What happens to shareholder wealth if a company consistently earns less than its WACC?

When a company consistently earns less than its weighted average cost of capital (WACC), it means that the returns generated by the company's operations are not sufficient to cover the costs associated with financing its capital. WACC represents the average rate that a company is expected to pay its security holders to finance its assets and encompasses the cost of equity and the cost of debt, reflecting the opportunity cost of investment.

If a firm’s earnings fall short of its WACC, it signals to investors that the company is not generating enough value to justify the investment risk they undertake. This underperformance can lead to a decrease in market confidence and a decline in the stock price, ultimately resulting in the destruction of shareholder wealth. Investors seek returns that exceed WACC; failure to achieve this can erode the value they derive from their ownership stakes.

In this scenario, shareholder wealth is harmed because the company's inability to generate adequate returns indicates poor management, ineffective operational strategies, or unfavorable market conditions, discouraging potential investors and possibly leading current shareholders to sell their holdings, further driving down the stock price.