The needs of the various shareholder types
Recognizing that firm market value is shaped by the investor’s expectations of the firms’ prospects, and that the market is composed of a variety of shareholders, with differing criteria of how value is derived, this report will detail how the Ford VEP plan added value by satisfying the needs of the various shareholder types within the context of the 2000 market environment. Corporate Strategy: the enhanced value for Ford Motor Company
With a corporate strategy that was refocusing attention on automotive and financial services the Visteon spin-off would allow Ford to negotiate the lowest cost deals with any parts supplier, which would lead to lower costs and increased profit margins. Ford must have also recognized that the surplus $23 million of cash was reducing profitability ratios like return on assets and return on equity which in the mature and competitive automotive industry would be quite significant.
Furthermore in the time period’s marketplace, which was investing in high tech and the dot com’s, it was unlikely that Ford could identify a significant enough sized ‘project’ (similar in significance to the purchases of Hertz, Jaguar, Land Rover or Volvo) which would achieve an expected rate of return of 8. 4% (Table 1) and fit
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So Ford is wise not to provide a special dividend payout as this will weaken PVGO via an increase in the payout ratio as well as a decrease in long term ROE. But for this potential to be realized Ford will still need to highlight what performance factors can achieve this potential. Overall, the plan had so many variations aimed at satisfying the needs of many of the investor types (i. e. the passive index investor, the exit strategy investor and the long term shareholder) that the plan should be seen nothing less than value enhancing for shareholders.
If Ford shares were not as undervalued as Ford management indicated than more employees, with their greater level of insider information, would have selected the $20/share payout and invested in a higher earning equity. But since the total VEP payout was ~$5 million it is likely that employees saw that Ford was in a position to increase long term valueiii. The VEP plan would also allow employees to more easily manage the capital gains tax from their stock option plan’s (Table 3). With a smaller spread between the ‘new’ strike and market price ($8.
05 compared to the original spread of $14. 07) employees would pay less capital gains tax per share thus allowing them to spread individual tax risk across a greater number of sell opportunities. While this scenario might also incentivize employees to sell options thus diluting future EPS and shareholder value it is likely this concept was accounted for when Ford developed the VEP program.
So overall the VEP programme is enhancing value for employees. With the ability to decrease their total equity holding form 5% to 3.6% without losing future dividend payments as well as obtain an increased number of dividend paying common shares, it is apparent that the Ford family would have the most enhanced value from the plans implementation.
Not only would it increase their total number of common shares through the plan, they would maintain their critical Class B shares as well as the historically significant 40% voting rights which provided them with the “exclusive right to approve a merger, sale or liquidation of the company”iv.
The facts are that this is not a $10 billion free lunch; this is a yield neutral event where the financial benefits provided by the payout are cancelled out by the lower future dividends and share price, so this has no effect on the firm’s book value. But what it does have is an effect on shareholders perception of market value and thus the share’s future potential market value. In the end VEP was to give marginal investors the option to liquidate at a time when greater value was perceived to be in high tech and dot com businesses.
It would become a clearing house for dissatisfied shareholders, while simultaneously ensuring that the Ford family retained voting rights and increased their cash streams. Since market value is based on market perception, Ford hoped that by satisfying the largest proportion of their shareholders they would be able shift market attention towards the company’s fundamentals and continue to strengthen long term shareholder value.