Corporate finance - Financial Management Collection

Financial Management (Financial Management Association), Fall, 1993 by Melissa Lunt, Ted Veit

Should Companies Really Attempt to Maximize Shareholder Value?

The following is a provocative exchange between prominent corporate strategist, C.K. Prahalad, and shareholder value advocate, Bennett Stewart. Also participating in this discussion were Ed Thompson, Charles Clough, and Len Williams. This excerpt is from the article "Continental Bank Roundtable on Global Competition in the 90's" published in the Journal of Applied Corporate Finance, Vol.6 No.1, Spring 1993, pp. 51-55.

Changing the Management Scorecard

PRAHALAD: I would like to return to this issue of why business units don't collaborate, because I think it has a lot to do with the problems at our largest companies-the IBM's, the ITT's, the General Motors of the world. To me, the really basic issue is this: What is the scorecard for top management? What is their primary goal? Most top managements simply sidestep the question by aggregating the financial numbers of all their business units and coming up with a single financial measure for the corporation. But, as Charlie was arguing in the case of TI, this kind of divisionalized, decentralized structure forces people to think and act in very narrow ways. It breeds turf wars.

If you think about the dimensions of corporate strength in a large diversified company, it's not just a matter of expanding markets by selling in multiple countries. More fundamentally, it's a matter of leveraging commonalities among business units, or what I like to call the "white spaces" between business units. Most of the new opportunities for corporations do not exist within the box called the business unit; they tend to span those boxes, or to exist in these white spaces, if you will. People focusing only on their business units will inevitably fail to seize such opportunities.

So, given this limitation, why do managers use financial performance as their scorecard? And why do they continue to use decentralized corporate structures? Two reasons, I think: One, it makes top management's job extremely easy. What do you do if one of your business units is not performing? You change the manager. This way, you've pretended to address the problem, and you're essentially off the hook. The second reason, which I won't go into now, has to do with restrictions our governance system places on communications between management and investors--restrictions that make it difficult for companies to communicate in ways other than the language of quarterly earnings.

Now, there is no value added in that kind of relationship between top management and corporate divisions. Top managers in this decentralized system are functioning at bottom no differently than portfolio managers who trade in and out of stocks. But, if you believe you're running an operating company, then top management must take some responsibility for creating synergies, for making the value of the total corporation worth more than simply the sum of its divisions. Of course, management must continue to make sure that divisional managers have strong incentives to be market-focused and entrepreneurial. At the same, though, they must continually ask themselves: How do I use corporate oversight and corporate functions to leverage the different divisions, to identify and take advantage of growth opportunities that could be pursued more effectively by people from different parts of the organization acting in concert?

You cannot produce co-operative behavior unless you take a broader view of corporate performance than that provided by financial measures. You certainly will never achieve a sharing of the agenda. And that, in my opinion, is why so many of the recent corporate success stories feature Japanese instead of American companies. It's not because Japanese top managers are smarter than American managers. They have simply tried much harder to provide people throughout their organizations with a broad understanding of the corporate mission, with a vision of the corporate future. At the same time, they have continued to encourage individual entrepreneurship and accountability at the business unit level.

So we need to ask the question: To what extent can you decentralize and multiply profit centers without destroying incentives for co-operative planning and action? At what level of senior management do you begin to hold people accountable not for business unit performance, but for the success of the organization as a whole? If you look at the three levels of management below the top that characterize most American companies, each of them is typically evaluated according to the same set of numbers. The business unit managers are looking at monthly or quarterly performance, and so are the group managers and the sector managers. If all of them are marching to the same drummer, then where is the value added by the upper layers? They don't bring a different perspective to operations.

In Defense of Decentralization and Corporate Focus

STEWART: That's true enough, C.K. But let me play devil's advocate and ask the following question: What's to prevent the organization-wide pursuit of this grand co-operative vision from degenerating into an unchecked quest for growth and market share? It seems to me that this is one of the big problems faced by many Japanese companies today. In this quest for growth and continuous renewal, they have diversified well beyond their capabilities and ignored profitability altogether. So where's the accountability necessary to rein in the impulse toward excessive growth?