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Financial metrics is a realistic way for companies to measure value.
Creating shareholder wealth or value has become the mantra for most corporate boards, especially in the United States. Yet as recently as the mid-1980s, the idea of "shareholder value" or "shareholder wealth" was not an overwhelmingly accepted principle. But as academics began to teach the principle in business schools around the world, such noted authorities as Professor Alfred Rappaport of Northwestern University's J.L. Kellogg Graduate School of Management, author of Creating Shareholder Value,l began to apply it to corporate mergers and acquisitions in the 1980s. Shareholder value, or free cash flow analysis, became the measurement standard for the 1980s and into the 1990s. Given today's increased demand for international capital returns, as well as the proliferation of private baby boomer pension funds in the United States, investors have imposed new stringency in their vigil against corporate wealth destruction. Even the brightest stars are not immune to the pressure of pension funds or Wall Street. Witness the pressure that CALPERS (the state of California's teachers' retirement funds) placed on Michael Eisner at Walt Disney Co. despite Eisner's laudable success in increasing Disney's market value from $5 billion to more than $42 billion during his first 10 years in office. During a 10-year period from January 1986 to December 1996, Disney's stock price grew at a cumulative annual growth rate of more than 21%, while the S&P 500 index has returned approximately 15%. Historical performances are not always enough; investors continue to ask for more.
Measuring performance no longer can be left to the traditional accounting department's calculations of earnings per share (EPS) or return on equity (ROE), as these accrual-based accounting measures aren't always useful indicators of future growth or performance. Thus, it is necessary to understand and adopt measurement techniques that will help make decisions while driving increasing profitability. One of the economic measurement techniques that can be used is free cash flow analysis or Shareholder Value Analysis (SVA).
SHAREHOLDER VALUE ANALYSIS
Because managers began to realize that businesses needed a more realistic means of assessing their value than accrualbased accounting standards offered, such respected academics as Professor Rappaport sought to develop sophisticated economic models for strategic evaluation. As a result, shareholder value...