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Economics & Finance - BLOG

Unilever: Why Firms Should Maximise Shareholder Value

Theo Vermaelen, INSEAD Professor of Finance |

If firms lose sight of shareholder value maximisation, they make themselves vulnerable to takeover.

Finance professors tell students that they should maximise shareholder value. Note that this is not the same as maximising profits, a short-term, accounting-driven performance measure. Shareholder value is the present value of expected cash flows from now until infinity, clearly not a short-term concept. In an efficient market, the market value of equity should be equal to shareholder value. If managers believe it’s not, in particular if market values are below shareholder value, managers should buy back stock.

One of the reasons we argue that MBAs should focus on shareholder value maximisation is that failure to do so will create an arbitrage opportunity. A bidder can pay a premium for the shares, switch to value maximisation and make a profit in the process. This is a key motivation in the bid for Unilever by Kraft Heinz.
As target shareholders typically ask for a premium of 30 percent, this “takeover threat” only becomes real if the value destruction is at least equal to 30 percent of the market value of the target firm. In other words, if a company trades today at US$100 million, in order to justify a takeover premium of 30 percent, the company has to be worth at least US$130 million after the takeover bid. The fact that Kraft Heinz only offered an 18 percent premium for Unilever explains the failure of their bid. Also on the day of the announcement, Kraft Heinz’s stock price increased by 7 percent suggesting that the conglomerate could potentially pay more. So resisting the bid was entirely reasonable.

A shareholder-friendly response

What is surprising is the speedy response of the Unilever board: Immediately after the failed bid, they promised to revamp Unilever to boost profits. As a result, Unilever stock price rose to the level of the Kraft Heinz bid price. It shows the most shareholder-friendly way to respond to an unsolicited bid: Increase shareholder value to become a less attractive takeover target. Although we don’t know what the board has in mind, Unilever is a conglomerate of unrelated businesses (food and personal care) that potentially could increase shareholder value by divesting or spinning off part of the company, perhaps the food business, and focus on the personal care business. 

Perhaps the restructuring will also result in the removal of CEO Paul Polman, one of the most vocal critics of shareholder value maximisation. In an interview with Forbes in 2015, Polman stated that “he was not working for shareholders…slavery was abolished a long time ago.” He seemed to be more interested in saving the planet by lowering the company’s environmental footprint than in pursuing shareholder-friendly activities such as share buybacks which he dismissed as financial engineering. This is somewhat surprising as he frequently blamed financial markets to be focused on short-term profits, not on long-term value. If this was the case, he should have bought back undervalued stock to benefit long-term shareholder value. So, depending on the outcome, the Kraft Heinz/Unilever confrontation may well become a classic business school corporate governance case study in what happens when firms don’t maximise shareholder value.

Theo Vermaelen is a Professor of Finance at INSEAD and the UBS Chair in Investment Banking, endowed in honour of Henry Grunfeld.

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Comments
David Abashidze,

Two points:
1) 30% premium is usually for the companies who have high risk/high growth (growth stocks) as such comapnies have moreof their value concetrated in future growth which creates more unceratinty around their value. hence there is a wider distribution among shareholders' opnions about fair value of company and to capture majority of shareholdes who will trade bidder has to pay higher premium - Mature cash cow companies like unilever have more certainty around their value (value stocks), hence distibution of sharehodlers opnions is narrower nad 18% premium should be fine to make shareholders trade in such company. (have worked on acquisition of life insurance company when 10% premium was making shareholders happy) However as 30% is widely publicized anchor number, the targets' boards who want to stay independent use it as a reason not to recommend acquisition at lower premium levels, even through lower premium is justified.
2) it is not necessary to recover premium paid for target only by eliminating value destruction done under current management. Kraft Heinz would have large cost synergies with Unilver's food business which would also be source of Value to Kraft Heinz, but Unilever standalone can not capture that value.

Theo,

Points well taken. The 30 % is indeed typically used as an excuse to reject bids with premiums below this number and of course cost savings from returns to scale could also justify a takeover bid.

MBA,

Embarassing for the school to have professors like this. Blatant mis-understanding of long-term value creation and shareholder value. The shareholders are holding it for its long term value, the market priced it wrong, Kraft made a bid. Now that the world realizes what its actually worth, i.e. seeing that long-term value is underpriced in a short term thinking world, the price has adjusted to reflect its more real value. There is nothing economically unsound about building a sustainable company.

Theo,

Apparently I stepped on some long green toes but that was not my intention. The fact is that the stock price only rose to the Kraft bid price after the board stated its commitment to shareholders. Its not that the market suddenly became more efficient and realized how wonderful sustainability is for long-term shareholder value. I am also talking about a different sustainability here: the sustainability of a stakeholder value governance model that does not believe that shareholders should come first. Kraft shows that even a large company like Unilever is not immune to takeover bids so the stakeholder value model may not be sustainable.

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