Business Performance Valuation and Value Creation

Business Performance Valuation and Value Creation

Maria Fernanda Matias (ESGHT, University of Algarve, Portugal), Ana Isabel Martins (ESGHT, University of Algarve, Portugal) and Sandra Rebelo (ESGHT, University of Algarve, Portugal)
DOI: 10.4018/978-1-7998-4552-2.ch008
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Abstract

The globalization of the economy, the evolution of technology, and the increasing level of competition have imposed constant change to companies, namely on the continuous improvement of their functioning and organization, in the permanent updating of their products, and in the attitude towards the satisfaction of their customers. This pressure for change has led to the emergence of new approaches and management methods. One of these new approaches, called value management, is based on the concept of value, which translates a relationship between the satisfaction of a product or service and the resources necessary for its execution. This study presents the main tools for monitoring performance, highlighting the most expressive indicators of business performance. Before, however, brief reflection will be made on management oriented towards value creation.
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Value Creation-Oriented Management

In the early eighties, few companies adopted the notion of shareholder value. The idea that the main responsibility of management is to add value gained great momentum and general acceptance only from 1986, when the book Creating Shareholder Value was published by Rappaport in the United States. Over the next ten years (nineties) market globalization, intensifying competition and the huge wave of privatizations promoted the notion of shareholder value as the main measure of performance around the world.

For long time, earnings were the main measure of performance of companies and managers. Indeed, even today, many of the evaluation models are based on earnings obtained and many of the evaluation parameters are defined based on net income, rate of income retention, dividend distribution rate, etc. Maximizing shareholder value is the politically correct attitude taken very often by managers. Shareholder value prevails in management reports, specialty magazines, and meetings of financial analysts, speeches and presentations.

With the development of value creation perspective, there was an increase in the use of cash flows in detriment of earnings. Rappaport (1998) identifies some of the most pressing gaps in earnings or incomes, since incomes are significantly dependent on accounting methods, do not reflect investment needs or the true value. The increase in net income does not necessarily imply an increase in economic value for shareholders. Shareholder value increases only when the rate of return on new investments is higher than the rate of return on alternative investments with similar risk. However, increases in income can be recorded even when investments provide lower return rates than the cost of capital, that is, when there is a loss of value.

It is therefore verified that traditional performance valuation measures based on accounting logic, such as the growth of earnings or sales, may not imply shareholder value creation. Given the existence of significant differences between cash flows and income, analysts assessed the need to reconcile analysis methodologies. In this context emerged the so-called new performance indicators such as Economic Value Added (EVA) or Market Value Added (MVA) (Young & O'Byrne, 2001).

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