Business leaders and investors are increasingly rating companies on their ability to create long-term shareholder value instead of solely focusing on short-term financial performance.
Today the most commonly used metrics to gauge a firm’s success are profitability ratios such as return on capital (ROC), total shareholder return (TSR) and earnings per share (EPS), according to INSEAD.
While these provide useful information, they are focused on the short-term and do little to reflect underlying economic performance or to precisely capture the creation (or destruction) of long-term shareholder value, the business school noted.
What is LIVA?
To address this gap, Phebo Wibbens, INSEAD Assistant Professor of Strategy, and Nicolaj Siggelkow, the David M. Knott Professor at The Wharton School of the University of Pennsylvania, have developed a new tool they call Long-term Investor Value Appropriation (LIVA), according to INSEAD.
LIVA, as introduced in a recent paper, “Introducing LIVA to measure long-term firm performance”, published in the Strategic Management Journal, uses stock price data to measure the degree to which a company has created and destroyed shareholder value by calculating a backward-looking net present value (NPV) over a given period, INSEAD pointed out.
This is best explained using an example such as Apple which between 1999-2018 had a LIVA of 1.002 trillion dollars, Wibbens said.
“This number indicates that if an investor bought all outstanding shares of the company in 1999 at the market price, borrowing the money for the purchase at a cost equal to the average market return, and then sold the shares at the end of 2018 at the market price, using the money received as well as dividends and share buy backs to repay the ‘debt’, they would have $1.002 trillion left in the bank,” he explained.
Factoring expectations and earnings into result
As LIVA is based on share price, expectations as well as earnings are factored into the result, the scholar said.
According to him, Unlike many other performance measures, the LIVA metric:
• is not weighted in favour of firms that outperform relative to their size ensuring it is driven by companies with significant economic impact.
• more accurately captures the actual economic effect of major corporate events such as M&As, spin-offs and bankruptcy
• values both profits and growth
• Reflects the long-term value creation of a firm’s entire shareholder base.
• is particularly suited for settings in which there is a long period before strategic actions are reflected in performance. In these cases, it is difficult for measures such as ROA and CAR (cumulative abnormal returns) to pick up long-term performance consequences.
As it is an additive measure, LIVA is simple to aggregate over multiple companies or time-periods, the business school noted.
To assist with this, the authors have created a database including more than 500,000 observations of 45,000 firms using 20 years of statistics from the Compustat North American and Global Security databases, said INSEAD.
Managers and researchers can access the LIVA database and web app by going to https://www.liva-measure.com/.
“They can use our tools there to compare a firm’s long-term performance against its peers, the best and worst performing companies globally or across a specific region or industry,” Wibbens said.
Users are also able to break down the LIVA to identify which parts of the firm have performed well at specific moments and to identify which strategic decisions have created or destroyed value - assisting executives and investors to make better-informed strategic decisions in the future, he pointed out.
Thee study reveals the markedly different strategic insights that can come from using LIVA compared to commonly used short-term ratios measures such as ROA and CAR (cumulative abnormal returns), according to INSEAD.
For instance, they show how the much-recognised U-shaped relationship between organisation acquisition experience and organisation performance is largely driven by short-term investor expectations and vanishes when using 10-year LIVA, the school said.
By helping decision-makers to measure and focus on long-term value creation, metrics like LIVA are also likely to have a broader societal impact, Wibbens said.
“Managers concerned mainly with short-term metrics such as quarterly earnings growth will be tempted to make quick cash at the expense of suppliers, customers and broader society,” he said. “In the long run these actions will likely backfire due to customer protests or stricter regulations, ultimately destroying value. LIVA provides managers with a metric that can help them gauge long-term value creation and consider which strategic decisions can allow their firms to flourish.”