Attempting to Manage the Value of a Publicly-Owned Business - Assignment Example

Topic: Arguments for and against attempting to manage the value of a publicly-owned business. Introduction This paper seeks to analyze and discuss the arguments for and against attempting to manage the value of a publicly-owned business. This paper will also define a public-owned as distinguished from those that are not publicly owned and attempt to explain the issue on the management of the value of the business. 2. Analysis and Discussion 2.1 What is a publicly owned business? Investor Dictionary (2006) defined a public company as “that is owned by stockholders who are members of the general public and traded publicly. Ownership is open to anyone that has the money and inclination to buy shares in the company. It is differentiated from privately held companies where the shares are held by a small group of individuals often members of one or a small group of families or otherwise related individuals (or other companies).” 2.2 Why the need to manage the value of the business? A business exists to provide needs and wants. Before it could the same, it must have investments from owners to be able to have assets to keep the business running. Assets which may include lands, buildings, equipments, inventories, materials resources will be used to generate revenues. The use of assets will result to expenses to eventually produce revenues. Deducting expense from revenue therefore would enable the business to earn profit. The stockholders deserve to have to have return from their investment since in the entrepreneur would rather have kept their funds in the and with the promise of a better profits. The business however may be owned privately or publicly. If owned private the probability is that only few individuals may actually owner the share of the corporation. If privately owned, the business would not normally have its stock floated in the stock market or the owners are just few that decision making would not necessarily be made dependent to propensity to change hands more often than once in a year. Given that the title of this paper deals on public held corporations, let us go deeper into analysis in the following sections. 2. 3 Will management of value be different in the case of public owned business, why and why not? McClure, (2005) said: “Creating economic value is everyone’s job in the public company, and everyone has an affect that’s either constructive or destructive of economic value.” Barring any attempt to go otherwise, it would seem on the basis of the above statement that anyone which is a part of a publicly held company has no choice but to help in making high the value of the company stocks. However, could there be any other reason that would force a manager not to maximize the value of the corporation for reasons higher than increasing the economic value? Could there be really an exception? Could there be an argument against managing the value of such corporations or business? McClure, (2005) said: “During some time your career, you are likely to work in a company that is owned by shareholders and is publicly traded. Enlightened executives and managers realize that the enterprise must operate in a way that provides an adequate return to the investors. That’s not someone else’s job in the finance department; it will be yours. Whether you’ll be a professional engineer or a researcher proposing and running programs, you’ll need to know the dynamics of creating economic value inside the public corporation.” The authors seemed to suggest no argument against managing the value of such publicly held companies and this is even made more manifest when he said: “Stock price is the ultimate metric of public company performance. You may know about balance sheets, cash flows and income statements, but none of them are useful predictors of stock price performance. Great products, effective R&D, huge sales and even Earning per Share doesn’t mean that your company (and therefore you) will prosper. The owners need to get a return that will make them buy, or at least hold the stock they have.” 2.4 Arguments against Sensing no way of really arguing against the management of value of corporation, we will have to digress a little and try to go back, why do corporations, whether publicly held or not? We are thus brought into the reason for existence of any corporation, which is to satisfy the need of its stakeholders. These stakeholders include the customers and stockholders. In the nature of things customers came first ahead of stockholders since the entrepreneur will have to be convinced first of the customers need before he goes to the investors for more funds. Customers loyalty could therefore take precedence before stockholders’ power. In so discussing about said loyalty, Reichheld, F. (1995) said: “The foundation of customer loyalty —that great engine of long-term profit and cash flow —is customer value and the long-term investment that creates it. For this reason, customer loyalty is hard to find at companies owned by shortsighted, fickle investors. Unfortunately, this means that customer loyalty is hard to find at most public companies. The average rate of annual investor churn at firms listed on the New York Stock Exchange skyrocketed from 14% in 1960 to more than 50% in 1995. Or to put that another way, the average publicly owned company can expect to lose half its owners over the course of the next 11 months.” It appears that more than the value or before the value of stocks of the corporation is customers’ loyalty to the company in terms of the latter’s products and services. Every organization came into being, it has its reason for existence. In an economic world that we have, business organization through its founders, the entrepreneurs, a felt need by fellow human beings was identified. The entrepreneur (Murphy, and Cantillon, 1986) thought about how to really satisfy that need (OBoyle, 2005). Having decided that the need is insistent because nobody has found the cure yet or if ever there are those who come first in the market, simply the supply could not satisfy the demand, the entrepreneur did thought inviting investors willing to serve the need via a promise of higher return (Durchslag, et.al., 1994) to these investors. And so a wider base on ownership might have come really into being because the need must be satisfied. By a twist of circumstances, the some investors became more interested in their profits than in customers’ loyalty (Griffin, 2002) because the economy offers or leaves then an opportunity cost (Heymann, and Bloom ,1990) to earn more under a free economy. The issue has now become clearer at this point where it is not the management of the value of the company that should or should not be done but the propensity of investors to sell their stocks and therefore change ownership so regularly or otherwise that makes our case different. It is also clear that propensity of changes in ownership happens most in publicly held companies more than a private company. This