Creating Value
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Preliminary Creating Value Winter 2005/06 Josef Zechner1 Course Contents This course focuses on how value can be created within a corporation where ownership and control are separated. The basic problem has already been addressed by Adam Smith (1776): “The directors of [joint stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance [as owners…] … Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company”2 The last few decades were a time of fundamental change in corporate activity around the world. Corporate control activities emerged to mitigate the above problem, creating enormous momentum for change. These transactions included improved internal corporate governance standards, takeovers, mergers, leveraged buyouts, shareholder activism and changes in executive compensation. This course will analyse each of these mechanism and their potential effects on value creation. We start by discussing various reasons for the increased importance of value-oriented management. We continue by analysing different measures of value creation, beginning with measures of stock price performance and then turning to measures of intrinsic value, various financial indicators and value drivers. Next we analyse the relationship between executive compensation and value creation. We will give detailed empirical evidence on the structure of executive compensation and the scientific evidence on the effects on corporate performance. Then we focus on companies` internal control systems and analyse how they ensure value creation. In this context we will give an overview over the main corporate governance codes. In particular we will focus on the role of boards as important element of the internal control system. We also investigate the role of takeovers and leveraged buyouts as a mechanism to create shareholder value. Finally we will analyse the phenomenon of shareholder activism. Throughout the world especially institutional investors have started to take a more activist approach, seeking to actively influence management decisions. In this last part of the course we will review the evidence on shareholder activism. _______________________________ 1 Prof. Josef Zechner, University of Vienna, Faculty of Business, Economics and Statistics, Department of Finance. 2 See Smith, Adam (1776), An Inquiry into the Nature and Causes of The Wealth of Nations. The Modern Library: New York. 1 Readings We will use the following readings as a basis for this course: - Lecture notes “Creating Value”. Koller T., M. Goedhart and D. Wessels (KGW), 2005, Valuation, Measuring and Managing the Value of Companies, 4th edition, John Wiley & Sons, Inc. Journal articles and working papers. Course evaluation There will be a midterm and a final exam. The midterm is scheduled for October 25th, from 1:30 to 2:20 p.m. It will make up 40% of the total grade. The final exam will take place on November 22nd (1:30 p.m. – 3:00 p.m.). It will make up 50% of the total grade. In addition there will be several cases to be discussed and solved in class. In teams of up to 5 students you will have to prepare an analysis and solution for each case. These solutions must be handed in electronically before the relevant deadline given in class to the following email address: simone.hirschvogl@univie.ac.at. These solutions will not be graded in detail. Instead it will only be checked that a consistent solution has been turned in on time. Solutions turned in after the deadline will not be considered. Consistently turned in solutions will make up 10% of the maximum grade. There will be bonus points given for classroom participation. For discussions, especially during analysis of the cases in class and for derivations of case solutions on the black board you can receive extra marks, up to an additional 10% of the total. To be able to evaluate your classroom participation, I will ask you to put up a sign with your name written on it on your desk in front of you during class. 2 Table of contents Part I. Introduction to value-based management.............................................................. 2 1. The increasing importance of value-oriented management ........................................... 6 2. Some basic principles of value creation ....................................................................... 