/15

CFROI n CFROI = cash flow return on investment î Originally developed by HOLT Value Associates in Chicago, USA î It is an economic profit (cash flow) based corporate performance/valuation framework on economic profit basis þ mainly used by portfolio managers and corporations î CFROI is normally calculated on an annual basis and is compared to an inflation-adjusted cost of capital to determine whether a corporation has earned returns superior to its costs of capital @ Sam PD Anantadjaya, July 2017 – 10/15

CFROI n CFROI applies dividend discount technique to inflation- adjusted cash flow growth projections, using î a firm specific risk premium, plus î Market required rate of return to determine the firms warranted value and the equity’s warranted price î CFROI is a bit complex calculation to apply @ Sam PD Anantadjaya, July 2017 – 11/15

Market Value Added n MVA is the difference between the equity market valuation of a listed firm and the sum of the adjusted book value of debt and equity invested in the firm î It is the sum of all capital claims held against the firm – the market value of debt and the market value of equity þMVA = firm’s market value – invested capital n The aim is to maximize MVA (not maximizing the value of the firm) @ Sam PD Anantadjaya, July 2017 – 12/15

Benefits of VBM n VBM can maximize value creation consistently n VBM increases corporate transparency n VBM helps organizations deal with globalized and deregulated n n n n n capital markets VBM aligns interests of top managers with the interests of shareholders and stakeholders VBM improves internal communication on strategy VBM prevents undervaluation of the stock VBM sets clear management priorities VBM facilitates improvements on decision-making VBM streamlines planning and budgeting VBM sets effective targets for compensation VBM facilitates the use of stock for mergers and acquisitions VBM prevents takeovers VBM helps to better deal with increased complexity and greater uncertainty and risk @ Sam PD Anantadjaya, July 2017 – 13/15

Drawbacks of VBM n VBM is an all-embracing, holistic management philosophy, often requiring culture change î VBM takes time, resources and patience to be successful n Value creation may sound more simple than corporate strategy, but it isn’t. î It is actually more or less the same n Measuring for value, performance management and balanced scorecard are very powerful management support tools and processes, but…. î Have a cost of their own so it is not advisable to go too deep in detail or use metrics that are over complex @ Sam PD Anantadjaya, July 2017 – 14/15

Drawbacks of VBM n Extreme caution must be made not to measure the wrong things as this may almost certainly lead to value destruction n VBM requires strong and explicit CEO and executive board support n Comprehensive training and consulting support is advisable or even necessary, but can be quite costly n The perfect VBM or valuation model has yet to be invented…… î No matter which one you choose, there will always be drawbacks to consider @ Sam PD Anantadjaya, July 2017 – 15/15