The value of value creation


Here is an excerpt from an article written by Marc Goedhart and Tim Koller for the McKinsey Quarterly, published by McKinsey & Company. To read the complete article, check out others, learn more about the firm, and sign up for email alerts, please click here.

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Long-term value creation can—and should—take into account the interests of all stakeholders.
Challenges such as globalization, climate change, income inequality, and the growing power of technology titans have shaken public confidence in large corporations. In an annual Gallup poll, more than one in three of those surveyed express little or no confidence in big business—seven percentage points worse than two decades ago.   Politicians and commentators push for more regulation and fundamental changes in corporate governance. Some have gone so far as to argue that “capitalism is destroying the earth.”  This is hardly the first time that the system in which value creation takes place has come under fire. At the turn of the 20th century in the United States, fears about the growing power of business combinations raised questions that led to more rigorous enforcement of antitrust laws. The Great Depression of the 1930s was another such moment, when prolonged unemployment undermined confidence in the ability of the capitalist system to mobilize resources, leading to a range of new policies in democracies around the world.

Today’s critique includes a call on companies to include a broader set of stakeholders in their decision making, beyond just their shareholders. It’s a view that has long been influential in continental Europe, where it is frequently embedded in corporate-governance structures. The approach is gaining traction in the United States, as well, with the emergence of public-benefit corporations, which explicitly empower directors to take into account the interests of constituencies other than shareholders.

Particularly at this time of reflection on the virtues and vices of capitalism, we believe it’s critical that managers and board directors have a clear understanding of what value creation means. For today’s value-minded executives, creating value cannot be limited to simply maximizing today’s share price. Rather, the evidence points to a better objective: maximizing a company’s value to its shareholders, now and in the future.

Answering society’s call

Recently, the US Business Roundtable released its 2019 “Statement on the purpose of a corporation.” Dozens of business leaders (the managing director of McKinsey among them) declared “a fundamental commitment to all of our stakeholders [emphasis in the original].” Signatories affirmed that their companies have a responsibility to customers, employees, suppliers, communities (including the physical environment), and shareholders. “We commit to deliver value to all of them,” the statement concludes, “for the future success of our companies, our communities and our country.”

A focus on the future

The Business Roundtable’s focus on the future is no accident: issues such as climate change and income inequality have raised concerns that today’s global economic system is shortchanging the future. We agree. The chief culprit, however, is not long-term value creation but its antithesis: short-termism. Managers and investors alike too often fixate on short-term performance metrics, particularly earnings per share, rather than on the creation of value over the long term. By prioritizing (or, perhaps more correctly, mischaracterizing) shareholders’ best interests in terms of beating analyst estimates on near-term quarterly earnings, the financial system can seem to institutionalize a model that cares only for today and all but ignores tomorrow. There also is evidence, including the median scores of companies tracked by McKinsey’s Corporate Horizon Index from 1999 to 2017, that the tendency toward short-termism has been on the rise. Certainly, the roots of short-termism are deep and intertwined. A collective commitment of business leaders to clear the weeds and cultivate future value is therefore highly encouraging.

Companies that conflate short-termism with value creation often put both shareholder value and stakeholder interests at risk. Banks that confused the two in the first decade of this century precipitated a financial crisis that ultimately destroyed billions of dollars of shareholder value. Companies whose short-term focus leads to environmental disasters also destroy shareholder value, not just directly through cleanup costs and fines but via lingering reputational damage. The best managers don’t skimp on safety, don’t make value-destroying decisions just because their peers are doing so, and don’t use accounting or financial gimmicks to boost short-term profits. Such actions undermine the interests of shareholders and all stakeholders and are the antithesis of value creation.

Managers and investors too often fixate on short-term performance metrics, particularly earnings per share, rather than on the creation of value over the long term.

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Here is a direct link to the complete article.

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