22 Part II. Measuring value creation ...................................................................................... 24 1. Traditional performance measures ............................................................................... 29 2. Value-based measures .................................................................................................. 37 Case Study: Identifying Value Creators Part III. Value-oriented strategy...................................................................................... 80 1. How the stock market values companies ..................................................................... 81 2. How companies create value...................................................................................... 102 Part IV. Executive compensation................................................................................... 124 1. Stylized facts .............................................................................................................. 126 2. EVA-based compensation .......................................................................................... 148 3. Option-based compensation ....................................................................................... 155 Case Study: Vyaderm Pharmaceuticals Part V. Board of directors................................................................................................. 171 1. International comparison............................................................................................ 174 2. Potential problems...................................................................................................... 183 3. Empirical findings ...................................................................................................... 188 Case Study: American Cyanamid Part VI. Takeovers .......................................................................................................... 205 1. Value creation/destruction in takeovers .................................................................... 207 2. Cash offer vs. stock offer ........................................................................................... 220 3. Empirical evidence on takeover gains........................................................................ 227 4. Empirical evidence on the disciplinary function of takeovers ................................... 246 Part VII. Shareholder activism........................................................................................ 251 1. The rise of shareholder activism ................................................................................ 253 2. Views about shareholder activism.............................................................................. 262 3. Empirical evidence..................................................................................................... 265 3 Readings in Detail Main Readings: - Lecture Notes Koller, Goedhart and Wessels, 2005, Valuation, 4th edition, John Wiley & Sons, INC. Martin and Petty, 2000, Value Based Management, Harvard Business School Press. Part I: Introduction to Value-Based Management Books, journal articles and working papers: - Koller, Goedhart and Wessels 2005, Valuation, 4th edition, John Wiley & Sons, INC.: Part One, Chapters 1-3. Martin and Petty, 2000, Value Based Management, Harvard Business School Press: Chapters 1-2. Arbeiterkammer, 2004, Corporate Governance Kodex. Die praktische Anwendung des Kodex an der Wiener Börse 2004. http://wien.arbeiterkammer.at/pictures/d16/Corporate_Governance_Studie_2004.pdf Additional Readings: - - Drobetz, Wolfgang, Andreas Schillhofer, and Heinz Zimmermann, 2004, Corporate Governance and Expected Returns: Evidence from Germany, European Financial Management 10, 267-293. Drobetz, Wolfgang, Klaus Gugler, and Simone Hirschvogl, 2005, The Determinants of the German Corporate Governance Rating, Working Paper, University of Basel/Vienna. http://www.wwz.unibas.ch/cofi/publications/papers/2004/02-04.pdf Part II: Measuring Value Creation Books, journal articles and working papers: - CASE: Harvard Case: “Identifying Value Creators”. Koller, Goedhart and Wessels, 2005, Valuation, 4th edition, John Wiley & Sons, INC.: Chapter 5. Martin and Petty, 2000, Value based Management, Harvard Business School Press: Chapters 3-5. 