Growth, Corporate Profitability, and Shareholder Value Creation

Abstract

Associating corporate performance and shareholder value creation to growth in earnings (or sales) has been the modus operandi in the investment industry, greatly influencing managerial compensation schemes and portfolio decisions. This paper sheds light on the relationship between growth and performance by addressing two broad questions. First, what is the relationship between corporate profitability metrics, such as EVA, ROE, or ROI, and the firm's earnings (sales) growth rate? Second, does maximizing corporate profitability necessarily enhance shareholder value (as measured by Jensen's alpha)? Using multivariate analysis, we show that while these measures generally rise with earnings and sales growth, there exists an optimal point beyond which further growth destroys shareholder value and adversely impacts profitability. Moreover, the analysis shows that firms with moderate growth in earnings (sales) show the highest rates of return and value creation for their owners, supporting Fuller and Jensen (2002) warnings about the "dangers of conforming to market pressures for growth."

Keywords: growth, EVA, MVA, ROE, ROI, performance measures

JEL Classification: G0, G3