CP

Summary 465

company’s shares, then management has a powerful tool for warding off takeovers.

This is not good for outside stockholders.

Are ESOPs good for a company’s shareholders? In theory, ESOPs motivate em-

ployees by providing them with an ownership interest. That should increase produc-

tivity and thereby enhance stock values. Moreover, tax incentives mitigate the costs

associated with some ESOPs. However, an ESOP can be used to help entrench man-

agement, and that could hurt stockholders. How do the pros and cons balance out?

The empirical evidence is not entirely clear, but certain findings are worth noting.

First, if an ESOP is established to help defend against a takeover, then the firm’s stock

price typically falls when plans for the ESOP are announced. The market does not

like the prospect of entrenching management and having to give up the premium

normally associated with a takeover. However, if the ESOP is established for tax pur-

poses and/or to motivate employees, the stock price generally goes up at the time of

the announcement. In these cases, the company typically has a subsequent improve-

ment in sales per employee and other long-term performance measures, which stim-

ulates the stock price. Indeed, a recent study showed that companies with ESOPs en-

joyed a 26 percent average annual stock return versus a return of only 19 percent for

peer companies without ESOPs.^15 Therefore, it appears that ESOPs, if used appro-

priately, can be a powerful tool to help create shareholder value.

What are two primary forms of corporate governance (that is, the carrot and the

stick)?

What are three provisions in many corporate charters that deter takeovers?

Describe briefly how a typical stock option plan works.

What are ESOPs? What are some of their advantages and disadvantages?

Summary

 Corporate assets consist of operating assets and financial, or nonoperating, as-

sets.


 Operating assets take two forms: assets-in-place and growth options.


 Assets-in-place, include the land, buildings, machines, and inventory that the

firm uses in its operations to produce products and services.


 Growth options refer to opportunities the firm has to increase sales. They

include opportunities arising from R&D expenditures, customer relationships,

and the like.


 Financial, or nonoperating, assets are distinguished from operating assets and

include items such as investments in marketable securities and noncontrolling in-

terests in the stock of other companies.


 The value of nonoperating assets is usually close to the figure reported on the

balance sheet.


 The value of operations is the present value of all the future free cash flows ex-

pected from operations when discounted at the weighted average cost of capital:

Vop(at time 0)a

t 1

FCFt

(1
WACC)t

.

(^15) See Daniel Eisenberg, “No ESOP Fable,” Time, May 10, 1999, 95.

462 Corporate Valuation, Value-Based Management, and Corporate Governance