In Britain and the United States, maximizing shareholder value is universally accepted as management’s paramount goal. While some continental Europeans share this point of view,¹ most continue to believe that shareholder value comes only at the expense of other stakeholders, leaving in its wake diminished job security, higher unemployment, poorer products and services, and weaker overall economic performance. Research conducted by the McKinsey Global Institute has shown that a focus on shareholder value is second only to open and competitive product markets in accounting for high productivity.² A study of the relationship between shareholder value creation, labor productivity, and employment growth in competing countries across the Triad (Germany, Japan, and the United States) found that winning companies are more productive, create more shareholder value, and grow employment faster than other players.³ To broaden and deepen this research, we recently studied the performance of more than 2,700 companies from 20 countries over a ten-year period. We found that, contrary to the prevailing European view, a focus on shareholder value boosts productivity and liberates resources that benefit stakeholders of all kinds in the long term.

Easier said than done

Creating shareholder value is what all managers should strive for—but even when they do, not all accomplish their goal. In the sample we studied, the average country spread over the weighted average cost of capital was basically zero; in other words, no value was created for shareholders above normal expected levels of return. The market is a stern disciplinarian. If shareholders’ wealth is to be increased, returns must exceed expectations, otherwise a company’s stock price will fall.

At the corporate level, just under half of all the companies in the sample managed to create shareholder value during the period covered by our survey (Exhibit 1). Even in the United States, where the principles of corporate governance are most closely aligned with shareholders’ interests, the figure was just 55 percent.

Beating the weighted average cost of capital over a longer period has proven even more difficult. Over a period of twenty years, only 10 of the 50 largest US companies generated above-expected shareholder returns. The list includes Merck, Coca-Cola, Johnson & Johnson, and Pfizer, but excludes other household names such as General Motors and DuPont (Exhibit 2).

Trends in value creation vary from country to country. At one extreme, virtually all the companies from Singapore, Thailand, and Malaysia that we studied managed to provide above-expected returns to shareholders over a ten-year period, averaging a substantial spread over their weighted average cost of capital. At the opposite extreme, the German companies in our sample undershot their cost of capital by around 38 percent, and the average continental European company achieved a negative spread (Exhibit 3).

Why do countries differ so widely? Macroeconomic conditions play a critical role. Companies in the fast-growing "tiger" economies of Singapore, Thailand, Hong Kong, and Malaysia seem able to find investment opportunities that generate high returns to shareholders, and new jobs that keep unemployment low. By contrast, companies in countries plagued with rising unemployment and poor economic growth prospects, such as Italy and Spain, tend to have difficulty finding value-creating opportunities.

Our analysis suggests that in a hypothetical country experiencing zero unemployment, companies would generate shareholder returns 20 percent higher than those of an average company from our sample operating in a country with 6 to 7 percent unemployment (Exhibit 4). Moreover, 17 percent more companies would create shareholder value in such a country. This is because countries with low unemployment also have more opportunities to put their capital to work at high returns. Back in the real world, this means that simply because they are producing in a country with an unemployment rate of less than 2 percent, companies in Hong Kong have been able to achieve a spread advantage of more than 15 percent of corporate return over those in Belgium, with its 10 percent unemployment.

In a similar vein, we estimated that companies in a hypothetical country that experienced no real growth in gross domestic product would have a corporate return 14 percent lower than that of the average company in our sample, with 9 percent fewer companies creating shareholder value. This may be because poorer prospects of economic growth reduce the number of profitable investment opportunities available to companies. Thus countries such as Singapore, with real GDP growth of 10 percent, are at a considerable advantage over countries with negative growth, such as Italy or Spain in the late 1980s.

A booming economy clearly makes creating value easier. However, when we adjust performance figures to compensate for differences in real GDP and unemployment growth, a different story emerges. The boom economies do not look nearly so good (Exhibit 5). Companies from Thailand, Malaysia, and Hong Kong (though not Singapore) have not necessarily generated shareholder returns in excess of what their macroeconomic situations would indicate, after unemployment and real growth effects have been taken into account. Moreover, the spreads for these countries have declined over the years as returns on invested capital have fallen.

Better spreads for shareholders were earned in countries with freer markets, such as the United States and Canada. The continental European countries with low competitive intensity—Germany, Austria, the Netherlands, Italy, and Belgium—lagged a long way behind. Even after allowance had been made for their poor macroeconomic conditions, some of these countries destroyed more and more shareholder value through the years of our sample.

Value and jobs

Continental Europeans often claim that poor value creation for share-holders is more than offset by superior performance for other stakeholders, such as employees. This view is countered by a number of theoretical and empirical arguments.

On the theoretical side, Adam Smith asserted two centuries ago that the most productive and innovative companies will create the highest returns to shareholders and attract better workers who will be more productive and increase returns further—a virtuous cycle. On the other hand, companies that destroy value will create a vicious cycle and eventually wither away. Today’s highly mobile labor market bears this hypothesis out. There is a strong trend for talented people to emigrate to countries that perform well. American academic institutions and corporations attract huge numbers of foreign nationals looking to improve their economic prospects.

Another common line of reasoning maintains that equity holders actually take care of the interests of all stakeholders, since they are the residual claimants on a company’s free cashflows. By this, we mean that shareholders profit only after all other claimants have been compensated. Customers have to be satisfied, workers must be paid, debtholders have to be reimbursed, and taxes must be collected. Shareholders must concern themselves with all of these claims before they themselves can win.