4 Part III: Value-Oriented Strategy Books, journal articles and working papers: - Koller, Goedhart and Wessels 2005, Valuation, 4th edition, John Wiley & Sons, INC.: Chapters 4 and 14. Martin and Petty 2000, Value based Management, Harvard Business School Press: Chapters 9-10. Additional Readings: - Lindenberg, E. and M. Ross, 1999, To Purchase or to pool: Does it matter? Journal of Applied Corporate Finance 12, 32-47. Part IV: Executive Compensation Books, journal articles and working papers: - - - - CASE: Harvard Case: Vyaderm Pharmaceuticals Abowd, J. M. and D. S. Kaplan, 1998, Executive Compensation: Six Questions That Need Answering, working paper http://instruct1.cit.cornell.edu/~jma7/ak-jep_revised_05-02.PDF Bebchuck, L.A., J.M. Fried and D. I. Walker, 2002, Managerial Power and Rent Extraction in the Design of Executive Compensation, Harvard Law School Discussion Paper No. 366 Core, John E., Wayne R. Guay, and David F. Larcker. 2003. “Executive Equity Compensation and Incentives: A Survey”. Federal Reserve Board New York Economic Policy Review. Evans, J., Evans, R. and D. Todesco, 2002, An Examination of Economic Value Added and Executive Compensation, working paper. Gillian, S. I., 2001, Option-Based Compensation: Panacea or Pandora’s Box? Bank of America, Journal of Applied Corporate Finance, Vol 14, 2, pp115-128. Hall, B., 2002, Incentive strategy II: Executive compensation and ownership structure, working papar, Harvard business school. Martin and Petty 2000, Value based Management, Chapter 8, Harvard Business School Press. Murphy, K., 1999, Executives compensation, in Handbook of labor economics, Ashenfelter and Card ed., vol. 3. New York: North Holland. Additional Readings: - - Acharya, V., K. John, and R. Sundaram, 2000, On the Optimality of Resetting Executive Stock Options, Journal of Financial Economics 57, 65-101. Brickley, James A., Sanjai Bhagat and Ronald C. Lease, 1985, The impact of longrange managerial compensation plans on shareholder wealth, Journal of Accounting and Economics, Volume 7, Issues 1-3, Pages 115-129. Chance, D., R. Kumar, and R. Todd, 2000, The Repricing of Executive Stock Options, Journal of Financial Economics 57, 129-154. 5 - - Morck, Randall, Andrei Shleifer and Robert W. Vishny, 1988, Management ownership and market valuation : An empirical analysis, Journal of Financial Economics, Volume 20, Pages 293-315. Yermack, D., 1997, Good Timing: CEO Stock Option Awards and Company News Announcements, Journal of Finance 52, 449-476. Part V: Boards of Directors Books, journal articles and working papers: - - CASE: Wruck, K. and S. Roper, 1997, American Cyanamid, Harvard Case No: 9-897048. Adams, R. B., 2001, The Dual Role of Corporate Boards as Advisors and Monitors of Management: Theory and Evidence, working paper. Bebchuk, L., C. Coates, 2002,The powerful antitakeover force of staggered boards: theory, evidence, and policy, NBER Working paper 8974. http://www.nber.org/papers/w8974.pdf Bhagat, S. and B. Black, 2001, The Non-Correlation Between Board Independence and Long-Term Firm Performance, Journal of Corporation Law, 231-274. Corporate Governance Codes Gugler, K., A. Stomper and J. Zechner, 2000, Corporate Governance, Ownership an Board Structure in Austria, Zeitschrift für Betriebswirtschaft, pp. 23-43. Hermalin, B. E. and M. S. Weisbach, 2000, Boards of Directors as an Endogenously Determined Institution: A Survey of the Economic Literature working paper. Monks, R, and N. Minow 1995, Corporate Governance, chapter 3, 5. Blackwell Publisher Ltd. Additional Readings: - - - Baker, M. and P. Gompers, 2000, The Determinants of Board Structure and Function in Entrepreneurial Firms, Working Paper, Harvard Business School. Brickley, J. and C. James 1987, The Takeover Market, Corporate Board Composition, and Ownership Structure, Journal of Law and Economics 30, pp. 161-180. Byrd, J. and K. Hickman, 1992, Do Outside Directors Monitor Managers? Evidence from Tender Offer Bids, Journal of Financial Economics 32, pp. 195-207. Cotter, J., A. Shivdasani, and M. Zenner, 1997, Do Independent Directors Enhance Target Shareholder Wealth during Tender Offers? Journal of Financial Economics 43, pp. 195-218. Hermalin, B. and M. Weisbach, 1988, The Determinants of Board Composition, The RAND Journal of Economics 19 (4), pp. 589-606. Mayers, D., A. Shivdasani, and C. Smith 1997, Board Composition and Corporate Control, Evidence from the Insurance Industry, Journal of Business 70. Perry, T., 2000, Incentive Compensation for Outside Directors and CEO Turnover, Working paper, Arizona State University. http://papers.ssrn.com/sol3/Delivery.cfm/000718303.pdf?abstractid=236033&mirid=1 Shivdasani, A., 1993, Board Composition, Ownership Structure, and Hostile Takeovers, Journal of Accounting and Economics 16 (1/2/3), pp. 167-98. Shivdasani, A. and D. Yermack, 1999, CEO Involvement in the Selection of New Board Members: An Empirical Analysis, Journal of Finance 54, pp. 1829-1854. 