issue is therefore in the hands of managers on how would they make their choices in the light of the reality of different kind of investors in a publicly held company, which is: “Can they really do something about it?” To appreciate more the points as discussed let us see how managers react to investments in publicly held corporations. In relation to this, Reichheld, F. (1995) said: “Most senior executives seem resigned to the fickleness and short- term focus of today’s capital markets, but in taking this fatalistic attitude, they make two grave mistakes. First, they underestimate the damage done by asset exploitation. Second, they ignore or fail to recognize, a range of pragmatic alternatives —ways of stabilizing their investment base and creating the conditions for long-term investor partnerships and the implementation of long-term, value-creating strategies.” Reichheld, F. (1995) then did reemphasized the reality of the situation when he said that the average publicly owned company can expect to lose half its owners over the course of the next eleven months. So the challenge really is given the reality in investors’ decisions of such corporation, do manager have some power to unleash? Reichheld, F. (1995) made some suggestions which are discussed in the next section. 2. 5 What to do now? In the context of a manager, every corporation in their hands is worth improving and valuing since the standard under which a manager could be gauged is the how do such manager managed the life of such a corporation by sustaining over the long-term the reasons of the company’s existence. Managers realize that to develop company value, customers’ loyalty be taken cared off first. Thus, Reichheld, F. (1995) agreed when he said: “If executives are serious about earning the benefits a loyal base of customers and employees can provide, they need to take control of their investor inventories.” He then gave four principal ways of overcoming or sidestepping the disadvantages of public ownership: First: “ Educate investors about the benefits and advantages of loyalty. Companies must explain the principles of loyalty-based economics, show how they work, and prove to investors that the companies with the highest loyalty earn the highest profits. Once investors believe loyalty is a rational goal leading to higher profits, they will want to see loyalty measures they can use to gauge the company’s progress….” Second: “Target low-churn institutional investors. While the average institutional investor churns its portfolio at a rate of 60% per year, there are institutions that prefer to buy and hold. By searching out loyal investors and persuading them to invest in your stock, companies can steadily enrich their investor mix.” He explained this part using the case of Nike, when he said: “By marketing itself to those investors, Nike was able to shift almost 30% of its shares into their hands. Among the 700 U.S. investment managers with more than $100 million under management, turnover rates range from less than 5% to almost 400% per year. Average turnover for the group as a whole was 62%.” (Paraphrasing made) Third: “Attract stable core owners. The third approach, which pushes the second one step further, is to find an institutional or individual investor who will buy a controlling position in the company, which remains publicly owned. Needless to say, the things to look for are business philosophy, integrity, and a track record of long term, stable holdings.” In explaining this, Reichheld, (1995) cited countries like Germany and Japan, where investors are much more likely to stick with their investment for the long-term. He said: “In Japan, the average share of stock in a public company is held for seven years, compared to less than two years in the United States.” Fourth: “Taking the company private —the final approach —frees managers from the volatility of public markets, the carping of securities analysts, and the short-term thinking of transient investors, but it has two substantial risks. The first is that most companies must take on additional debt in order to buy back their stock. The second and greater risk is the choice of a leveraged buyout firm to act as a partner. Luckily, there is a class of private investment firms, that make excellent partners, every bit as attractive as Warren Buffett. They’re asset builders, and they recognize the value of long-term stability and loyalty.” He also explained this saying: “Experts estimate that the average holding period for private equity investments is four to six years —two to three times longer than the average for public markets. (Reichheld, 1995) (Paraphrasing made) Conclusion: Who does not want to control one’s destiny if one has a choice? Managers may not necessarily be owners of stocks of publicly held corporations and neither are stockholders necessarily managers. But it could happen that a manager may be stockholder. As manager he knows therefore the meaning of what really creates value to a corporation. He knows what is meaning of loyal capital, ‘which is more committed to his business, knows more about it, and therefore tends to demand more than the transient investors you never meet or hear from.’ He knows too that it ‘not patient money companies need, but smart money and that smart investors know that the only way to maximize shareholder value is to earn the loyalty of customers and employees.’ (Reichheld, 1995) Wise manager need not be at the mercy of investors. They could exercise some discretion and ‘must take steps to find smart investors, educate the investors they already have, and avoid the high cost of disloyal capital.’ (Reichheld, 1995) Therefore, the issue of responsibility of management of value of any business would be that always of maximizing it whether a company is publicly held or not. What will make it different is the wisdom of making the right choices if one is publicly held or not, that is, smart investors are needed in the case of publicly held companies, not just any kind of investors. Bibliography: 1. Durchslag, et.al. (1994), The Promise of Infrastructure of Privatization, The McKinsey Quarterly 2. Griffin, (2002), Customer Loyalty: How to Earn It, How to Keep It , Jossey-Bass 3. Heymann, H. and Bloom R. (1990), Opportunity Cost in Finance and Accounting; Quorum Books 4. Investor Dictionary (2006), Define: Public Company, {www document} URL http://www.investordictionary.com/definition/public+company.aspx, Accessed July 9, 2006 5. McClure, M. (n.d.), Engineering Success in a Publicly Owned Company {www document} URL http://engr.smu.edu/~rajand/EEseminars/McClure_Mar05.htm, Accessed July 9, 2006 6. Murphy, A. and Cantillon, R. (1986): Entrepreneur and Economist, Clarendon Press 7. OBoyle, E. (2005) , Homo Socio-Economics: Foundational to Social Economics and the Social Economy; Review of Social Economy, Vol. 63. 8. Reichheld, F. (1995), The Loyalty Effect, Harvard Business School Press, {www document} URL, http://www.loyaltyrules.com/bainweb/pdfs/cms/marketing/23.pdf, Accessed July 9,2006 Read More