Executives have developed tunnel vision in their pursuit of shareholder value, focusing on short-term performance at the expense of investing in long-term growth. It's time to broaden that perspective and begin shaping business strategies in light of the competitive landscape, not the shareholder list. In this article, Alfred Rappaport offers 10 basic principles to help executives create lasting shareholder value. For starters, companies should not manage earnings or provide earnings guidance; those that fail to embrace this first principle of shareholder value will almost certainly be unable to follow the rest. Additionally, leaders should make strategic decisions and acquisitions and carry assets that maximize expected value, even if near-term earnings are negatively affected as a result. During times when there are no credible value-creating opportunities to invest in the business, companies should avoid using excess cash to make investments that look good on the surface but might end up destroying value, such as ill-advised, overpriced acquisitions. It would be better to return the cash to shareholders in the form of dividends and buybacks. Rappaport also offers guidelines for establishing effective pay incentives at every level of management; emphasizes that senior executives need to lay their wealth on the line just as shareholders do; and urges companies to embrace full disclosure, an antidote to short-term earnings obsession that serves to decrease investor uncertainty, which could reduce the cost of capital and increase the share price. The author notes that a few types of companies--high-tech start-ups, for example, and severely capital-constrained organizations--cannot afford to ignore market pressures for short-term performance. Most companies with a sound, well-executed business model, however, could better realize their potential for creating shareholder value by adopting the 10 principles.

Business decisions based on poor valuation practices can create significant losses. Here's a straightforward set of calculations that will help your company assess the impact of its valuation decisions on shareholder returns.

In 1988, less than 2% of large deals were paid for entirely in stock; by 1998, that number had risen to 50%. The shift has profound ramifications for shareholders of both the acquiring and acquired companies. In this article, the authors provide a framework and two simple tools to guide boards of both companies through the issues they need to consider when making decisions about how to pay for--and whether to accept--a deal. First an acquirer has to decide whether to finance the deal using stock or pay cash. Second, if the acquirer decides to issue stock, it then must decide whether to offer a fixed value of shares or a fixed number of them. Offering cash places all the potential risks and rewards with the acquirer--and sends a strong signal to the markets that it has confidence in the value not only of the deal but in its own stock. By issuing shares, however, an acquirer in essence offers to share the newly merged company with the stockholders of the acquired company--a signal the market often interprets as a lack of confidence in the value of the acquirer's stock. Offering a fixed number of shares reinforces that impression because it requires the selling stockholders to share the risk that the value of the acquirer's stock will decline before the deal goes through. Offering a fixed value of shares sends a more confident signal to the markets, as the acquirer assumes all of that risk. The choice between cash and stock should never be made without full and careful consideration of the potential consequences. The all-too-frequent disappointing returns from stock transactions underscore how important the method of payment truly is.

As the stock market began its ascent in the mid-1990s, executive pay--always the subject of heated debate--mounted along with it. That's because among the largest U.S. companies, stock options now account for more than half of total CEO compensation and about 30% of senior operating managers' pay. One problem became particularly clear during the bull market's astonishing run: even below-average performers reap huge gains from stock options when the market is rising rapidly. The author proposes steps to close the gap between existing compensation practices and those needed to promote higher levels of achievement at all levels of the corporation. For top managers, he recommends replacing conventional stock options with options that are tied to a market or peer index. Below-average performers would not be rewarded under such plans; superior performers could, depending on the way plans were structured, receive even more. He notes that managers at the business unit level should not be judged on the company's stock price--over which they have little control--and advocates an approach that accurately measures the value added by each unit. Finally, he suggests how certain indicators of value can be used to measure the contribution of frontline managers and employees. The concept of pay for performance has gained wide acceptance, but the link between incentive pay and superior performance is still too weak. Reforms must be adopted at all levels of the organization. Shareholders will applaud changes in pay schemes that motivate companies to deliver more value.

Establishing competitive advantage and creating shareholder value both stem from a common economic framework. The stock market values the long-term productivity of companies. It is not necessary to depart from the shareholder-value model to improve a company's competitive position. Maximum returns for current shareholders will materialize only when managers maximize long-term shareholder value and deliver interim results that attest credibly to sustainable competitive advantage.

The publicly held corporation has not outlived its usefulness. Though LBOs release much of the untapped value and correct many of the inefficiencies of large public companies, they also have a limited demand and a limited life. The public corporation is inherently flexible and self-renewing. A four-point plan to maximize shareholder value will help public companies to: 1) find the highest valued use for all assets; 2) limit investment to opportunities with credible potential to create value; 3) return cash to shareholders when such investments are not available; and 4) establish incentives for managers and employees to focus on the critical drives that create value.

Managers must stop arguing about whether the market has valued their company's stock price fairly and learn to interpret what share prices tell them about market expectations of their future performance. Here is a "market signals approach" that allows management to compare its own plans against those of the market. This technique enables executives to: determine whether a suggested acquisition price is too high; use share price to ascertain whether market expectations about a company's hurdle rates are reasonable; discover at what level it should set hurdle rates for capital investment projects; and better align management and shareholder interests.

Earnings per share, return on investment, return on equity, and other conventional accounting-oriented approaches for evaluating corporate strategy fail to answer basic questions regarding the creation of shareholder value. With discounted cash flow analysis as a basis, the recommended shareholder value approach uses readily available data to determine the value-creating prospects for alternative strategies at the business unit and corporate levels. A case example illustrates the sequential steps of the shareholder value approach.

Accurate and rapid analysis of the risks and future benefits of an acquisition is necessary in today's market. The planning of corporate strategy with a view toward the economic and technological environment is the initial step of the analysis. The subsequent search and screen process establishes a list of candidates. The financial evaluation process includes an analysis of the worth and future value of both companies according to several hypothetical scenarios. The "discounted cash flow" (DCF) evaluation technique is useful because it includes the acquisition's added cash flow and the cost of capital. Use of such evaluation techniques can determine maximum acceptable acquisition prices quickly and serve as a catalyst for reexamining a company's overall strategy.

Bonuses and incentive compensation encourage management's preoccupation with short-term financial results. This emphasis is an important contribution to the United States's lag behind other countries in research and development investment and capital spending. Federal tax policies have failed to provide incentive for investment to further economic growth. Restructured management incentives would reintroduce entrepreneurial spirit without sacrificing the systematic cost-benefit approach to decision making.