Principles : A CEO guide to Finance

It’s one thing for a CEO to understand the technical methods of valuation. For members of the finance, organization to apply them to help line managers monitor. To improve company performance. But it’s still more powerful when CEOs, board members, and other nonfinancial executives internalize the principles of value creation. Doing so allows them to make independent, courageous. Also, unpopular business decisions in the face of myths and misconceptions about what creates value.

When an organization’s senior leaders have a strong financial compass. It’s easier for them to resist the siren songs of financial engineering, excessive force.  The idea (common during boom times) that somehow the established rules of economics no longer apply. Misconceptions like these which can lead companies to make value-destroying decisions. Also, slow down entire economies—take hold with surprising and disturbing ease.

The Four Values Principles

What we hope to do in this article is show how four principles, or cornerstones, can help senior executives and board members make some of their most important decisions. The four cornerstones are disarmingly simple:

1. The core-of-value principle establishes that value creation is a function of returns on capital and growth. While highlighting some important subtleties associated with applying these concepts.
2. The conservation-of-value principle says that it doesn’t matter how you slice the financial pie with financial engineering, share repurchases, or acquisitions; only improving cash flows will create value.
3. The expectations treadmill principle explains how movements in a company’s share price. How it reflects changes in the stock market’s expectations about performance. Not just the company’s actual performance. The higher those expectations. The better that company must perform just to keep up.
4. The best-owner principle states that no business has an inherent value in and of itself. It has a different value to different owners or potential owners—a value based on how they manage it and what strategy they pursue.

Conclusion

Obvious as this seems in hindsight, a great many smart people missed it at the time. And the same thing happens every day in executive suites and boardrooms as managers. Moreover, company directors evaluate acquisitions, divestitures, projects, and executive bonus. As we’ll see, the four cornerstones of finance provide a perennially stable frame of reference for managerial decisions like these.

Applying the four cornerstones of finance sometimes means going against the crowd. It means accepting that there are no free lunches. It means relying on data, thoughtful analysis, and a deep understanding of the competitive dynamics of an industry. None of this is easy, but the payoff the creation of value for a company’s stakeholders. Also. for society at large—is enormous.