The capacity of a firm's board of directors and senior management to make strategic choices, including making intelligent investments and providing a healthy return on invested capital, are critical factors in determining the company's shareholder value. If this value is produced, especially over a prolonged period, the share price will improve, and the firm will be able to pay higher cash dividends to its shareholders. In that case, the firm can either increase the cash dividend it distributes to shareholders or keep the additional profits for internal use. In particular, mergers have a propensity to result in a significant boost in the value of the company's shareholders.
The generation of wealth for shareholders does not necessarily or equally convert to value for the workers or consumers of the firm, which may cause shareholder value to become a contentious issue for companies. Shareholder value can become a hot-button issue for corporations.
Understanding Shareholder Value
The total amount that appears in the stockholders' equity part of the balance sheet rises whenever the value of the company's shareholders rises.
How the Use of Assets Influences Value
Companies seek investors to purchase assets to either use those assets to create sales or invest the proceeds from those sales in new initiatives with a good projected return. A business that is run efficiently will make the most of its resources, which will allow it to function with a lower initial investment in those resources. For the sake of this example, assume that a plumbing firm incurs a total cost of $50,000 for the use of a truck and other pieces of equipment while doing residential service. The plumbing company can produce more value for its shareholders by increasing the amount of revenue it brings in using its truck and its equipment. Companies that can raise their profits while maintaining the same dollar amount of assets are considered valuable.
Cash Flow Contributes to an Increase in Value
The ability of a company to operate and grow its sales without having to borrow money or issue more stock is one of the most important factors that determine the value of a company's shareholders. Generating sufficient cash inflows to operate the business is one of the most important indicators of shareholder value. The speed with which an organization can turn accounts receivable and inventory into cash collections might help that organization's cash flow. Turnover ratios are used to determine the speed at which cash is collected. Value for shareholders may increase when there is a high rate of inventory turnover and accounts receivable turnover.
Taking Into Account the Earnings per Share
Suppose management can make choices that result in increased annual net income. In that case, the firm can either increase the cash dividend it distributes to shareholders or keep the additional profits for internal use. Earnings accessible to common shareholders are divided by the total number of shares of common stock that are outstanding to calculate a company's earnings per share (EPS), which is a critical ratio for determining the value of a company's stock to its shareholders. When a firm can boost its profits, the ratio improves, and investors regard the company as having a higher market value.
The Fallacy of Attempting to Maximize Shareholder
In the case of publicly listed firms, in particular, it is generally accepted that the job of directors and management of a corporation is to increase shareholder value as much as possible. However, case law suggests that this conventional knowledge is, in reality, a practical fallacy; contrary to popular belief, there is no legal obligation for the management of a business to maximize the company's earnings. In that case, the firm can either increase the cash dividend it distributes to shareholders or keep the additional profits for internal use. In particular, mergers have a propensity to result in a significant boost in the value of the company's shareholders.
The oversize effects of a single ruling that is now out of date and widely misunderstood can be traced back to the 1919 decision by the Michigan Supreme Court in Dodge v. Ford Motor Co. A business that is run efficiently will make the most of its resources, which will allow it to function with a lower initial investment in those resources. This decision can be traced back to the origin of the idea. The management of a firm places a high priority on maximizing the return on investment for its shareholders.
Therefore, while management is making choices, they should have the best interests of the shareholders in mind when there is a rise in the value of the firm's stock to its shareholders, both the company and its management benefit. For this to occur, management has to make effective decisions to generate or raise earnings, which will ultimately result in a rise in shareholder value. On the other side, making poor decisions and using unethical strategies might be detrimental to shareholder value.
