Shareholders Value Definition
Shareholders’ value can be defined as the value that shareholders of a company receive as dividends and stock price appreciation as a result of better decision making by the management that ultimately results in a company’s growth in sales and profit.
It is nothing but the value that is delivered by an entity to its existing equity holders. Maximizing the shareholders’ value is one of the key objectives for any organization. It highly depends on the ability of its management to make appropriate decisions and the way these decisions are implemented for driving in more sales and leveraging the profits earned by the same. Higher the profits earned, higher shall be the dividends offered to the equity holders.
Shareholders Value Creation
A company must always prioritize the interests of its shareholders and must take every possible measure for shareholders’ value creation. There are various principles that a company must necessarily follow for shareholder’s value creation. The first principle that a company must abide by is that it must not manage its earningsManage Its EarningsEarnings Management refers to producing “fabricated” financial statements by the company managers to display its monetary success in front of the stakeholders. or, in other words, it must not participate in the earnings expectations game.
This is high because of the fact that if a company focuses too much on maximizing its earnings, it tends to compromise the value, and this can even destroy its ability to make operating decisions. The company must take strategic decisions that can help the same in maximizing the expected value, even if it comes at the cost of slight losses or a lowered rate of earnings in the nearing time. The company must make acquisitions that can help it by maximizing the expected valueExpected ValueExpected value refers to the anticipation of an investment's for a future period considering the various probabilities. It is evaluated as the product of probability distribution and outcomes.. The company must move forward with assets that add value to the business.
How to Maximize Shareholders Value?
The measure of an organization’s success can be learned to the extent it goes for maximizing its shareholder’s value. The management of an organization should primarily focus on the interests of its shareholders while making necessary management decisions. There are seven drivers through which a company can maximize its shareholder value. These drivers are revenue, cash tax rate, operating margin, cost of capital, investment in WC (working capital), incremental CE (capital expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year.), and competitive advantage period. The organization must not just provide a focus on profit maximization. Short-term profit maximization is short-lived.
Following are the 4 ways –
- The organization can choose to increase the unit priceThe Unit PriceUnit Price is a measurement used for indicating the price of particular goods or services to be exchanged with customers or consumers for money. It includes fixed costs, variable costs, overheads, direct labour, and a profit margin for the organization. of its product by assuming that it is selling goods at the same amount.
- The management of the organization must make appropriate decisions so that it is able to sell more units of goods. This will ultimately boost the revenues earned by the organization, and as a result of this, it can declare a higher amount of dividends for its shareholdersDividends For Its ShareholdersDividend is that portion of profit which is distributed to the shareholders of the company as the reward for their investment in the company and its distribution amount is decided by the board of the company and thereafter approved by the shareholders of the company..
- The management must take necessary decisions for decreasing or eliminating the unnecessary costs in order to boost the savings.
- The management must make the necessary decisions for increasing its fixed cost utilizationFixed Cost UtilizationFixed Cost refers to the cost or expense that is not affected by any decrease or increase in the number of units produced or sold over a short-term horizon. It is the type of cost which is not dependent on the business activity..
- Shareholder’s value can bring a lot of benefits to an organization. It offers the management of a company with a long-term view and based on this. The management can design strategic decisions.
- It allows the company to emphasize more on the future and its clients and consumers and offers a universal approach as well.
- Shareholder’s value can even have implications on the well being of an organization. A lot of organizations tend to stress only upon maximizing their profits for the sake of maximizing shareholder’s value. This is why the organizations take up rigorous and devastating measures that compromise business ethics but fetch profits.
- The organization might choose to compromise on quality, increasing the prices of the products unnecessarily, etc. However, these profits earned are just short-lived. Such organizations might end up losing customer’s trust and may earn bad goodwillGoodwillIn accounting, goodwill is an intangible asset that is generated when one company purchases another company for a price that is greater than the sum of the company's net identifiable assets at the time of acquisition. It is determined by subtracting the fair value of the company's net identifiable assets from the total purchase price. in the eyes of society and its industry too. This increases the risk for the organization and may even result in bankruptcy for the same.
The importance of creating shareholders’ value is strongly linked with the efficiency of capital marketsCapital MarketsA capital market is a place where buyers and sellers interact and trade financial securities such as debentures, stocks, debt instruments, bonds, and derivative instruments such as futures, options, swaps, and exchange-traded funds (ETFs). There are two kinds of markets: primary markets and secondary markets.. It also encourages a legitimate process of evaluation of the performance of the management. The shareholder’s value is also important for organizations in developing an environment of trust that will keep the shareholders glued with the organization and will also help in leveraging capital investments in the companyCapital Investments In The CompanyCapital Investment refers to any investments made into the business with the objective of enhancing the operations. It could be long term acquisition by the business such as real estates, machinery, industries, etc..
Shareholder’s value is a primary objective for most companies in the 21st century. With its help, the companies are able to focus with a broader perspective that is they are evaluating decisions based on not just current but the future environments too.
The decision-making skills of the management incorporate all the necessary measures that can be taken for the purpose of maximizing shareholder’s value so that they remain contented and stay glued with the organization. The way the present equity holders are treated decides not only their exit but also the entry of potential equity holders.
This has been a guide to Shareholders Value and its definition. Here we discuss how to calculate shareholder value along with its creation, advantages, disadvantages, and importance. You can learn more about accounting from the following articles –