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This article is a guest piece from the 2022 Labor Activity in Healthcare Report, written by Gregory Milano, Founder and CEO of Fortuna Advisors. He is a recognized industry leader in financial performance measurement and valuation, capital allocation and incentive compensation. He is the author of Curing Corporate Short-Termism: Future Growth vs. Current Earnings, and his work is regularly published in The Journal of Applied Corporate Finance, CFO Magazine, Fortune, and The Wall Street Journal, amongst others.
Experts recommend bringing divergent sides together in diplomatic circles and consensus-building business meetings by finding and starting from a place of mutual agreement. More often than you might think, industries, corporate rivals, and even competing internal departments must sit at the same table to solve problems and devise solutions to serve their constituents. This article explains how this advice and the concept of a culture of ownership applies to bringing divergent stakeholder groups together to increase a company or organization's value.
Value can be defined in many ways for different stakeholders. For shareholders of public companies, the benefits of increased value are well known – share price and dividends. For internal audiences, including employees, unionized or not, value improvements signal company growth, which leads to higher wages, security, and more jobs. And some companies share the benefits of stock price increases more widely, producing a greater opportunity for everyone. Thus, when embarking on conversations, negotiations, or other potentially challenging circumstances, make it clear that the outcomes of the meeting and ensuing actions taken together will improve company value, which can be good for everyone.
Unfortunately, within the corporate world, adopting a "good for everyone" mentality when maximizing value has generally been underappreciated. The perception is that shareholder value is compromised where stakeholder value is concerned. But in August 2019, the Business Roundtable issued a new Statement on the Purpose of a Corporation declaring that "companies should serve not only their shareholders but also deliver value to their customers, invest in employees, deal fairly with suppliers and support the communities in which they operate."
Corporations' view of who is fiscally important to serve has evolved to include the welfare of a broader group of stakeholders, including employees, customers, suppliers, and society. It can be viewed both ways. Increasing the share price benefits all stakeholders, not just shareholders. And being concerned with employment levels, wages, customer satisfaction, and broad societal benefits like environmental protection and a sense of social purpose also benefits shareholders.
Although all companies can improve on these types of stakeholder goals, many successful management teams have already realized that companies that take care of their employees and consumers also tend to deliver better results for shareholders. Fortuna Advisors demonstrated this principle in research published in 2020 in an article titled 'Companies that Do Well Also Do Good' on CFO.com.
Fortuna's research takes these findings further. Their 2021 study, conducted in collaboration with Chief Executives for Corporate Purpose, showed that "High Purpose" companies delivered significant outperformance across a broad range of financial, valuation, and value creation metrics. Additionally, the performance gap expanded materially as both consumers and investors flocked to purpose-led companies during the COVID-19 crisis.
These results imply that businesses should not view employees and labor as adversaries but instead see them as partners in their business endeavors. This article will present a framework for aligning the interests of those who own and those who operate companies. Beyond this, you will see how companies can realize their growth and value creation ambitions and thus enhance the benefits to all stakeholders, including shareholders, all while maintaining strong accountability for investor capital.
Now that we've established why everyone at a company needs to have a stake in an organization's success, here are the most significant ways Fortuna has helped companies generate superior value generation while creating alignment among internal audiences.
Effective incentives align the interests of employees with the owners of a business. This makes what's good for the investors of a business also good for those running and operating the business.
Most financial performance measures don't provide a clear directional signal on value creation, leading to sub-optimal outcomes. On the other end, companies that focus on efficiency, through return-on-capital measures, can end up stymying their long-term growth potential by overcutting costs and underinvesting in valuable projects. The key is focusing on a comprehensive measure that proxies value creation.
Because of this, among other reasons, Fortuna recommends using economic profit (EP), a measure that balances all key financial inputs, including growth, profitability, and capital efficiency. One example is Residual Cash Earnings (RCE), which differs from traditional EP metrics in that it creates more incentive to replace old assets while maintaining strong accountability for earning a return over time. And this means more investment in stakeholders and more prosperity all over time. Greg Milano, Founder & CEO of Fortuna Advisors, wrote Curing Corporate Short-Termism; Future Growth vs. Current Earnings to address the lack of growth investment in corporate America in part due to the infatuation with return measures and profitability over growth. With RCE, there is a blueprint for motivating valuable growth investments, but with accountability to ensure an adequate return on that investment over time. Essentially it is a formula for investing more in stakeholders, but in a disciplined way that also creates more value for the business owners– truly a win-win situation.
EP measures like RCE also have another benefit: they help clarify where, among various business segments, products, geographies, etc., a company creates the most value. And this makes it a much simpler process to reallocate capital strategically and nimbly. In uncertain times, with highly volatile price inputs, including labor, EP can help managements easily cut through the fog of indecision and understand how to optimize decision-making with agility.
It is common to implement incentive compensation plans for upper and middle management but less so for employees further down the hierarchy. Companies interested in putting their money where their mouth is on stakeholder value should consider applying owner-like compensation practices more broadly. This can be through widely distributed RCE-based incentives or profit-sharing plans, or in some cases, through actual common equity stock ownership.
When companies use better measures to achieve alignment between those who own and operate the business, this forges what you can call a "culture of ownership," which has five unique traits that help propel the value of the company:
Every day, the goal is to help clients make strides in each of these areas, and clients find that it is easier than they think to adopt new practices to instill a culture of ownership and evolve rather than transform existing frameworks. These activities can further align divergent sides and result in prosperous times for all.
Don't forget to download the full Labor Activity in Healthcare Report, from IRI Consultants. Click the image below to download your free copy!