治理结构与公司价值-美国与东亚若干经验比较2

CorporateGovernance

and

theValueofFirms

--SomeExperiencesofU.SandAsiaProfessorK.C.JohnWei,PhDTel:(852)-2358-7676;Fax:(852)-2358-1749E-mail:johnwei@ust.hkDepartmentofFinance,HKUSTandVisitingDepartmentofFinance,PekingUniversityPreparedforCCER,PekingUniversityNovember8,2003CFAII_SS18:OptionsHKUSTBusinessSchool1ProfileofProf.K.C.JohnWeiProf.K.C.JohnWeireceivedhisPhDinFinanceattheUniversityofIllinois,Champaign-Urbana,in1984.HeservedtheUniversityofMississippiasanAssistantProfessorfromJanuary1984toJune1988.AfterservingtheUniversityofMiamiasanAssistantProfessorforoneyear,hemovedtoIndianaUniversity,whereheservedasanAssociatedProfessorfromJuly1989toJune1992.

SinceJuly1992,Prof.JohnWeihasbeenservingtheHKUSTBusinessSchoolinitiallyasanAssociateProfessorandlaterwaspromotedtofullProfessor.HeservedasActingHeadoftheDepartmentofFinancefromJanuary2001–August2002andFebruary–June2003.Prof.WeihasalsobeenappointedtheDirectoroftheCentreforAsianFinancialMarketssince1995.HewasvisitingUniversityofTexasatAustinfromSeptembertoDecember2002andiscurrentlyvisitingGuanghauSchoolofManagement,PekingUniversity.Withresearchfocusesonempiricalresearchincapitalmarkets,derivativesandassetpricingofAsianandU.S.markets,Prof.Weihasproducedanumberofhighqualitypapersontheseareas.Manyofthesepaperswerepublishedintopjournalsinfinanceandhavemadeconsiderablecontributionstothefinanceliterature.Heisanauthoroffourbooks(inChinese)onHongKongstockandwarrantsmarketsandTaiwanesestockmarket.Inaddition,Prof.WeiisaregularcolumnwriterfortheHongKongEconomicJournal,alocalnewspaperspecialisedinfinancialnews.Ontheconsultancyactivities,Prof.WeihashelpedHangSengBanktodevelopapersonalfinancialplanningmodelcalled“SmartInvest,”andHSBCtodevelopafinancialplanningmodel,called“Rule-BasedInvestmentSolutions.”HealsoconductedaconsultancyprojectinitiatedbyHKSARforAPECandafewprojectsforHongKongStockExchange.

Prof.WeihavebeeninvolvedexecutiveteachingforHKUST,PekingUniversity,HongKongStockExchange,Chineseprovincialgovernmentofficials,generalcorporateexecutives,XieanJassen,Daimler/Chrysler,ChinaMobile,Aspire,andBenQ.CFAII_SS18:OptionsHKUSTBusinessSchool2ValuecreationandbusinessstrategiesValuationCreationQijiaCEOXiushenZhiguoPingtianxiaManagementteamAssetsinplaceGrowthopportunityCapitalPeopleManagementskillsVisionIntegrityCorporategovernanceIncentivesRestructuringCompetitiveadvantagesM&A(external)Investment(internal)(ROIC>WACC)R&DEquityDebtCentralbankCommercialbanksInvestmentbanksMutualfundsInsurancecompaniesValuationmethodsDCFComparativemeasureROAInvestorsTimingCostofcapital(WACC)FinancialengineeringCBCapitalmarketsObjective/StrategyInvestorbehaviorGreedandfearCognitiveorheuristicbiasFocusvsDiversified(CiscovsGE)OEMvsBrandLowvshighendCFAII_SS18:OptionsHKUSTBusinessSchool3ValuecreationviafinancialstrategiesDividendpolicy:ReinvestmentShareholdervalueInvestmentdecision:GrowthoptionsFinancingdecision:WACCCorporategovernance:AsymmetricinformationApproachestovaluationMergers&AcquisitionsValuecreationROIC>WACCDCF(NPV)valuationComparablevaluationROARestructuring(Strategy)Whyvaluevalue?ManagementdisciplineTransparencyIndependenceAccountabilityResponsibilityFairnessSocialresponsibilityStrategiestocreatevalueInternalgrowthWhatisyourdreamcompany?FocusvsdiversifiedCorecompetence

