Introduction Traditionally,in answering the question ‘is your company doing well?’ company management wouldsolely be focused on financial performance based on historic trends and otherfinancial (quantitative) measures Fitzgerald, 2007.
However, our everchangingsociety has caused a need for variations to the way businesses measureperformance. In the early 2000s, a survey of US companies found that themajority of them were unsatisfied with their performance indicators as too muchemphasis was given to financial measures, with not enough emphasis given toother indicators such as customer satisfaction, innovation and quality WhartonSchool, 2000. In the same year, businesses started turning more tonon-financial (qualitative) performance indicators as opposed to thetraditional measures Bhimani et al, 2015. The reason for this shift inapproach is primarily due to the increased expectations of stakeholders andtheir needs for value-driven delivery by creating, preserving and increasing thevalue of the business CIMA, 2000. However, this approach to measuringfinancial performance can be seen as being unfavourable to the shareholders oforganisations when compared to EVA (Economic Value Added) and other quantitativeperformance measures. In this assignment I will critically assess the differentkinds of performance measures available to organisations, which are linked moredirectly to the needs of shareholders and the reasons why.
Agency Conflict Owingto their differing needs, an agency conflict can arise between of themanagement of a company and its shareholders which can result in differentperformance measures being preferred by each party. The preferred measureswould be those which assist the interests of each party, as there is anunderlying presumption that parties continually act in ways which maximise theirown interests Moyer et al, 2018. Accordingly, management are more concernedwith the long-term sustainability of the company rather than short-termprofitability, which in turn retains their own job security Moyer et al, 2018.They do, however, have to “walk a fine line between supervising and maintainingthe current resources they have to work with and the constant push forprofitability” from the shareholders Lewis, n.d.
who are only interested in theirown personal wealth maximisation Moyer et al, 2018; as such the shareholderswould be reluctant for money to be spent on any expenses they deem to be unnecessary. Qualitative Performance Measures Indicatorswhich are based purely on financial performance are typically short-sighted, focusingprimarily on annual (or even shorter-term) performance. This creates anenvironment “where short-term earnings become more valuable than the factorsthat cause them” Akers, 2017, leading to longer-term strategic goals being sacrificedat the expense of short-term profitability Wharton School, 2000. This resultsin purely financial indicators not capturing the longer-term benefits of anydecisions made in the present – for example, any investments in made intoresearch and development ideas must be expensed in the period they are incurredthus reducing profits, however, successful innovation coming as a result of theresearch can lead to an increase in future profits Wharton School, 2000.
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Thisapproach would therefore be more beneficial to the management of a company thanits shareholders due to their need for long-term sustainability over short-termprofitability Moyer et al, 2018. Opponentsof the traditional financial indicators argue that successful businesses are infact driven by customer loyalty and intellectual capital Wharton School,2000. Investing in customer satisfaction “encourages long-term financialsuccess by increasing levels of customer loyalty” Akers, 2017 as well asattracting new ones, resulting in more transactions and increased profits downthe line Wharton School, 2000. Again,this approach would be more beneficial to the management of a company than itsshareholders due to their need for long-term sustainability over short-termprofitability Moyer et al, 2018.However,a study which looked at how non-financial indicators affected the stock marketprices of US companies found that management capability, innovation and brandvalue comprised a significant amount of a company’s worth. Therefore, by ignoringthese indicators management may make detrimental business decisions WhartonSchool, 2000. Interestingly, this approach would also see a benefit to thecompany shareholders as well as management due to their need to maximise theirown personal wealth Moyer et al, 2018.
Thebenefits of implementing a system that monitors both financial andnon-financial data on a large scale can be outweighed by both its cost and theamount of time spent analysing the data Wharton School, 2000. In contrast tofinancial indicators, there are various ways in which non-financial indicatorscan be measured due to the fact that they are not all denominated in the sameway. This makes assessing the performance of non-financial indicators morechallenging, and with businesses struggling to choose how to rank theindicators the amount of time needed to be spent analysing data can increasedramatically – for example, one bank saw a jump from one to six days in thetime needed for area directors to evaluate the performance of the quarter afterundertaking such changes to how financial performance is measured WhartonSchool, 2000. Well-intentioned performance indicators can also descend intopurely administrative exercises which often offer no help with meetingstrategic goals. An example of an organisation which was affected in this wayis Florida Power and Light, which was the first US corporation to win theDeming Prize for quality improvement. However, the employees felt that thebusiness was far too heavily orientated on reporting and presenting aridiculous number of indicators, therefore wasting time which should be usedserving customers. As a result, the number of indicators (and hence the numberof reports and presentations surrounding them) heavily reduced. This was a caseof measurement disintegration, where too many indicators dilute the outcome ofthe performance measurement Wharton School, 2000.
