Value-based management with corporate social responsibility

As the first decade of the 21st century winds down we have seen a sea change in society's attitudes toward finance. The 1990s can best be described as the decade of shareholder supremacy, with each firm trying to outdo the other in their allegiance to shareholder value creation, or as it came to be known, Value-Based Management (VBM). No one seemed to question this culture as the rising firm valuations translated into vast wealth creation for so many. Three significant economic events have reshaped how the public feels about an unbridled devotion to VBM and have defined the last decade: the dot.com bubble in 2000, the infamous accounting scandals of 2001, and the collapse of the credit markets in 2007-2008. In all three of these events the CEOs were portrayed as reckless and greedy and Wall Street went from an object of admiration to an object of scorn. The first edition of this book, Value Based Management: The Corporate Response to the Shareholder Revolution was written to help explain the underpinnings of Value-Based Management. At the time of its publication, few questioned whether the concept was the proper thing to do. Instead, the debate was focused on how to implement a VBM program. With this new second edition, the authors look at VBM after having seen it through good times and bad. It is not their intent to play the blame game or point fingers. Nor is it their intent to provide an impassioned defense of VBM. Instead they provide an academic appraisal of VBM, where is has been, where it is now, and where they see it going.

Author Notes

John D. Martin holds the Carr P. Collins Chair in Finance in the Hankamer School of Business at Baylor University where he teaches in the Baylor EMBA programs. Over his career he has published over 50 articles in the leading finance journals and served in a number of editorial positions including the co-editorship of the FMA Survey and Synthesis Series for Oxford University Press. J. William Petty is Professor of Finance and the W.W. Caruth Chairholder of Entrepreneurship at Baylor University, where he teaches an undergraduate and graduate course in entrepreneurial finance. He has published in a number of academic journals, is a co-author on several leading textbooks, and is currently serving as director of a business angel network. James S. Wallace is Associate Professor at The Peter F. Drucker and Masatoshi Ito Graduate School of Management at The Claremont Graduate University. Prior to his career in academics, Professor Wallace worked in public accounting and in industry with a Fortune 500 Company.

Part I Value-Based Management, Corporate Social Responsibility, and the Purpose of the Corporation
1 The Purpose of a Corporation	p. 5
Adam Smith and the Invisible Hand	p. 6
A Stakeholder Perspective	p. 7
Value(s)-Based Management: A Middle Ground	p. 8
Summary: Creating Firm Value-Think Value(s)-Based Management	p. 10
Appendix 1A John Mackey and Milton Friedman on the Goal of the Firm	p. 13
2 The Elements of Value-Based Management	p. 17
Wealth Creation Is Not Universal	p. 18
The Proper Design of a V s BM Program	p. 20
Alternative Valuation Paradigms: Earnings versus Discounted Cash Flow	p. 22
Connecting Business Strategies with the Creation of Firm Value	p. 23
Summary	p. 24
3 The Need to Measure What You Want to Manage	p. 26
The Need for a Single Metric	p. 27
Total Shareholder Return	p. 29
Total Market Value	p. 30
Accounting-Based Metrics	p. 31
Think Economic Profits, Not Accounting Profits	p. 32
Summary	p. 37
Appendix 3A Accounting versus Economic ROIC	p. 39
Appendix 3B More Problems with Accounting-Based Metrics	p. 42
Part II The Finer Details of Value-Based Management and Corporate Social Responsibility
4 Free Cash-Flow Valuation: The Foundation of Value-Based Management	p. 49
The Beginning for Value-Based Management: Free Cash Flows	p. 50
What Is Free Cash Flow?	p. 51
Calculating a Firm's Free Cash Flows	p. 51
Calculating the Investors' Cash Flows	p. 53
Free Cash Flow and Firm Valuation	p. 55
Valuing the Firm: Framing the Analysis	p. 56
Free Cash Flows, but for How Long?	p. 56
Forecasting Free Cash Flows	p. 57
Computing a Firm's Intrinsic Value	p. 61
Determining the Discount Rate	p. 63
The Value Drivers: Digging Deeper	p. 65
Summary	p. 68
5 Pick a Name, Any Name: Economic Profit, Residual Income, or Economic Value Added	p. 69
The Fundamental Concept: Residual Income or Economic Profits	p. 70
Residual Income and Free Cash Flow	p. 71
An Illustration of Valuation	p. 72
A Comparison of the Residual Income and Free Cash Flow Approaches	p. 75
"Fine-Tuning" Residual Income with EVA	p. 75
What is EVA?	p. 76
Measuring a Firm's EVA	p. 77
Calculating NOPAT and Capital	p. 79
From EVA to MVA	p. 83
More Than a Financial Exercise	p. 87
Summary	p. 91
Appendix 5A The Equivalence of the Residual Income and Discounted Dividends Valuation Approaches	p. 93
Appendix 5B An Illustration of the Computation of EVA	p. 95
Appendix 5C Performance Evaluation Using CFROI	p. 101
6 Corporate Social Responsibility: Putting the S in Value(s)-Based Management	p. 103
The Moral Argument for CSR	p. 104
The Economic Argument for CSR	p. 104
CSR within a VBM Framework: The Academic Evidence	p. 106
Driving the Value Drivers	p. 108
Red Mountain Retail Group: Creating Value through Relationships	p. 108
Southwest Airlines: The Employee Comes First	p. 110
Herman Miller, Inc.: Creating Wealth through Design and Innovation	p. 111
Whole Foods Market, Inc.: Creating Wealth through Whole Foods, Whole People, and Whole Planet	p. 112
Sony Blames Economic Value Added Mentality for Its Woes	p. 113
Summary	p. 116
Part III VBM Applications
7 Project Evaluation Using the New Metrics	p. 121
Example Capital Investment Project	p. 122
Traditional Measures of Project Value	p. 122
Using EVA to Evaluate Project Value Creation	p. 124
Fixing the Problem	p. 124
Unequal Cash Flows and Positive NPV	p. 127
Summary	p. 127
Appendix 7A The Equivalence of MVA and NPV	p. 132
8 Incentive Compensation: What You Measure and Reward Is What Gets Done	p. 133
All-Too-Common Mistakes	p. 136
Creating a Culture of Ownership	p. 139
Determining a Firm's Compensation Policy	p. 142
What Should the Level of Compensation Be?	p. 142
How Should Pay Be Linked to Performance?	p. 143
Formula for Determining Incentive Pay	p. 143
Single-Period Performance Measures and Managerial Incentives	p. 146
Managerial Decision Horizon and the Use of EVA	p. 146
Extending Managerial Horizons	p. 150
How Should Employee Compensation Be Structured?	p. 151
Fairness as an Additional Characteristic of a Firm's Compensation Policy	p. 152
Summary	p. 153
Appendix 8A Whole Foods Market Executive Compensation Discussion and Analysis	p. 155
Part IV Lessons We Have Learned
9 Lessons Learned	p. 163
VBM Studies Based on Archival Data	p. 164
VBM Studies Based on Survey Data	p. 165
Factors Critical to the Success of VBM	p. 166
More Recent Survey Evidence	p. 168
Current CSR Research	p. 171
Summary	p. 172
Epilogue: Where We Are Now	p. 175
Notes	p. 181
References	p. 187
Index	p. 193

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