5.12 Value-based management
Select strategic options
Here the best strategic option or options are selected and formed into a strategic plan.Review and control
The performance of the business should be measured against the strategic plan. This
is rather like the post audit for an individual investment project, but for the entire
strategy rather than for just one of its building blocks.Evidence on the place of strategic planning and investment
decision making
Two studies were mentioned in Chapter 4 in the context of non-financial factors in
investment decision making. They were by Chen (1995) and Alkaraan and Northcott
(2006), who looked at the position in the US and the UK, respectively. Both studies
found that decision makers tended to regard strategic fit as of very great importance
when assessing investment proposals.5.12 Value-based management
Traditional accounting-based measures of management effectiveness, like the return
on capital employed (ROCE) ratio and the earnings per share (EPS) value, have been
criticised for not focusing sufficiently on what businesses ultimately seek to do: to
generate wealth or value for their shareholders. The problem with the accounting
measures is that they tend to focus on sales revenue and profit increases, not on value
generation. For example, it is always open to a business to increase its ROCE and EPS,
at least in the short term, by taking on more risky activities. Such activities may well
have the effect of reducing value.
The increasing emphasis on the wealth of the shareholders as a corporate goal,
which we discussed in Chapter 2, has led to the emergence of ideas like shareholder
value analysis(SVA) and economic value added(EVA®).Shareholder value analysis
SVA is based on the totally logical principle that the value of the business overall is
equal to the sum of the NPVs of all of its activities. This is to say, that at any particu-
lar point in time, the business has a value equal to the projected future cash flows from
all of its existing projects, each discounted at a suitable rate. The shareholders’ finan-
cial stake in the business is the entire value of the business less the value of its out-
standing debt (borrowings). Thus if the value of the NPVs of any of the business’s
various activities can be increased, this should mean greater value for shareholders,
either to be paid out as dividends or to be reinvested in other projects that will, in turn,
result in still more shareholder value.
The claimed advantages of SVA, as a philosophy of business decision making,
are that the actions of managers can be directly linked to value generation, and the
outcomes of decisions can be assessed in that context. SVA was first suggested by
Rappaport (1986).‘
‘