New Report Reveals Causes for Shareholder Value Destruction

Booz Allen analyzed approximately 1,200 firms with market capitalizations over $1 billion as of 12/31/1998 for the five-year period from 1999 through 2003 and identified the poorest performers — the 356 companies that trailed the lowest-performing index for that period, the S&P 500. The companies lost more than 2 percent a year in shareholder value on a Compound Annual Growth Rate basis over the five-year period.

The results were startling — only 13 percent of the decrease in shareholder value in these companies resulted from compliance failures. Sixty percent of the value destruction was attributable to strategic mistakes, such as misjudging customer demand or competitive pressure, or management ineffectiveness. An additional 27 percent was due to operational blunders, such as cost overruns or poorly managed integration during mergers and acquisitions.

"The problem runs deeper than a few bad apples, and compliance is not the main culprit in the destruction of shareholder value," notes Booz Allen Senior Vice President Paul Kocourek. "Risk governance is the key to finding the balance between control and innovation. Companies need to develop a process that both protects shareholder value, by eliminating earnings surprises, and also enhances it, by fostering growth."

Booz Allen identified five imperatives for developing a risk governance program that fosters growth while managing risk:

• Define what constitutes risk and develop early-sensing mechanisms — expand the definition of risk beyond the traditional; consider threats to earnings drivers such as customer churn, as well as cultural risks, such as misaligned incentives or communications breakdowns.



• Determine the risk agenda — establish priorities and build the capabilities that ensure a company is able to handle risks when they occur.



• Build or adapt the risk management architecture — identify the processes, organization, information and cultural tools needed to manage risk.



• Make risk management part of strategic planning — help the company drive growth, as well as deliver compliance.



• Adapt to changes in the risk environment — stay flexible and responsive enough to adjust quickly to changing market dynamics.

Industry Findings

The study revealed significant industry differences in its examination of shareholder value destruction. Strategic losses were the most common cause in the telecom, media, tech and manufacturing industries, at 70 percent of the total. By contrast, strategic losses made up only 30 percent of the total in energy, and 42 percent in the transportation industry.

Operational losses were highest in the transportation (50 percent) and energy (48 percent) industries. Energy (22 percent) and financial services (21 percent) had the greatest compliance-related losses, but compliance was consistently the smallest factor overall in shareholder value destruction. International results were relatively consistent, with one exception — in Latin America, strategic losses were lower than the global average, (50 percent vs. 60 percent), but compliance losses averaged 25 percent of overall decline in shareholder value, nearly double the global average of 13 percent.

"Risk management needs to be about more than compliance with regulatory mandates — it should be a tool to position a company for uninterrupted growth," said Booz Allen Principal Jim Newfrock. "Companies that take a narrow and defensive approach and reduce risk management to a 'box-checking' activity will have a harder time innovating and growing in today's networked, global economy."