Adam Smith

The directors of such [joint-stock] companies, however, being  the managers rather of other people’s money than of their  own, it cannot well be expected, that they should watch over it  with the same anxious vigilance with which the partners in a  private copartnery frequently watch over their own. Like the  stewards of a rich man, they are apt to consider attention to  small matters as not for their master’s honour, and very easily  give themselves a dispensation from having it. Negligence and  profusion, therefore, must always prevail, more or less, in the  management of the affairs of such a company.
—Adam Smith, The Wealth of Nations (1776)

What is Value-Based Management (VBM)?

Lower risk when companies are aligned with investors.

Managers create value by finding and implementing investments that earn returns greater than the firm’s cost of investment capital. When managers do this, resources are most effectively allocated and there is a benefit to society. Competition among firms for financial capital to fund their growth investments brings the economy’s savings to the most attractive investments – benefitting the entire society. This is Adam Smith’s invisible hand at work.

We believe managers need a way to measure what is better when they embark on change efforts at public companies – strategies, plans or other tactics – and better should be measured by the increase in long-term intrinisic value of the firm because that single focused “objective” results in the least social waste and will get the most out of society’s limited resources.

Unfortunately, most corporate managers are paid for caring about other things than creating value. When they don’t own the companies they manage, or they own a tiny percentage of the shares, it is not really surprising that creating value is not their top priority. After all, the value they may create belongs to others – the shareholders.

That means in most public corporations value is destroyed unintentionally because managers pursue other goals that often conflict with the creation of value. Sometimes having the largest market share, the most volume growth, the best customer satisfaction, the most jobs, the most capacity, or even the biggest earnings per share by themselves destroy value over time instead of maximizing value over time.

It’s not that these other goals are undesirable. All value creating companies pursue these goals and others not for their own sake but because value maximization is not possible if they don’t. The difference is that companies that manage for value understand that these other goals are means to the ultimate end which is the creation of as much value as possible.

Corporate bureaucracies isolate managers from the capital markets and soon those managers believe that money for their projects comes from budgets and not from investors. Value-Based Management (VBM) is a set of management practices that attempts to align the explicit and impicit incentives of corporate managers with the overarching goal of creating long-term value.

Financial economists and investors have noticed these fundamenetal problems arise where ownership and control of the modern corporation are separated – as Adam Smith discusses in the quote above. Managers control the firm and can make decisions that benefit themselves at the expense of the firm’s owners. VBM systems are the answer to this problem.

VBM is a management system that encourages employees to think like and act like owners – even though they might only own a tiny sliver of the firm or nothing at all.