StrategyStreet and the Board of Directors
COSTS
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9. How do our returns on investment compare to others?
The primary charge for the board is to represent shareholders' interests. The board serves these interests by ensuring that the company will grow, allowing the shareholders' investment to grow, and by insisting on an attractive return on investment through the business cycle. The previous eight questions set the stage for the long-term growth of the company. This question examines the returns the growth of the company produces for its shareholders.
The board evaluates these returns against objective standards set by others. At its most basic level, these returns must compare with the returns of other similar investments that shareholders might have made in competing companies, in similar industries or, if need be, in other companies listed on its stock exchange. More than likely, the board has even more refined measures available to it. These measures might include calculations of the company's cost of capital.
Relying on these measures, the board would ask management to produce the company's target returns through the business cycle. In cyclical industries, returns will rise and fall with the cycle. The board cannot set a single return target in these environments. The board should ask what returns management plans in each year in the cycle, from low point through high, in order to make its overall return target through the cycle. The objective of the return target in each year should be a favorable comparison with your competition. These return targets then become important benchmarks for the management appraisal and compensation system.
For further discussion of this question, see:
Basic Strategy Guide Step 24: Identify current shortfalls in financial results.
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