CFAII_SS18:OptionsHKUSTBusinessSchool4HowtovalueafirmThevalueofafirmwithaconstantgrowrateis whereNOPLAT=netoperatingprofitlessadjustedtaxes EBIT=earningsbeforeinterestandtaxes t=averagetaxrate WACC=weighedaveragecostofcapital g=growthrate=reinvestmentrate×ROIC ROIC=returnonnewinvestedcapital=NOPLAT/IC g/ROIC=reinvestmentrate=rICFAII_SS18:OptionsHKUSTBusinessSchool5HowtoenhancethevalueofafirmTheMMformulaHowtoenhancethevalueofafirmIncreaseoperatingefficiency(NOPLAT)Increasereturnonnewinvestedcapital(ROIC)InvestinnewprojectonlywhenROIC>WACCIncreasethegrowth(g),rI=g/ROICProlongtheperiodofcompetitiveadvantage(N)Reducethecostofcapital(WACC)CFAII_SS18:OptionsHKUSTBusinessSchool6ValueDriversThreevaluedrivers:Abnormalprofit(investonlywhenROIC>WACC):intherightindustryGrowth(g)orreinvestment:inthehighgrowthindustryRisk(WACC):(1)economy-widerisk(businesscycle),(2)operatingrisk(degreeofcapitalintensity),and(3)financingrisk(leverage)Commonmistake:Managersoftenignorethecostof“equity”capitalCFAII_SS18:OptionsHKUSTBusinessSchool7SourcesofabnormalprofitMonopoly(Highprofitmargin):MicrosoftoreBay(priceorservicedifferential;intherightindustry)Lowcostoperator:HonHaiPrecision,TaiwanSemiconductor,Dell,BYD(makemoneyfromgoodmanagement)Lowfinancingcost:GEBarriertoentry:(1)capital,(2)technology(patents),(3)distributionchannels,(4)governmentprotectionExample:Profitmargin=20%;WACC=15%;Capitalturnover=2timesForevery$100sales,profit=$20,requiredcapitalinvestment=$50,costofcapital=$50*15%=$7.50,abnormalprofit=$20–$7.5=$12.5.Atwhatlevelofprofitmargin,willthefirmbecomeamaturecompany?CFAII_SS18:OptionsHKUSTBusinessSchool8Abnormalprofit:Motorola,EricssonandNokia1993-19951994-961995-971996-98MotorolaROIC20.26%16.83%14.14%8.17%WACC8.21%13.00%14.01%14.11%Diff12.05%3.84%0.12%-5.94%EricssonROIC27.25%28.54%32.73%20.60%WACC5.07%8.10%11.80%11.69%Diff22.18%20.44%20.92%8.90%NokiaROIC11.94%15.42%18.71%27.60%WACC6.56%8.80%8.32%9.07%Diff5.39%6.62%10.39%18.54%CFAII_SS18:OptionsHKUSTBusinessSchool9EarningsqualityAreyourcompanyfutureincomeseasytoforecast?Aretheysensitivetobusinessorindustrycycle?(MicrosoftvsIntel;GMvsCocaCola)Economy-widerisk:Businesscycle(GMvsMerck)Operatingrisk:Levelofcapitalintensity(TSMCvsYuYuan)Financingrisk:Leverage(NWDvsSHKProperties)Accountinginformationrisk:Disclosureandcorporategovernance(CASvsIAS;TSMCvsUMC)InventoryAccountsreceivablesGrossmarginS&AexpensesReserveforbadaccountsreceivablesR&DProductivityCFAII_SS18:OptionsHKUSTBusinessSchool10CorporateGovernanceCFAII_SS18:OptionsHKUSTBusinessSchool11RecentcorporategovernanceproblemsintheU.S.ManipulationsofaccountingearningsEnron,GlobalCrossing,Xerox,AdelphiaCommunications,WorldCom,TycoInternational,ImCloneSystems,ArthurAnderson,FreddieMac,MicrosoftOff-BalanceSheetborrowingsEnron,ElanMotivation:Smoothearnings,jackupstockprices(stockoptions)ConsequencesFirmsinvolvedwenttobankruptcyorwereintroubleWholemarketdroppedduetoinvestors’lossofconfidenceRemediesStrengthentheregulationsbySECandtheU.S.CongressInternalandexternalauditingMoreefficientboardsofdirectorsCFAII_SS18:OptionsHKUSTBusinessSchool12CharacteristicsofAsianCompaniesOwnedandcontrolledbyfamily(pyramidorcrossholding)Enhancement(interestsofmanagersandshareholderscanbemorealigned)Entrenchment(stealing,tunneling,ignoringordestroyingfirmvalue)Lackofcorporategovernance(TSMCCEO:Integrity)CannottrustoutsideprofessionalmanagersDon’tknowhowtodelegatePassCEOpositiontoownsonratherthancapablemanagerCommittomorecognitiveorheuristicbiasCFAII_SS18:OptionsHKUSTBusinessSchool13Whyiscorporategovernanceimportant?ArecentsurveyconductedbyMcKinsey&Co.showsinvestorspayapremiumofmorethan20%forgoodCGfirms.Thebenefitsofgoodcorporategovernance:reducethecostofcapital(WACC)increasethevalueofthefirmsbenefitshareholders,employees,andsocietyChen,Chen,andWei(2003)findcompaniesinEastAsia:non-disclosureCGimprovesfrombottom25%totop75%:thecostofequitycapitalisreduced1.26%pointsDisclosureimprovesbythesamemagnitude,thecostofequitycapitalisreducedby0.47%pointFirmsinbetterCGcountrycanalsoreducethecostofcapitalSimons(HBR,September2002)profitabilityispositivelycorrelatedwithhowworkersperceivetheirmanagers'behavioralintegrity(hotelindustry)CFAII_SS18:OptionsHKUSTBusinessSchool14Whatiscorporategovernance?ThemechanismsofPushingfirmstooperatemoreefficientlyandtocreatevalue,andPreventingpotentialexploitationofoutsideinvestors,particularlyshareholders,bycorporateinsiderssuchasthemanagementShareholdershavecontrolrightsDirectorsandmanagersaresupposedtorunthefirmsintheinterestsoftheshareholdersCFAII_SS18:OptionsHKUSTBusinessSchool15Whyisitneeded?Agencyproblembetweenshareholdersandmanagers(problemforU.S.companies)Agencyproblembetweenmajorityshareholdersandminorityshareholders(problemforAsiancompanies)Expropriation(entrenchment,stealing,tunneling)CFAII_SS18:OptionsHKUSTBusinessSchool16GoodgovernancepracticeWhatmakesgreatboardsgreat(SonnenfeldHBR,September2002)verysimply,high-functioningworkgroupsaclimateofrespect,trust,andcandoramongboardmembersandbetweentheboardandmanagement.Informationissharedopenlyandontimefeelfreetochallengeoneanother’sassumptionsandconclusionsmanagementencourageslivelydiscussionofstrategicissues.feelresponsibilitytocontributetoperformance.assesstheirownperformance,bothcollectivelyandindividually.InstallingeffectivelyindependentboardAnindependentboardchairman(CEOnotthechairman)ThreemostindependentcommitteesonanyboardTheauditcommitteeThecompensationcommitteeThenominatingcommitteeCFAII_SS18:OptionsHKUSTBusinessSchool17WhyValueValue?CFAII_SS18:OptionsHKUSTBusinessSchool18JapaninMid-1980s:WeareNumberOneFromKimandYoungCFAII_SS18:OptionsHKUSTBusinessSchool19JapanNow:WeareinProlongRecessionFinancialTimes:February2,2002CFAII_SS18:OptionsHKUSTBusinessSchool20Nikkei225vs.Dow:January1984-June2003

CFAII_SS18:OptionsHKUSTBusinessSchool21NotEveryThingisEqual:SonyisDifferent

CFAII_SS18:OptionsHKUSTBusinessSchool22ToyotaMotorisalsoDifferent

CFAII_SS18:OptionsHKUSTBusinessSchool23ButNissanisthesameuntilRecentlyCFAII_SS18:OptionsHKUSTBusinessSchool24Renault’s44.4%purchaseinMarch1999

makesNissandifferentsince

