The value–based management and share price relationship for companies listed on the banking sector of the JSE Ltd. / Louis Arthur Fourie

Abstract

After the market exuberance of the dot com bubble in the late 1990's, the sobering period that followed the burst brought with it a renewed interest in the concept of shareholder value. Since then, all kinds of companies have been publicly proclaiming their commitment to increasing long–term value for their shareholders. One look at the statements of directors or chief executives in annual reports can confirm this. To a certain extent this is old news. The aim of publicly listed companies has always been to increase the value of shareholders' investment. Value–based management (VBM) was developed to determine whether companies, through management actions, can create value for their shareholders. Value is created when capital is invested at returns higher than the cost for that capital. VBM is defined as "a managerial process which effectively links strategy, measurement and operational processes to the end of creating shareholder value". It is generally understood to consist of three key elements: creating value, measuring value and managing for value. Since value–based management has appeared in the 1980s, various consulting firms have developed and popularised metrics that can assist management in measuring economic profit. Consultants such as Rappaport and Stewart recognised problems in the traditional accounting measures. As a result, they turned to the concept of sustained shareholder value creation. This has, in turn, led to the development of a number of "value metrics", the most significant of which are: shareholder value analysis (SVA), economic profit (EP), economic value added (EVA) and cash flow return on investment (CFROI). The main goal of this study was to investigate and determine whether investors can use value–based management metrics as an indicator for share price movement of South African banking companies listed on the Johannesburg Securities Exchange. In order to do this, the respective banks were initially isolated and five individual multiple linear regressions were run. This was done in order to determine whether the results of the specified metrics have an impact on the respective share prices of the individual banks. Subsequently a pooled panel data model was run to determine whether the combined effect of the banks over time could lead to different results. Value–based measurement metrics selected were shareholder value analysis (SVA), economic profit (EP), economic value added (EVA) and cash flow return on investment (CFROI). Other measurements such as group operating assets (GOA), price per earnings (P/E) and net operating profits after tax (NOPAT) were also tested. The results from the study indicate that most of the metrics tested cannot be used as indicator for share price movement of these banks. A rise in net operating profits after tax (NOPAT) and price per earnings (P/E) lead to an increase in the banks' share price. Even though it was found that investors should only use NOPAT or P/E for predicting share prices, companies should still focus on creating value for shareholders. It is beneficial to investors to understand what value–based management is, and to understand management actions in terms of value creation.