Valuation: Measuring and Managing the Value of Companies, Fifth Edition

3

The Expectations Treadmill

The performance of a company and that of its management are frequently measured by total returns to shareholders (TRS). This measure combines the amount shareholders gain through any increase in the share price over a given period with the sum of dividends paid to them over the period. That sounds like a good idea: if managers focus on improving TRS to win performance bonuses, then their interests and the interests of their shareholders should be aligned. The evidence shows that this is indeed true over very long periods of more than 10 years at least. But TRS measured over periods shorter than 10 years may not reflect the actual performance of a company and its management for two main reasons.

First, improving TRS is much harder for managers leading an already successful company than for those leading a company with substantial room for improvement. The reason is that a company’s progress toward performance leadership in any market will attract investors expecting more of the same, pushing up the share price. Managers then have to pull off herculean feats of real performance improvement to satisfy those expectations and continue improving TRS. We call their predicament the “expectations treadmill.” Clearly, managers’ capacity to influence TRS depends heavily on their business’s position in the cycle of shareholder expectations, from start-up to maturity. But this position is beyond their control, making TRS in isolation an unfair measure ...