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Strategy

LIVA: How to Truly Measure Long-Term Success

Phebo Wibbens, INSEAD Assistant Professor of Strategy, and Nicolaj Siggelkow, the David M. Knott Professor at the Wharton School |

Most executives care about creating long-term shareholder value but haven’t had the right tool to track it – until now.

Imagine you were fortunate enough to have bought 100 shares of Apple stock in 1999. If you had then reinvested any dividends and sold your shares 20 years later, you would have made an annualised return of 27 percent, well above the market average of 6 percent. This is surely a healthy return, but hardly as spectacular as one would expect. In fact, in terms of total shareholder returns (TSR), Apple’s performance ranks 3,175th amongst companies worldwide. Does this mean that Apple’s success hasn’t been as exceptional as is often claimed?

No, the problem isn’t the performance, it’s the tool used to measure information. What the TSR ranking example shows is that current measures of corporate performance do not capture long-term value accurately. Even though the list of performance measures seems almost endless ROA, ROC, EBIT, EBITDA, CAR, EPS, quarterly earnings growth and so on none of them precisely captures what is most important to many executives and investors: creating long-term shareholder value. Therefore, in a recently published paper in the Strategic Management Journal, we introduce a new performance measure that does exactly that, Long-term Investor Value Appropriation (LIVA).

The idea behind LIVA is simple: Use share price data to calculate the value a company has either created or destroyed for its entire investor base. Our measure is closely related to net present value (NPV), which estimates the value of a project based on expected future cash flow. NPV has been the gold standard for CFOs to decide in which projects to invest. LIVA, on the other hand, uses historical data to estimate how much value a company actually created for its investors.

Expanding on the Apple example: If in 1999 you had bought the entire company at its then-market price, accounted for any cash received through dividends or share buybacks, and went on to sell the company 20 years later at its (much improved) market price, you would have been over a trillion dollars richer than if you had invested the same amount of money in an index fund. In other words, Apple’s LIVA over this period was more than US$1,000,000,000,000. This number shows the truly exceptional performance of Apple. It is the number one company in our global database, with a LIVA 57 percent higher than number two (Amazon) in our rankings.

This example shows the power of LIVA: Unlike other metrics, it measures long-term value creation for the entire shareholder base.

The global top 10 and bottom 10

To help managers and researchers identify the best and worst performing companies in the world, or a region, or an industry, we have created a database of more than 45,000 companies with LIVA data over the past 20 years. The figure below shows the global top 10 and bottom 10 over the period 1999 to 2018.

The top five consists of tech companies which have created more than US$2.6 trillion in shareholder value. Interestingly, the bottom list includes several tech companies as well: Lucent, MCI/WorldCom and AOL/Time Warner (which over this period destroyed a remarkable amount of value). In fact, the Technology Hardware & Equipment companies in our database had a LIVA of negative US$2.2 trillion in aggregate the second-most value destroying industry (after Telecommunication Services). The extreme distribution of long-term performance in tech is a consequence of network effects. Only those companies that dominate their respective sectors are able to create enormous shareholder value, while the majority of tech companies actually destroy investor value.

Limiting one’s view to the top-performing companies is dangerous. A look at the top 10 might lead to the conclusion that tech is the place to be to create value. However, the overall picture leads to a very different conclusion: Only companies that were able to exploit a unique competitive advantage have been successful.

Short-termism doesn’t improve society

Of course, creating shareholder value should not be executives’ sole focus. Recently many American CEOs redrafted their vision of the corporation to encompass the importance of all stakeholders. We believe that using LIVA can be a step towards a focus on broader society.  Companies that prioritise their long-term performance cannot ignore their stakeholders. 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. However, in the long run these actions will likely backfire due to customer protests or stricter regulations, ultimately destroying value as measured by LIVA.

Moreover, to meet rising pension demands in an ageing society, the world badly needs more companies that create long-term returns. Such firms can play an instrumental role in energy transition and feeding the world more sustainably. 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 in society.

Get started using LIVA with the tools on www.liva-measure.com, including interactive access to the full global LIVA database of more than 45,000 companies.

Phebo Wibbens is an Assistant Professor of Strategy at INSEAD.

Nicolaj Siggelkow is the David M. Knott Professor at the Wharton School, where he is also a Professor of Management. He is the co-director of the Mack Institute for Innovation Management.

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Comments
David Abashidze,

I am sorry if I missed it anywhere but looks like LIVA does not incorporate measure of risk and is more related to TSR expressed in actual money terms rather than to NPV, as NPV incorporates measure of risk with cost of capital.

To continue with example of Apple: Apple created a lot of money for shareholders, but how much Value is harder to quantify. We should not miss the risks Apple took in the journey, there was even case when it was on the brink of collapse. Just because eventually than risk did not materialize does not mean it was not there. You might gamble and create a lot of LIVA but at the expense of massive risks.

I think when we measure Value created it should consider not only money created but how much risks we took for creating that money. For example, in world of corporate finance performance measures always incorporate risk factor in them.

So my questions is: does LIVA account for the risks taken by the companies?

Phebo Wibbens,

Thank you for your question. Indeed the measure as presented here is not risk-adjusted, for two primary reasons:
1. Based on academic studies in finance, for most companies their risk profile does not affect the discount rate in a statistical significant way. This means that for most companies it is not possible to get a sufficiently precise measurement of so-called "systematic risk" that is significantly different from the average.
2. Consistent with the above, when we did use a risk-adjusted measure, this did not affect our main results, while it did make it significantly harder to calculate and thus implement LIVA.

For more background on this topic, please have a look at our website (https://www.liva-measure.com/faq) and the academic article (https://onlinelibrary.wiley.com/doi/full/10.1002/smj.3114) which provide more details on the methodological choices made, and how you can calculate a risk-adjusted version of LIVA if needed.

HS,

I followed the earlier question. Could you tell if Beta has been incorporated in LIVA? I would be interested if the top 10 stocks could highlight some risk from the Beta.

David Abashidze,

Also consistent with the question by HS.

Looks like systemic risk measure like beta was incorporated in valuation and it did not make difference. Not surprising as beta generally rarely makes difference. But what about non-systemic risk measures? I know that in CAPM world they do not matter, but the reality is that investors pay a lot of attention to firm-specific risks, especially in today's world with increased activity of private equity investors who do not have very diversified portfolios and take large stakes in companies.

I understand the logic of removing systemic risk measure as beta did not make difference, but as a practitioner still would find it difficult to use in practice the value creation measure which does not incorporate risk.

Practitioners care about firm-specific risks and there are a lot of models based on Modigliani–Miller and CAPM worlds which provide a “good starting point” (no sarcasm), but after so many years of research we want something which is more practical to use in real world.

Anonymous,

Very useful article, excellent that you wrote point by point. I want to apply this to my business. I will share this article with my colleagues! Thanks for your work!

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