The empirical evidence of a relationship between shareholder focus and job creation is compelling. In Belgium, for instance, greater shareholder value creation (as measured by market-to-book value and market value increases) goes hand in hand with employment growth (Exhibit 6). Our overall sample corroborates this link. If we compare the shareholder value performance of continental Europe with that of the United States and Canada, we see that the negative shareholder spread in Europe is associated with a decline in employment in both manufacturing and service sectors (Exhibit 7).

This is alarming, since it has long been supposed that employment in services will expand to absorb lost manufacturing jobs. Instead, with jobs in both manufacturing and services disappearing, overall unemployment in Europe is on the increase. In fact, our research suggests that because they generated a shareholder spread 20 percent lower than the prevailing macroeconomic conditions would have led one to expect, continental European countries have reduced job opportunities, raising the unemployment rate by about 2.5 points (Exhibit 8). By contrast, the United States, Singapore, and Canada have cut their unemployment rates by 2 points by delivering more shareholder value than macroeconomic conditions indicated. These findings support the idea that shareholder value and job creation are related—good news for those who espouse the principles of shareholder value.

Our research indeed provides evidence for the existence of a virtuous cycle linking shareholder value with overall economic performance. A shareholder value focus at the country level expands employment opportunities because the distribution of the value created releases more disposable income into the economy. This in turn tends to increase consumption, which produces additional growth opportunities for companies and generates more shareholder value. And so the cycle continues, creating a "multiplier effect" that over time will double the size of the original increase in value creation to shareholders (Exhibit 9).

Consider how this virtuous cycle might work in a hypothetical case using Belgium as the example. We estimate that if Belgian companies’ return on investment between 1990 and 1994 had been 10 percent higher than it was in reality, the national unemployment rate would have been about 1.1 percentage points lower (on the assumption that listed Belgian companies are representative of the whole economy). In turn, this decline in unemployment would have boosted consumption, fuelling economic growth and opening up new business opportunities. As a result, the market value of companies would have risen and unemployment would have fallen still further. After five years of this virtuous cycle, the multiplier effect would have brought about a rise in companies’ market value of 12 percent and a fall in unemployment of 1 percentage point. In total, the hypothetical 10 percent increase in return on investment would have cut unemployment in Belgium by 2.1 percentage points and boosted companies’ market value by 25 percent (Exhibit 10).

Corporate governance and employment

Creating shareholder value calls for more transparent corporate governance to align management incentives with shareholder expectations. Few convincing fact-based studies provide a link between corporate governance and employment performance. However, our research indicates that countries with corporate governance structures that provide poor freedom to shareholders also tend to suffer more severe unemployment problems.

Suppose we divide the world into four economic regions. One region comprises the United States, the United Kingdom, Canada, and Australia. All are exponents of a system characterized by well-developed financial markets and the large-scale presence of open corporations with widely dispersed share ownership and active markets for corporate control. A second region is made up of continental Europe (comprising Germany, the Netherlands, Austria, and Switzerland), where closely held corporations and extensive involvement by universal banks in companies’ financing and control restrict shareholders’ freedom.

With its dual economy (spanning both highly competitive global businesses such as consumer electronics and local unproductive businesses such as food processing) and its public but controlled ownership of companies, Japan is positioned half-way between these two regions. Finally, the Latin countries—Spain and Italy, and to a lesser extent France and Belgium—employ a model of corporate governance characterized by family control, financial holding companies, cross-shareholding and state ownership, and the most limited shareholder freedom of all. When we allow for differences in macroeconomic growth, our research shows that continental Europe has performed badly in employment, and the Latin countries still worse (Exhibit 11).

The journey to value creation

Shifting to a shareholder value mindset transforms the role that management plays. It involves establishing a whole new set of metrics and management processes to track value creation.⁴

Making the transition is not easy, but it is possible. Exhibit 12 depicts a consumer goods company, A, that lags well behind its two main competitors, B and C, in market value added and returns to shareholders. After explicitly adopting a value-based approach, with more systematic analysis of capital spending and the introduc-tion of incentive pay linked to share prices, company A recovers on both dimensions, and after five years lies only slightly behind the top competitor.

The insurance industry tells a similar story. Historically, continental European insurers have been protected by high entry barriers. As a result, they have been far less productive in property and casualty insurance than their US counterparts (Exhibit 13). After the recent deregulation, however, winning companies such as Swiss Re began to emerge. These companies make value creation and operational excellence their explicit priority. The payoff has been considerable. In 1994, Swiss Re sold all of its direct insurance activities to focus on high-value reinsurance activities. Since then, its share price has more than doubled, and in 1996 alone the company increased its workforce by 4 to 5 percent—and that in an industry in which global employment is declining by 1 to 2 percent per year. A few more examples like this, and Europe will be back on track for sound corporate and social performance.

This example from the insurance industry also illustrates how thoughtful government involvement in the form of deregulation can spur shareholder value creation and lift overall economic performance. With heavy lobbying from corporations and unions alike, continental Europe has a tradition of protecting its industries. While this approach has produced some short-term gains, it ultimately jeopardizes economic well-being. A virtuous cycle of value creation can come into play only when governments encourage competition and labor mobility.

Shareholder value is still a controversial topic in Europe, but we believe that embracing it is an essential ingredient of any plan for European economic reform. There is overwhelming evidence to support the view that shareholder value should be the explicit goal of all corporations. A shareholder mindset benefits not only the shareholders themselves, but society at large, setting in motion the virtuous cycle of value creation, job creation, and wealth creation.