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 / Winter 2012 / Issue 69(originally published by Booz & Company)


The Lesson of Lost Value

A new study finds that underestimating strategic risk is the number one cause of shareholder value destruction. But it doesn’t have to be.

Many benchmarks of corporate practice start by looking at successful companies. But a recent Booz & Company survey took the opposite tack. We decided to study the biggest losers: companies that, in one way or another, had seen their fortunes go south over a 10-year period. We had gone through this exercise once before. In 2004, when the Enron, Tyco, and WorldCom scandals were fresh, we surveyed thousands of public companies and determined that, contrary to prevailing wisdom, it was not compliance issues that were most responsible for destroying shareholder value. That distinction went to the mismanagement of strategic risks — those risks embedded in the top-level decisions made by the executive team, such as what products and services to offer, whether to outsource manufacturing, or what acquisitions to make.

Our 2012 survey revealed the same culprit, and suggested that it still leads to significant value destruction. Making matters worse, the sources of strategic risk have increased. Accelerating technology development is forcing the rapid adoption of new products, services, and business models; digital information is making organizations more vulnerable to theft and loss; supply chain disruptions quickly ripple around the globe, affecting both companies and customers; consumer connectivity via social networks can broadcast missteps instantaneously to millions of people worldwide; and natural, political, or regulatory shocks can reverberate widely. Companies must learn how to effectively anticipate and hedge against these and other risks in order to survive.

To be sure, during the past decade, companies have steadily dialed up their focus on risk, in part as a reaction to the requirements of the U.S. Sarbanes-Oxley Act of 2002. But they have usually done so with a bottom-up approach that has proven flawed. Individual functions such as accounting, finance, and compliance have improved risk controls. Meanwhile, executives have made their enterprise risk management (ERM) teams accountable for identifying and evaluating the interconnected risks facing their companies.

But although ERM teams can identify and hedge risks related to relatively narrow business decisions, they do not have the mandate to evaluate the strategic risks rooted in the decisions made by senior management. An ERM team must assume that the strategic course set by senior management is sound.

For example, an ERM team can call attention to risks associated with doing business with manufacturers in Southeast Asia, but it can’t evaluate whether the company should be outsourcing to the region in the first place. This responsibility gap can be costly.

Studying the Biggest Losers

To more fully support this conclusion — that the lack of attention to risk destroys shareholder value — we must look at our study in more detail. We analyzed U.S. public companies around the world with at least US$1 billion in enterprise value on January 1, 2002 (1,053 companies met these criteria). We calculated each company’s change in enterprise value over the next 10 years, and then indexed each company’s annualized return to that of its industry benchmark to control for industry-specific effects. This allowed us to zero in on the biggest losers — the companies that experienced the most dramatic losses of enterprise value. Only 103 companies had annualized returns relative to their respective industry benchmarks that were worse than negative 10 percent. This group corresponded to the bottom 10 percent of performers in our overall sample.

We checked to see if the companies on our list of the biggest losers were simply the weakest companies in one or two industries in terminal decline. But this was not the case. There was broad industry representation among the bottom performers.

Next, to get at the root cause of this lost value, we conducted an event analysis by going back to news reports, press articles, and brokerage reports for each of the 103 companies before and after their loss of value. We then assigned each company’s economic decline to one of four categories.

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