CFAII_SS18:OptionsHKUSTBusinessSchool25Value-BasedManagementMakestheDifferencesTheperformancedifferencebetweenU.S.firmsandJapanesefirms,andbetweenSonyandotherJapanesefirmsisGoodperformersadoptValue-BasedManagement(VBM),whilelosersdonot.WhatistheproblemfortheU.S.marketnow?WhatisVBM?VBMfocusesonvaluecreationfortheirshareholdersratherthanstakeholdersCFAII_SS18:OptionsHKUSTBusinessSchool26WhatistheDecisionRuleforVBM?VBMfocusesoninvestments(oldornew)thatcangenerateareturnoninvestedcapitalgreaterthantheircostofcapital.Thatis,investonlywhenROIC>WACCCFAII_SS18:OptionsHKUSTBusinessSchool27WhatistheValueofaFirm?Firmvalue=Valueofequity+ValueofdebtFirmValue=Assetsinplace+Growthopportunities=Bookvalue+GrowthoptionsGrowthoptionmakesamajordifferenceinvalueamongfirmsCFAII_SS18:OptionsHKUSTBusinessSchool28Shareholder-OrientedEconomiesPerformBetterTheU.S.corporatefocusonshareholdervaluesincethemid-1980.Thebenefitsare:GDPpercapitaintheU.S.hasaleadofmorethan20%overothercountriesandhasbeenwideningsinceearly1990s,duetoMuchhigherfactorproductivity,especiallycapitalproductivityInvestedinmoreproductive(orvaluecreating)projects,i.e.,higherfinancialreturnsCFAII_SS18:OptionsHKUSTBusinessSchool29Shareholder-OrientedFirmsBenefitAll200yearsago,AdamSmithpostulatedthat“themostproductiveandinnovativecompanieswouldcreatethehighestreturnstoshareholdersandattractbetterworkers,whowouldbemoreproductiveandincreasereturnsfurther””–avirtuouscycleOntheotherhand,“Companiesthatdestroyvaluewouldcreateaviciouscycleandeventuallywitheraway”CFAII_SS18:OptionsHKUSTBusinessSchool30Shareholder-OrientedFirmsBenefitAll(con’t)CompanieswithhigherlaborproductivityaremorelikelytocreatemorevalueCompaniesthatareabletocreatemorevaluealsocreatemorejobsHappyworkers,happyinvestors(Fortune,May2002)Conclusion:AshareholdervaluefocusnotonlyisgoodforshareholdersbutalsogoodfortheeconomyandotherstakeholdersCFAII_SS18:OptionsHKUSTBusinessSchool31Casestudies(HBR)LeadingforvaluebyPitman(March2003):BritishbankLloydsTSBACEO-ledtransformationofthecompany'sculturebySirBrianPitman:value-basedmanagementasingledefinitionofsuccessandasinglemeansofmeasuringit.AtLloyds,hereplacedtheexistingarrayofimplicitobjectiveswithasinglegoverningobjective(generategreatervalueforshareholders)andestablishedincreasinglysophisticatedinternalmetricsforachievingit.createvalueforeveryone:Customer,employees,andcommunities.From1983to2001,BritishbankLloydsTSBincreaseditsmarketcapitalization40-fold,inpartbysheddingassetsandnarrowingitsfocus.CFAII_SS18:OptionsHKUSTBusinessSchool32Casestudies(HBR)WhencompanyvaluesbackfirebyEdmondsonandCha(2002-11)MaymisinterpretandbrandtheCEOasahypocriteMakeyourvaluesmeansomethingbyLencioni(2002-07)Enron2000annualreportforcorporatevalue:“Communication.Respect.Integrity.Excellence.”EmptyvaluesstatementscreatecynicalanddispiritedemployeesandunderminemanagerialcredibilityValuesstatementsreallytomeansomethingshouldfollow:understandthedifferenttypesofvalues:core,aspirational,permission-to-play,andaccidental.beaggressivelyauthenticowntheprocessweavecorevaluesintoeverythingCFAII_SS18:OptionsHKUSTBusinessSchool33RestructuringCompaniesGeneralCFAII_SS18:OptionsHKUSTBusinessSchool34TheValueManagerAfocusonlong-runcashflowreturns,notquarter-to-quarterchangesinearningspershareValue-orientedview:Investonlywhenreturnoninvestedcapital>costofcapital(ROIC>WACC)Abilitytotakeanoutsider’’sviewofthebusinessWillingnesstoactonopportunitiestocreateincrementalvalueFinally,andthemostimportant,theneedtodevelopandinstitutionalizeamanagingvaluephilosophythroughouttheorganization(itisanongoinginitiative)CFAII_SS18:OptionsHKUSTBusinessSchool35TheProcessofBecomingValue-OrientedArestructuringthatunleashesvaluetrappedwithinthecompany(highbenefit;butthecostcanbehigh)DivesturesLayoffsDevelopingavalue-orientedapproachtoleadingandmanagingtheircompaniesafterrestructuringEstablishingprioritiesbasedonvaluecreationGearingplanning,performancemeasurement,andincentivecompensationsystemstowardshareholdervalueCommunicatingwithinvestorsintermsofvaluecreationCFAII_SS18:OptionsHKUSTBusinessSchool36WhenareCompaniesinNeedofRestructuring?Scoreof6-24with24beingtheworst(basedonMonitor)Totalreturntoshareholders(TRS)Salesgrowthrelativetoindustry(growth)Operatingmarginrelativetoindustry(operatingefficiency)Capitalreturnrelativetoindustry(ROIC)Numberofbusinessunits(focus?)Distancefrommedianindustrycapitalstructure(WACC,optimalcapitalstructure)CFAII_SS18:OptionsHKUSTBusinessSchool37RestructuringProcessDiagnosticScan(Decisiontorestructure)Restructuring(Implementationplan)Value-basedManagement(VBMimplemented)IncentiveDesign(Newincentivesystem)CFAII_SS18:OptionsHKUSTBusinessSchool38RestructuringFrameworkCurrentmarketvalueTotalpotentialvalueDCFvalueusinganalystforecastsValuewithinternalandexternalimprovementsDCFvalueusingmanagementexpectationValuewithinternalimprovementsMarketInefficiencyTakeoverspeculationInternalimprovementsCorporategovernanceOptimalopportunityPublicheldbusinessGrowthopportunities+FinancialEngineeringCapitalstructureDividendpolicyRiskmanagementDisposal/newownersM&AJointventureSpin-offsIPOsLetterstockDivestureOperatingimprovementsRevenuegrowthCostreductionCapitalefficiencyPerceptionGapOvervaluedUndervaluedValuecreatedThroughRestructuringCFAII_SS18:OptionsHKUSTBusinessSchool39RestructuringFramework:ExampleThiscompanyhad10businessunitsanditsstockpricewasdecliningMarketValue$1,000MaximumValuePotential$1,800DCFvalueusinganalystforecasts$1,050Valuewithinternalandexternalimprovements$1,650DCFvalueusingmanagementexpectation$950Valuewithinternalimprovement$1,200MarketInefficiency$50Valuecreated$800Growthopportunities+FinancialEngineering$150NotenoughdebtInternalimprovements$450Sold3losersInternalimprovements$250ExitunprofitableproductlinesReduceinventoryPerceptionGap-$100OvervaluedValuecreatedThroughRestructuringCFAII_SS18:OptionsHKUSTBusinessSchool40ImproveOperations:InternalImprovementsChallengeeverypartofthebusinesssystemProcurementRawmaterialsManufacturing/Work-in-progressFinishedgoods(aretheycompetitive?)InventoryDistributionchannelandsalesAccountsreceivableCFAII_SS18:OptionsHKUSTBusinessSchool41Rethinkyourportfolioofbusinesses:ExternalImprovementsFocusontwodimensionstolookforvalueimprovementValuecreationpotentialCompetitiveadvantageDecision:Highvaluecreation+bestincompetitiveadvantage:shouldgrowHighvaluecreation+weakincompetitiveadvantage:shouldimproveLowvaluecreationbusinesses:shoulddisposeCFAII_SS18:OptionsHKUSTBusinessSchool42OwnershipAlternatives:ExternalImprovementsSpin-offsAvoidcrosssubsidization(IBM/PC)Eliminatemanagementconstraints(ATT&Lucent)TaxfreeAnnouncementeffectispositive(mayexceedvalueofentitytobespunoff)InitialPublicOfferingsAllowdirectinvestmentinasubsidiaryTaxfreeifIPOkeepscash(whichmaybeusedtorepaycorporatedebt)Allowconsolidation(taxandaccounting)iflessthan20%ofequityissoldDirectSalesTaxable(mayprovidetaxshield)CFAII_SS18:OptionsHKUSTBusinessSchool43FinancialEngineeringMinimizingWeightedAverageCostofCapitalDoesNotMaximizeValueofFirm(Bankruptcycost)CostofequityWACCAfter-taxcostofdebtMinimumWACCMaximizeValueDebt/EquityPercentCFAII_SS18:OptionsHKUSTBusinessSchool44SourcesofRestructuringValueIntheU.S.,theaveragebreakdownofsourcesofvaluecreationfromrestructuringindicatesthatapproximately60%comesfromstrategicandoperatingimprovementsInternalImprovements60%DivestureorAcquisition25%FinancialEngineering15%CFAII_SS18:OptionsHKUSTBusinessSchool45PuttheValueCreationPlanintoActionPutValueintoPlanningFocusplanningandbusinessperformancereviewsaroundvaluecreationDevelopValue-OrientedTargetsandPerformanceMeasuresFocusonameasurethatincorporatebothgrowthandreturnoninvestedcapital(ROIC)EP(Economicprofit)=Investedcapital××(ROIC–Opportunitycostofcapital)TieCompensationtoValueAssessValueofStrategicInvestmentsDevelopInvestorCommunicationsStrategyReshapetheCFO’’sRoleCFAII_SS18:OptionsHKUSTBusinessSchool46SummaryforRestructuringManagingvalueconsistsofthreebroadsteps:Takingstockofthevalue-creationsituationwithinthecompanyandidentifyingrestructuringopportunitiesActingonthoseopportunities(operationalefficiencyimprovements,divestures,acquisitions,reorganization)Instillingavalue-creationphilosophyAmanaging-valuefocusdoesnotcreatevaluethroughfinancialmanipulations.ItcreatesvaluethroughdevelopingsoundstrategicandoperatingplansMostcompanieswouldbenefitfromathroughreviewofrestructuringopportunitiesManagersneedtoensurethattheyidentifyandactonvalue-creationopportunitiesregularlyCFAII_SS18:OptionsHKUSTBusinessSchool47ApproachestoValuationDiscountCashFlow(DCF)valuationComparativemeasuresorrelativevaluationRealOptionsAnalysis(ROA)valuationCFAII_SS18:OptionsHKUSTBusinessSchool48DiscountedCashFlow(DCF)ValuationEstimatingFreeCashFlowCFAII_SS18:OptionsHKUSTBusinessSchool49MeasuringValueF1FirmCashflowsInvestedCapitalFixedAssetsOperatingWorkingCapitalYear1Year2Year3Year4Year5CFAII_SS18:OptionsHKUSTBusinessSchool50DiscountedCashFlowModelValueofoperations=Discountedvalueofexpectedfuturefreecashflow(FCF)CashflowsTimingRiskCFAII_SS18:OptionsHKUSTBusinessSchool51FreeCashFlow-DefinitionFreecashflowsare:after-taxcashflowfromoperationsremainingafterallre-investmentneedshavebeenmet.availablefordistributiontoallprovidersofcapital(bothshareholdersandbondholders).CFAII_SS18:OptionsHKUSTBusinessSchool52DCFValuation012TTerminalValueT=FCFT+1/(WACC-g)FCF1FCF2…FCFT-1FCFTT-1FCF=FreecashflowWACC=WeightedAverageCostofCapitalTV=TerminalValue(attimeT)=FCFT+1/(WACC––g),wheregisthelong-termgrowthrateinsalesT=Lengthoftheforecasthorizon(typically,7to10years)CFAII_SS18:OptionsHKUSTBusinessSchool53SensitivityanalysisExaminesensitivityofvaluationstodifferentassumptionsabout:Salesgrowth(affectsFCF)Profitmarginsoroperatingefficiencyoroperatingcost(affectsFCF)Assetturnoverratios(I.e.,capitalexpenditureorworkingcapitalinvestment)(affectFCF)WeightedaveragecostofcapitalCFAII_SS18:OptionsHKUSTBusinessSchool54FundamentalDriversofaCompany’’sValueValueDriversCFAII_SS18:OptionsHKUSTBusinessSchool55BasicsofValueCreationAfirmcreatesvalueonlyifitearnsareturnonitsinvestedcapitalthatishigherthanthecostoffinancingtheinvestment.Thatis,ROIC>WACCThreevaluedrivers:GrowthAbnormalreturn(ROIC>WACC)WACC(risk)CFAII_SS18:OptionsHKUSTBusinessSchool56ValueCreationAssetsInvestedCapital$100millionAfter-taxoperatingprofit(NOPLAT)$18millionReturnonInvestedCapital18%Debt$50millionEquity$50millionCostofDebt(after-tax)6%CostofEquity16%InvestedCapital$100millionWeightedAverageCostofCapital11%CFAII_SS18:OptionsHKUSTBusinessSchool57TheReturnSpreadReturnSpread=ReturnonInvestedCapital(ROIC)–WeightedAverageCostofCapital(WACC)WhenROIC>WACC,thefirmcreatesvalue.WhenROIC=WACC,thefirmneithercreatesvalue,nordestroysvalue.WhenROIC<WACC,thefirmdestroysvalue.EconomicProfitorEVA=(ROIC––WACC)InvestedCapitalCFAII_SS18:OptionsHKUSTBusinessSchool58ValueMetricsEPS(Earningspershare)ProfitMargin(ReturnonSales)Book-to-Market(B/M)Price-Earningsratio(P/E)ROIC(ReturnonInvestedCapital)EconomicProfitorEVA(EconomicValueAdded)DCF(DiscountedCashFlow)CFROI(CashFlowReturnonInvestment)TRS(TotalReturntoShareholders)…CFAII_SS18:OptionsHKUSTBusinessSchool59ValueDriverAnalysisEconomicProfit=(ROIC-WACC)InvestedCapitalValuedrivers:Abnormalreturn:InvestonlywhenROIC>WACCGrowth:gRisk:WACCCFAII_SS18:OptionsHKUSTBusinessSchool60ROICTreeROICEBIT/InvestedCapitalCashTaxRateEBIT/SalesSales/InvestedCapitalOperatingWorkingCapital/SalesNetPPE/SalesOtherAssets/SalesCOGS/SalesDepreciation/SalesSGAExpenses/SalesROIC=ProfitmarginxAssetTurnoverValueGrowthROICWACCCFAII_SS18:OptionsHKUSTBusinessSchool61MergersandAcquisitionsCFAII_SS18:OptionsHKUSTBusinessSchool62IdentifyingValueCreationPossibilitiesWhatmakestwofirmsworthmoretogetherthanapart?Synergy(relatedness,economiesofscaleandscope):Gillette’sacquisitionof-DuracellEconomiesofverticalintegration(mergerofcompaniesatdifferentstagesofproduction):Time’sacquisitionofWarnerBrothersComplementaryresources(Thetargetmayhaveauniqueproductbutlacktheengineeringandsalesorganizationtoproduceandmarketitonalargescale.)Quickerandcheapertomergewithafirmthatalreadyhasalotoftalentthantodevelopengineeringandsalestalentfromscratch.CFAII_SS18:OptionsHKUSTBusinessSchool63EvidenceonValueCreationinM&ATransactionsThecombinedvalueofcompaniesengagedinmergersandtenderoffersincreasesbyabout7percentaroundtakeoverannouncements.Howisthevalueshared?Targetsgetthebulkofit.Acquirersgetroughlyzero.CFAII_SS18:OptionsHKUSTBusinessSchool64ReasonsForFailuresOveroptimisticappraisalofmarketpotential:skepticalaboutReboundfromacyclicalslumpTurnaroundRapidgrowthcontinuesOverestimationofsynergiesOverlookingproblems:duediligenceOverbidding:escalationcommitmentPoorpost-acquisitionintegrationCFAII_SS18:OptionsHKUSTBusinessSchool65ValueCreationorEnhancementSummaryCFAII_SS18:OptionsHKUSTBusinessSchool66ValueEnhancement:SummaryIncreasecashflowsfromexistinginvestments(NOPLAT)Poorinvests:keep,divest,orliquidateImproveoperatingefficiency:operatingmarginReducethetaxburdenReducenetcapitalexpendituresonexisting