6 - Weisbach, M., 1988, Outside Directors and CEO Turnover, Journal of Financial Economics 20, 431-460. Wu, Y., 2000, Honey, I Shrunk the Board, Working Paper, University of Chicago. http://papers.ssrn.com/sol3/Delivery.cfm/000706305.pdf?abstractid=235295&mirid=1 Yermack, D.,1996, Higher Valuation of Companies with a Small Board of Directors, Journal of Financial Economics, 40, pp. 185-212. Part VI: Takeovers Books, journal articles and working papers: - - - Agrawal and Jaffe 2003, The Disciplinary Motive for Takeovers:A Review of the Empirical Evidence, working paper. http://bama.ua.edu/~aagrawal/review.pdf Bild, M., A. Cosh, P. Guest and M. Runsten, 2002, Do takeovers create value? A residual income approach on U.K. data, working paper. http://scholar.google.com/url?sa=U&q=http://www.cbr.cam.ac.uk/pdf/WP252.pdf Franks, J., C. Mayer and L. Renneboog, 2001, Who disciplines management in poorly performing companies?, Journal of Financial Intermediation. Grinblatt and Titman 2002, Financial Markets and Corporate Strategy, chapter 20. Kaplan, S. N., M. Mitchell and K. Wruck, 1997, A clinical exploration of value creation and destruction in acquisitions: organisational design, incentives and internal capital markets. Additional Readings: - - Agrawal, A. and J. F. Jaffe, 1995, Does Section 16b Deter Insider Trading by Target Managers? Journal of Financial Economics 39, 295-321. Agrawal, Anup, Jeffrey F. Jaffe, and Gershon N. Mandelker, 1992, The Post-merger Performance of Acquiring Firms: A Re-examination of an Anomaly, Journal of Finance 47, pp. 1605-1621. Agrawal, Anup, and Ralph Walkling, 1994, Executive careers and compensation surrounding takeover bids, Journal of Finance 49, 985-1014. Andrade, Gregor, Mark Mitchell, and Erik Stafford, 2001, New Evidence and Perspectives on Mergers, Journal of Economic Perspectives 15, 103-120. Asquith, P., 1983, Merger Bids, Uncertainty and Stockholder Returns, Journal of Financial Economics 11. Franks, Julian, Robert Harris, and Sheridan Titman, 1991, The postmerger share-price performance of acquiring firms, Journal of Financial Economics 29, pp. 81-96. Franks, J. R., and C. Mayer, 1996, Hostile Takeovers in the UK and the Correction of Management Failure, Journal of Financial Economics 40, 163-181. Hasbrouck, J., 1985, The Characteristics of Takeover Targets: q and Other Measures, Journal of Banking and Finance 9, 351-362. Healy, Paul M., Krishna G. Palepu and Richard S. Ruback, 1992, Does Corporate Performance Improve after Mergers? Journal of Financial Economics 31, 135-176. Kini, O., W. Kracaw; and S. Mian, 1995, Corporate Takeovers, Firm Performance and Board Composition, Journal of Corporate Finance 1, 383-412. Malatesta, P. H., 1983, The Wealth Effect of Merger Activity and the Objective Functions of Merging Firms, Journal of Financial Economics 11, 155-182. 7 - Martin, K. J., and J. J. McConnell, 1991, Corporate Performance, Corporate Takeovers, and Management Turnover, Journal of Finance 46, 671-688. Mitchell, Mark, and Erik Stafford, 2000, Managerial Decisions and Long-Term StockPrice Performance, Journal of Business 73. Ravenscraft, David and F.M. Scherer, 1987, Mergers, Sell-offs and Economic Efficiency, The Brookings Institution, Washington, D.C. Safieddine, Assem and Sheridan Titman, 1999, Leverage and Corporate Performance: Evidence from Unsuccessful Takeovers, The Journal of Finance 54, pp. 547-580. Part VII: Shareholder Activism Books, journal articles and working papers: - - - Gillian, S. L. and L. T. Starks, 2000, Corporate governance proposals and shareholder activism: the role of institutional investors, Journal of Financial Economics, pp. 275305. Goldman, M.D. and E.M. Filliben, 2000, Corporate governance: current trends and likely developments for the twenty-first century, Delaware Journal of Corporate Law, Vol. 25, pp. 683-713. Karpoff, J., 2001, The Impact of Shareholder Activism on Target Companies: A Survey of Empirical Findings, working paper. http://finance.bi.no/~governance/conference_2001/Karpoff.PDF 8
