Maximizing Shareholder Value – in between geocentric and heliocentric theories
(This is the English translation summary of the letter we sent out to CEOs in August 2020)
Dear CEOs of our portfolio companies
My name is Yuya Shimizu, Representative Director of Hibiki Path Advisors. I would like to share my personal views on maximization shareholder value. I would hope to say it is my genuine personal opinion, but in reality it is actually something came up as a candid advice from someone. However, for me, the power of this simpleness was such that the gray clouds spreading in front of me cleared up and the blue sky and the sun came out in one fell swoop. It may be lacking some specifics, but nevertheless I hope that it will provide enrichment for the daily discussions of your own business management and board of directors, and further strengthen your future business vision. I am talking about “Maximizing Shareholder Value – in between geocentric and heliocentric theories”.
1. No “de facto” shareholder value maximization
The definition of the term “shareholder value maximization” is rather textbook-like and theoretical to begin with, and when dealing with it practically, there is always a gap in perception between investors and management. As an investor, I have always wondered if there is some kind of rule that would make it easier for us to reach a common understanding. In the midst of all this, a certain executive who had served as a director and president of a number of companies over the years taught me one way of thinking that enables both sides to feel convinced and satisfied. I would like to talk to you about that.
In terms of maximizing shareholder value, the debate about whether it is good or bad in itself seems to be settling down in Japan as well. Until about 10 years ago, there was a misconception that maximizing shareholder value meant increasing current market capitalization as quickly as possible, that is, increasing the share price in “any way” possible. As a derivative of this, it often led to a meaningless debate on “whether shareholder value alone should be the top priority”. This is what I call the geocentric theory.
On the other hand, the concept of “corporation”, a key element of capitalism, is the ethos behind the so-called going concern, which is “the existence stipulated by law that progresses on the infinite timeline on behalf of a person”. In other words, there is no concept of time, or if there is, it will be an “eternal” timeline, such grandiose. In other words, shareholder value maximization consistent with that would be “maximization over a very long (eternal) time line,” which would instantly become a little too abstract concept for those who sweat and run the company every day. Having said that, this is at least conceptually correct, and is obviously the heliocentric theory.
In my opinion, every listed company has a “company motto,” “mission,” and “values” that describe what the company is trying to achieve. By doing so, it is possible to move closer to this concept of “maximizing shareholder value on this very long (eternal) timeline “with something”. This effort will become even more important in the future as the relationship between individuals and corporations becomes more diluted. It will be a very important “language” not only for shareholders, but also for the human resources who will be responsible for the future.
Unfortunately, as the concept of maximizing shareholder value evolves along an eternal timeline, the decision-making criteria become very vague and abstract, which can lead to a blurring of the decision-making process for investing in business growth, entering, creating new businesses, and exiting or divesting, a phenomenon which I am sure you are experiencing every day.
So, when I posed this question to my good senior friend, 70 years old but who is still on the frontline of all this (now mainly as independent board), he simply said, “Shimizu-san, 10 years is good enough“. It was too simple an answer and I was like, “What?”, when I responded. Indeed, it was rather embarrassing for me. As a business owner (CFO and CEO), for many years he was troubled by the lack of a concept that could be managed on both a short-term, incremental timeline, such as the formulation of a budget for the next fiscal year, a three-year medium-term business plan, as well as a timeline that would allow him to talk about an “eternal” mission, such as the company’s motto, and this “10 years”, he realised, is a realistic timeline that developed out of his own struggles.
In other words, in practical world, we are basically aware that any long-term investment project will show some (if not most) degree of success or failure over a 10-year time horizon, so, if you can think hard and judge in the first place “whether it can deliver results that are commensurate with the company’s cost of capital” as the decision axis over a 10-year period, it is something that is long enough time frame but then not too long that to dilute the scientific angle of decision making, i.e. ROIC, Business landscape, competition, etc. The company of which the person who advised me is involved in only cared about one discipline, and it was “to become global top three or be in a position that can possible consider acquiring those top three in 10 years”. After nearly signing a MOU on a large, newspaper headline-worthy (but expensive) acquisition, the company bitterly pulled out of the deal, and instead went on to another smaller but profitable acquisition, which is now a huge success as a result. He did mention this 10 year discipline worked well to make this difficult judgment work.
There are two reasons why 10 years is a good time frame for the human brain. First, and very obvious, is the fact that when people enter the workforce, and as part of their personal goal setting, many will think in terms of decade-by-decade increments when setting their goal to achieve certain milestones by a certain age. If you think about it in terms of time to retirement, it is about 40 or 50 years, which means that there will be four to five breaks in between, and this is a very convenient time frame to digest things! The other point is that human society is based on the decimal system developed by Arabic mathematics, and with 10 being the number of fingers that we have, it is easy for both the body and the mind to naturally absorb the time frame of 10 years! It is indeed best to do everything naturally.
It may be too obvious to the extent of being anticlimactic, but the difficulty lies in making major decisions regarding the steps that should be taken to maximize corporate value (≒shareholder value) over a 10-year time horizon, based on the premise of future uncertainty, bringing together as much rationality as possible and with evidence that can stand up to scientific calculations, and then discussing and making major decisions.
One way to address this difficulty is to make a case study of a slightly simplified version of the day-to-day operations of a CFO’s office or corporate planning department of a sophisticated foreign company. Generally speaking, this is what business decision-making is all about, and we hope you will find it useful.
**Later in the actual letter, in Section 2, we compared three investment projects with different cash flow cycles, calculated their IRRs and NPVs, and discussed the type of business decisions that should be made based on our own current business structure. This is omitted in the summary translation.**