Shareholder Value
For publicly held companies, the value assigned by markets is the ultimate measure of the degree to which the company is meeting its business goals. Market valuations are objective and applied consistently across all publicly held companies and markets. If they were not there would be opportunities for arbitrage; that is, one could buy shares of a company at a lower price in one market and simultaneously sell it at a higher price in another market. Seeking higher stock value is clearly important to senior management. A company whose stock is depressed because it is not effectively managing for shareholder value is a candidate for investor takeover.
It is important to understand that managing for shareholder value and managing for profitable cash flows are two very different things. As shown by the figure below, the market value of a company does not equal the risk-adjusted discounted value (NPV) of its projected future earnings. In the literature on real options, the difference is referred to as "option value."
Figure 3: Company value depends on market perception of "real option value"
as well as projected earnings (data for four companies in the same industry)
As illustrated, it is not uncommon to find two companies in the same industry such that one has a higher NPV of projected returns but the other has a higher total market value. Market value depends not only on projected future cash flows, but also the how buyers and sellers in the marketplace perceive, among other things, the ability of the business to respond to future opportunities and avoid future threats. Option value does eventually translate into increased earnings.
However, because it is difficult or impossible to forecast the exact mechanisms by which this will occur, option value and other indirect sources of value will not be represented in accounting forecasts of cash flows. Companies that evaluate projects by estimating impacts on profits alone ignore a significant component of market value.
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Reason 3: Lack of the Right Metrics
