82  The Alchemy of Stock Market Performance when share prices increased primarily because of falling inflation and interest rates, rather than anything those managers did. Conversely, many stock op- tion gains were wiped out during the 2008 financial crisis. Again, the causes of these gains and losses were largely disconnected from anything managers did or didn’t do (except for managers in financial institutions). Instead of focusing primarily on a company’s TSR over a given period, effective compensation systems should focus on growth, ROIC, and TSR per- formance relative to peers. That would eliminate much of the TSR that is not driven by company-specific performance. In addition to fixing compensation systems, executives need to become much more sophisticated in their interpretation of TSR, especially short-term TSR. If executives and boards understand what expectations are built into their own and their peers’ share prices, they can better anticipate how their actions might affect their own share prices when the market finds out about them. For example, if you’re executing a great strategy that will create signifi- cant value, but the market already expects you to succeed, you can’t expect to outperform on TSR. The management team and board need to know this, so the board will take a long-term view and continue to support manage- ment’s value-creating priorities, even if these do not immediately strengthen the share price. Executives also need to give up incessantly monitoring their stock prices. It’s a bad habit. TSR is largely meaningless over short periods. In a typical three-month time frame, more than 40 percent of companies experience a share price increase or decrease of over 10 percent,7 movements that are noth- ing more than random. Therefore, executives shouldn’t even try to under- stand daily share price changes unless prices move over 2 percent more than the peer average in a single day or 10 percent more in a quarter. Finally, be careful what you wish for. All executives and investors like to see their company’s share price increase. But once your share price rises, it’s hard to keep it rising faster than the market average. The expectations tread- mill is virtually impossible to escape, and we don’t know any easy way to manage expectations down. 7 Share price movement relative to the S&P 500 index for a sample of nonfinancial companies with greater than $1 billion market capitalization, measured during 2004–2007. 83 6 Valuation of ESG and Digital Initiatives As we write this book at the beginning of 2020, two items on any execu- tive’s agenda are noteworthy for their emerging importance in creating value and their slipperiness when it comes to valuing them. One is man- aging the intertwined elements of environmental, social, and governance (ESG) concerns. The other is grappling with the myriad manifestations of technological improvement or transformation commonly referred to as “digital.” The principles of corporate valuation do not include simple prescrip- tions for assigning values to various approaches to ESG or individual digi- tal assets or strategies. Today, for even the most proficient analyst seeking a corporate valuation, there is only so much that can be done with these elusive elements. Many services publish various ESG ratings, for example, but researchers have found that the ratings are uncorrelated across differ- ent services, because work is still in progress on how to identify robust metrics of their success. This chapter offers instead a way to think about how to value strate- gies and decisions related to ESG and digital initiatives. Our view is that companies should focus on the few areas that make a difference in their industry—for example, water consumption for beverage makers, supply chain management for apparel companies, or carbon emissions for many industries. It’s also important, particularly at times of rapid technological change, to fix a gimlet eye on the risks of embracing—or ignoring—trends big and small. In each case, we recommend trying out the basic principles of valuation to establish a foundation for measuring outcomes, combined with gathering data to improve their application in the future.