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Value: The Four Cornerstones of Corporate Finance

ISBN: 978-0-470-42460-5
272 pages
November 2010
Value: The Four Cornerstones of Corporate Finance (0470424605) cover image
An accessible guide to the essential issues of corporate finance

While you can find numerous books focused on the topic of corporate finance, few offer the type of information managers need to help them make important decisions day in and day out.

Value explores the core of corporate finance without getting bogged down in numbers and is intended to give managers an accessible guide to both the foundations and applications of corporate finance. Filled with in-depth insights from experts at McKinsey & Company, this reliable resource takes a much more qualitative approach to what the authors consider a lost art.

  • Discusses the four foundational principles of corporate finance
  • Effectively applies the theory of value creation to our economy
  • Examines ways to maintain and grow value through mergers, acquisitions, and portfolio management
  • Addresses how to ensure your company has the right governance, performance measurement, and internal discussions to encourage value-creating decisions

A perfect companion to the Fifth Edition of Valuation, this book will put the various issues associated with corporate finance in perspective.

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About the Authors.

Preface.

Acknowledgments.

Part One The Four Cornerstones.

1 WhyValueValue?

2 The Core of Value.

3 The Conservation of Value.

4 The Expectations Treadmill.

5 The Best Owner.

Part Two The Stock Market.

6 Who Is the Stock Market?

7 The Stock Market and the Real Economy.

8 Stock Market Bubbles.

9 Earnings Management.

Part Three Managing Value Creation.

10 Return on Capital.

11 Growth.

12 The Business Portfolio.

13 Mergers and Acquisitions.

14 Risk.

15 Capital Structure.

16 Investor Communications.

17 Managing for Value.

Appendix A The Math of Value.

Appendix B The Use of Earnings Multiples.

Index.

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McKINSEY & COMPANY is a global management consulting firm that helps leading private, public, and social-sector organizations make distinctive, lasting, and substantial performance improvements. With consultants deployed from more than ninety offices in over fifty countries, McKinsey advises companies on strategic, operational, organizational, financial, and technological issues.

TIM KOLLER leads the firm's research activities in valuation and capital market issues. He advises clients globally on corporate strategy, capital markets, M&A, and value-based management. Tim is a coauthor of Valuation: Measuring and Managing the Value of Companies.

RICHARD DOBBS is a director of the McKinsey Global Institute, the firm's business and economics research arm. He advises Korean and other Asian companies and governments on strategy, economics, and M&A issues. Richard is an associate fellow of University of Oxford's Saïd Business School.

BILL HUYETT advises clients in healthcare and other technology-intensive industries on corporate strategy, M&A, product development and commercialization, and corporate leadership. Bill is active on several not-for-profit boards in basic life sciences research.

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November 10, 2010
Value

It’s surprising how often executives and boards make decisions that defy their own intuition about what creates lasting shareholder value. Market pressure, new financial engineering techniques, and misconceptions dressed as conventional wisdom all conspire against them. As all too recently witnessed, such misconceptions can damage companies and even the economies of entire countries.

A new book by McKinsey & Company, VALUE: The Four Cornerstones of Corporate Finance (Wiley; November 2010; $29.95; 978-047042460-5; Hardcover), provides a clean view into what drives corporate value creation—and what doesn’t—offering CEOs and other senior executives a stable basis for making sound, courageous, and sometimes unpopular strategic and financial decisions, even in the face of flawed thinking.

Understanding the four cornerstones explains why, for example:

  • Growth isn’t always the key to value creation, despite the business world's obsession with it.
  • Share repurchases, currently much in favor, rarely create value.
  • Companies and investors should spend less time worrying about earnings guidance.
  • The voices of a certain minority of investors should be heeded, and the rest should be ignored.
  • Near-term changes in a company’s market valuation—often used to assess corporate performance and management compensation—are mostly due to factors beyond executives’ control.
  • Earnings are inevitably variable, so trying to smooth them is a fool’s game.
  • Divesting high-performing businesses can create more value than retaining them.
  • Predicted EPS accretion or dilution is no indicator of an acquisition’s potential to create value.

The four cornerstones are built upon deep and broad McKinsey research and are illuminated with anecdotes, examples and company cases. The cornerstones are:

  • The core of value:  The combination of growth and return on capital, and resulting cash flow, drives value creation. This explains why some companies typically trade at high P/E multiples despite low growth. What’s important about this is that where a business stands in terms of growth and return on invested capital (ROIC) can drive significant changes in its strategy. For businesses with high returns on capital, improvements in growth create the most value; for businesses with low returns, improvements in ROIC provide the most value.
  • The conservation of value:  Value is created when companies generate higher cash flows, not by rearranging investors’ claims on those cash flows. When a company substitutes debt for equity or issues debt to repurchase shares, for instance, it changes the ownership of claims to its cash flows—but it typically doesn’t change the total available cash flows or add value, unless taxes change. Similarly, changing accounting techniques may create the illusion of higher performance without actually changing the cash flows, so it won’t change the value of a company.
  • The expectations treadmill:  A company’s performance in the stock market is driven by changes in the stock market’s expectations, not just the company’s actual performance (growth, ROIC and resulting cash flow). The higher the stock market’s expectations for a company’s share price become, the better a company has to perform just to keep up. Although certain companies can deliver unusually high total returns to shareholders for some period of time (usually no more than three years), they eventually hit a wall and disappoint.
  • The best owner:  There is no such number as an inherent value for a business; rather, a business’s value is relative to who owns it or might own it. Different owners will generate different cash flows for a business based on the strategies they pursue and their unique abilities to add value. Some, for instance, add value through unique links with other businesses in their portfolios, such as those with strong capabilities for accelerating the commercialization of products formally owned by upstart technology companies.

Value draws on research from the definitive reference on corporate finance and value creation, McKinsey’s Valuation: Measuring and Managing the Value of Companies. That book is now in its fifth edition, having sold more than 500,000 copies in 10 languages. But McKinsey came to see the need for a more accessible work to guide senior executives and board members through the quagmires of strategy formulation, business portfolio configuration and decisions about mergers and acquisitions.

“It’s one thing for a CFO to understand the mathematically based laws of valuation and apply them to the tools and processes that drive company performance. But it’s more powerful still when CEOs, board members and other non-financial executives understand the principles and practices of value,” says author Tim Koller. “Companies dedicated to value creation are more robust and build stronger economies, higher living standards, and more opportunities for individuals.”

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