Tuesday, March 3, 2015

Measuring shareholder value focus: the Dow Jones case study

As mentioned in my article “How to measure stock reputation”, the focus on shareholder value is the second thing to look at in order to measure stock reputation. For this case study, I looked at American companies on the Dow Jones Index.

Focus of the Board

To begin with, the focus on shareholder value has to come from the board of Directors.  In order to rate this focus, I looked in detail at board composition and governance for several companies. In particular, I identified the presence (or not) of significant shareholders on the board and the separation (or not) of the CEO and Chairman roles. To refine my analysis, I looked at other secondary criteria to answer the following questions: Is a significant shareholder the Chairman of the Board? Is the CEO the main shareholder of the company? Is there a State shareholder with a representative present on the Board? In case on a combined CEO and Chairman role, is there a Lead Independent Director on the Board? Is a majority of the board composed of independent board members? Are there only independent board members when excluding the CEO and significant shareholders? Finally, based on these two main criteria, as well as secondary ones, I rated the shareholder value focus of each board.


This analysis showed that few boards have a strong focus on shareholder value, but that is not the case for the majority. Two-thirds of Dow Jones companies are rated below average and two elements explain this.

First, most of these companies were founded decades ago and do not have any reference shareholder. They are fully public and owned by institutional investors who do not sit on the board.

Second, most of the time, the CEO is also the Chairman of the Board. Despite corporate governance best practices and shareholder pressure, American CEOs cling to this traditional model that gives them the power and allows them to control the board. Facing criticism, they have recently accepted to name Lead Independent Directors to their boards, but those board members still do not have enough power to really threaten CEOs in the case of share price underperformance.

Focus of the CEO

Next, to measure how much of a priority is given to shareholder value, the CEO’s incentive linked to the share price performance needs to be analyzed. Indeed, the best way to align the interests of executives and shareholders is to pay executives a high proportion of shares and stock options. Also, I looked at the number of shares (and stock options) owned by each CEO. More precisely, I measured the value of the CEO’s stocks ownership and compared it to his annual salary (including bonus). On this basis, I was able to rate and rank the shareholder value focus of each CEO.

*Before recent change of CEO

Overall, this analysis is very positive for US companies. Three-quarters of the CEOs analyzed own shares equivalent to more than five years’ worth of salary. Therefore, they are extremely incentived by the performance of their share price.

Among them, JP Morgan and UnitedHealth CEOs are the most incentivized. Their stock ownership represents more than 80 years of salary. In part, this can be explained by their seniority as CEOs (for almost 10 years they have cumulated shares and stock options), and in the case of JP Morgan’s CEO by his relative low annual salary (he did not receive a bonus in 2014). Yet, this shows above all the boards willingness to align CEO interest with that of shareholders.

On the contrary, McDonald’s and IBM’s CEOs owned relatively few shares compared to their salaries. This is due partly to their relatively limited seniority in their positions but also because they have sold many shares over the last years. Whatever the reason, at the end, their wealth is not linked to share performance and this may worry investors.

Investor Relations intensity  

Investor Relations activity is the last thing to analyze in order to measure shareholder value focus. Even without board pressure and without financial incentives, management can involve itself in an active IR program. To measure these actions, the best approach is to measure the time dedicated by management (CEO and CFO) to investors (results, roadshows, conferences, investor days…). It is unfortunately difficult to obtain precise information on the management timetable from outside of the company. Also, to get an idea of management involvement in IR activities, I listed the number of investor’s events to which the company participated (excluding the mandatory ones such as quarterly results and AGM). This allowed me to rate IR intensity.

On average, Dow Jones’ companies participated in six events per year. However, some are much more active than that. For example, General Electric and Cisco have participated in more than 20 events per year. Alternatively, Nike seems to have participated in a limited number of events.

Conclusion

By adding the results on these three criteria, it was possible to rate the shareholder value focus for each company.

Microsoft and Wal-Mart obtained the best rating due to the presence of important shareholders on their boards, the separation of the CEO and Chairman roles and an significant share ownership of their CEOs. To the contrary, Chevron was at the bottom of the ranking as its CEO was also Chairman and owned very few shares on its company.

More broadly, these American companies have relatively good ratings as regard to their shareholder value focus. On the negative side, CEOs are often Chairmen and there is not much threat in theory from their boards. On the positive side, they are highly incentivized by their share price performance. This is not often the case in Europe or Asia.


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