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The conservation-of-value principle is an excellent reality check for executives who want to make sure their acquisitions create value for their shareholders. In fact, most empirical research shows that just half of the acquiring companies create value for their own shareholders. But although they create value overall, the distribution of that value tends to be lopsided, accruing primarily to the selling companies’ shareholders. You can see this effect in the increased combined cash flows of the many companies involved in acquisitions. Acquisitions that put companies in the hands of better owners or managers or that reduce excess capacity typically create substantial value both for the economy as a whole and for investors. Mergers and acquisitionsĪcquisitions are both an important source of growth for companies and an important element of a dynamic economy. As we’ll see, the four cornerstones of finance provide a perennially stable frame of reference for managerial decisions like these. And the same thing happens every day in executive suites and board rooms as managers and company directors evaluate acquisitions, divestitures, projects, and executive compensation. Obvious as this seems in hindsight, a great many smart people missed it at the time. Securitizing the assets simply enabled the risks to be passed on to other owners: some investors, somewhere, had to be holding them. Securitization did not increase the aggregated cash flows of the home loans, so no value was created, and the initial risks remained. But this notion violates the conservation-of-value rule. Participants in the securitized-mortgage market all assumed that securitizing risky home loans made them more valuable because it reduced the risk of the assets. Consider what happened during the run-up to the financial crisis that began in 2007. Ignoring these cornerstones can lead to poor decisions that erode the value of companies. View these principles and their implications at a glance. The best-owner principle states that no business has an inherent value in and of itself it has a different value to different owners or potential owners-a value based on how they manage it and what strategy they pursue.
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The higher those expectations, the better that company must perform just to keep up.Ĥ. The expectations treadmill principle explains how movements in a company’s share price reflect changes in the stock market’s expectations about performance, not just the company’s actual performance (in terms of growth and returns on invested capital). The conservation-of-value principle says that it doesn’t matter how you slice the financial pie with financial engineering, share repurchases, or acquisitions only improving cash flows will create value.ģ. The core-of-value principle establishes that value creation is a function of returns on capital and growth, while highlighting some important subtleties associated with applying these concepts.Ģ. The four cornerstones are disarmingly simple:ġ. What we hope to do in this article is show how four principles, or cornerstones, can help senior executives and board members make some of their most important decisions.