The Information That Boards Really Need

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In the wake of corporate scandals and ensuing concerns about board oversight, various suggestions for reforming boards and redefining the role of directors have been put forward. The proposals have focused on issues such as board composition and ways to ensure board independence from management. Such recommendations, while useful, do not deal with the fact that directors, no matter how dedicated and diligent, cannot serve as adequate monitors of management without sufficient information and the means to analyze it.

The author urges companies to provide directors with that information in the form of detailed discounted-cash-flow (DCF) valuation models — the tool that can help them understand how the company intends to create value over time. In conjunction with observed financial results, review of the evolution through time of the valuation models can give directors the critical information they need to discharge their duties to shareholders. The author stipulates that DCF models are not the silver bullet that will forever safeguard investors from management chicanery — the models can be manipulated. But a sequence of DCF models serves two important purposes. It forces management to translate its vision into specific numbers that show how shareholder value will be created, and it forces the board to continually monitor and evaluate those numbers in light of ongoing financial performance and stock market valuation.

Bradford Cornell is a professor of financial economics at the Anderson Graduate School of Management at the University of California, Los Angeles. He can be reached at brad.cornell@anderson.ucla.edu.

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