The primary objective of value based management is long
term, sustainable shareholder wealth maximisation. A company’s share price is
considered an indicator of shareholder wealth maximisation, as it considers
future dividend payments and investor views. It follows that shareholders, as
the owners of the company who bear the most risk, deserve a proportion of
company profits. By maximising shareholder value, a company can expect to
attract further investment and be viewed as successful in the financial market.
Over the past 6 months supermarket giant Tesco has
experienced a very public fall from grace. As a consequence, many believe
shareholder wealth has been destroyed. During the fourth quarter of 2014, Tesco
issued its fourth profit warning in six months, concluding a disastrous year
for the company. The announcement stated trading profits for the year ending
February 2015 would not exceed £1.4bn. With already reduced market forecasts of
£1.9bn, this is a £500m reduction. Whilst profits do no directly affect
shareholder wealth, they do influence it. Profit warnings are perceived by
financial markets as a sign of financial weakness. This fall in profits may
have been the initial source of investors beginning to lose confidence. In my opinion, this
fall in confidence is likely to have been reinforced by top shareholders in
Tesco selling shares in the months around this.
Market share is considered to be associated with shareholder
wealth and is usually set as a strategic objective to help maximise this
wealth. Improving market share generates economies of scale, creates barriers
to entry for potential competitors and encourages brand loyalty. Such benefits
all link to shareholder wealth, albeit indirectly. An obsession with margins
and an obsessive quest for market share has negatively impacted other aspects
of Tesco, including shareholder wealth. Tesco are under increasing pressure to
protect market share from upcoming, low cost supermarkets such as Aldi. Despite
their attempts, Tesco’s market share fell from 29.9% to 29.1% over the course
of 2014. Conversely, the market shares of Aldi and Lidl grew. Analysts have
predicted a prolonged price war in the supermarket industry, leading to the
demise of many of the current companies. Tesco admitted it is losing an
escalating supermarket price war to discount rivals Aldi and Lidl, which could
be a cause for concern for shareholders.
In late 2014, Tesco admitted misstating its profits by
£263m, representing another blow to the company. This arose as Tesco had been
doing deals with suppliers over promotions, but failing to report them
accurately. Returns were recorded too early and costs were pushed back. The
practice of stretching accounting regulations to the limit eventually catches
up with companies, as it did with Tesco. Such practices stop the company
meeting investor expectations and partly destroy market value. The incident
reduced the value of Tesco by billions. Consequently, eight executives were
suspended whilst an investigation was carried out. Four of these are now
believed to have left the company. However, today Tesco announced they would
make a pay out to the ousted CEO and ex-finance chief. This pay-out has a
combined value of almost £2.2m, further undermining shareholders and
questioning Tesco’s creation of shareholder wealth.
Perhaps not surprisingly, share prices of Tesco have
plummeted in light of these events. Share price halved over a twelve month
period, falling by 44% over the past year, compared to a 2% rise for the wider
FTSE100, seen in the graph below. During this period the share price reached
its lowest in 14 years. Accordingly, this dramatically reduced shareholders
capital gains. In August, Tesco cut their dividend by 75%. They have recently
announced they will pay no dividend for the financial year 2014/15 in a bid to
reduce capital expenditure. Whilst this reduces shareholder wealth, it shows their
commitment to the long term success of the company which may help improve
shareholder wealth in the future.
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