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8 September 2017 Financial Analysts Journal Book Review

Outperform with Expectations-Based Management: A State-of-the-Art Approach to Creating and Enhancing Shareholder Value (a review)

  1. Mark S. Rzepczynski
This practical handbook for managers (which is also highly useful for investment analysts) provides arguments and a well-reasoned framework for embedding market expectations into the company’s decision process to enhance shareholder value.

This unique book provides practical advice on how to incorporate expectations into the corporation’s decision processes to enhance shareholder value. Surprisingly, the literature on investment management pays little attention to shareholder value from the perspective of the relationship between corporate managers’ behavior and investors’ expectations. Similarly, corporate finance research often sidesteps the issue of how management actions affect investor expectations and stock price discovery.

Anyone dealing with Wall Street understands that beating expectations drives shareholder value. Even so, embedding this message in corporate managers’ behavior is difficult. Incorporating expectations into fundamental management behavior, beyond guidance on quarterly earnings, is particularly problematic because it requires corporate managers to adopt an unaccustomed mind-set and focus.

Although integrating investor expectations with management behavior is a tall order, the authors of Outperform with Expectations-Based Management: A State-of-the-Art Approach to Creating and Enhancing Shareholder Value prove more than up to the challenge. Tom Copeland is a distinguished financial scholar who has moved to consulting, and Aaron Dolgoff is an associate principal of consulting firm CRA International. Their premise in this book is that managing based on beating expectations through a systematic decision process is the best way to increase shareholder value.

Copeland and Dolgoff divide the book into three major parts:

  • measuring performance with expectations,
  • managerial implications of expectations-based performance, and
  • the expectations-based model from viewpoints other than management's.

The first section of the book examines the validity of expectations-based management (EBM) through the simple test of determining which management approach is most correlated with increases in shareholder value. The authors test several well-known value-creation alternatives—top-line growth, earnings (bottom-line growth), the top-line and bottom-line growth combination, return on investment capital, and the spread between return on capital and the cost of capital. None of these can explain variance in shareholder return as well as the expectations-based approach. This powerful research was previously published in a leading accounting journal, but the authors have expanded it here to provide clear descriptions of the alternative approaches.

EBM’s underlying intuition is almost too simple: To create value, managers must beat the expectations embedded in stock prices. Merely achieving what analysts already predict about the company will not create value. The challenge is determining how EBM can be incorporated into everyday operating behavior.

In the second main section of the book, the authors argue that expectations count. This claim is backed by clear research and good examples of how expectations can be incorporated into decisions. The corporate manager’s job is to identify investors’ most important expectations and systematically include them in all aspects of company behavior. Copeland and Dolgoff argue that EBM is not a simple lesson but a way of thinking that must be translated into action throughout the company.

For example, the authors explain how a company should evaluate a new investment proposal. The projected return on investment must exceed not only the cost of capital but also investors’ expectations for returns on existing projects. This section of the book contains a helpful discussion of the relevance of weighted average cost of capital and the need to adjust it to incorporate expectations. All budget processes, say the authors, need to be consistent with the EBM approach.

Copeland and Dolgoff argue that managers need to reverse-engineer the value of the company to determine what the market thinks returns should be. The market’s expected return is the hurdle rate that must be met, not for a given quarter but over multiple periods. The stock price and analysts’ views signal the market’s expectations. Management has to send a signal indicating what the company is doing to match or exceed expectations—not in a given quarter but from a longer-term perspective. Clarifying a company’s actions to exceed market expectations is the key role of management.

A chapter on investor relations explains how to reduce noise in signaling what is happening inside the company. The authors also contend that expectations can become truly operational only if a clear set of incentives motivates all managers. Top management has to be driven to beat expectations, rather than rewarded for rising stock prices that merely reflect a general market increase.

The third section, which deals with other points of view, further examines investor relations from the investor’s perspective. This section also contains a discussion of public policy issues associated with the information that investors receive about the company’s behavior. The book ends with a persuasive summary argument for the authors’ approach.

Copeland and Dolgoff follow the consulting profession’s time-honored custom of writing about their key strategic theories. The result, however, is much more than marketing material for new business. Their book offers a well-reasoned framework for embedding expectations in the budget and management process. In addition, it is refreshingly free of consulting platitudes. The authors make a compelling case, which they present in a clear and forceful manner.

In summary, Outperform with Expectations-Based Management is a practical handbook for managers who have a solid grounding in the paradigm of rational expectations and efficiency as well as the basics of corporate finance. At the same time, it is a highly useful book for investment analysts. It provides clarity for managers on using expectations and gives investment analysts a framework for evaluating the actions of management.


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