Staffmembers would be forced to take time away from their actual job in order todeal with the administrative burden with no valuable output at the end of theprocess. Consequently, more money would need to be spent on hiring moreemployees to pick up the work existing staff members can no longer do due tothe administrative pressures. These costs would be on top of the already largeinitial set up costs for such indicators, which primarily occur due to the dataneeded feeding in from various systems which are frequently incompatibleWharton School, 2000.
Ifthis were the case then the implementation of non-financial performanceindicators would not realise a benefit to either the company’s management orits shareholders. Any resulting cash flow issues could affect both thelong-term sustainability of the company as well as the short-term profitability.Furthermore, this would be compounded with the already high set up costs, thusseeing less money heading towards the shareholders and all for no overallpurpose Moyer et al, 2018. Quantitative PerformanceMeasures Anexample quantitative performance measures is EVA (Economic Value Added). It wasdeveloped by Stern Stewart and Co.
, with a Partner inside the company arguingthat for a great number of management decisions it is superior to other performancemeasures Bhimani et al, 2015. The thinking behind EVA was to create a measurethat links shareholder wealth directly to the performance of the company, incorporatingthe value added in the period into the performance measurement Kaplan Financial,2012. As the EVA measure was created specifically in order to encompassshareholder wealth, the maximisation of this shareholder wealth is crucial. TheEVA measure works by taking the ‘net operating profit after tax’ figure anddeducting the ‘economic value of capital employed’ figure multiplied by the’weighted average cost of capital (WACC)’ Kaplan Financial, 2012.
This seemsfairly straightforward in principle, however, there are a number of adjustmentswhich need to be made to the figures of profit and capital taken from thefinancial statements as they “do not give the true picture and that theaccounting figures need to be adjusted to show the true underlying performance”in terms of cash flows Kaplan Financial, 2012. These adjustments are usefulas they remove the effect of any accounting policies from the calculationsmeaning that shareholders are able to compare the multiple investments they mayhold with each other. Conclusion Unlikethe vast majority of qualitative performance measures, the quantitative EVAmeasure was created specifically in order to encompass shareholder wealth andits maximisation Kaplan Financial, 2012. Consequently, in the eyes of theshareholders the EVA measure is seen as the superior method for management tobase their decisions off of Bhimani et al, 2015. However, purely quantitativemeasures are unlikely to completely capture all the dimensions of businessperformance needed for management to assess the long-term sustainability of howthe company currently operates. The qualitative performance measures looked atas part of this assignment primarily benefitted the company’s management ratherthan the shareholders, so due to the aforementioned agency conflict amiddle-ground will need to be identified in order for both sides to be satisfied.Therefore, quantitative performance measures (including the EVA measure) shouldbe used by management, however they must be supplemented with qualitativeperformance measures Wharton School, 2000. Reference List Akers, H.
, 2017. What Are the Disadvantages and Advantages of PerformanceMeasures? Leaf Group onlineAvailable at: html> Accessed 28 December 2017. Bhimani, A., Horngren, C. T., Datar, S.M. and Rajan, M.,2015. Management and Cost Accounting,Sixth Edition. Harlow: Pearson Education Limited. CIMA,2000. Official Terminology. London: Chartered Institute of ManagementAccountants. Fitzgerald,L., 2007. Performance measurement. In: T. Hopper, D. Northcott and R. Scapens,eds. Issuesin Management Accounting, Third Edition. London: FT Prentice Hall. Ch.11. Kaplan Financial, 2012. Economic ValueAdded (EVA). Kaplan Financial online Available at: aspx> Accessed 28 December 2017. Lewis, J., 200?. A Manager’s Goals vs. a Shareholder’s Goals. Hearst Newspapers online Available at: C., McGuigan, J. R. and Rao, R.P., 2018. Contemporary Financial Management, FourteenthEdition. Boston:Cengage Learning. WhartonSchool, 2000. Non-financial Performance Measures: What Works and What Doesn’t. Wharton School of the University ofPennsylvania online Available at: upenn.edu/article/non-financial-performance-measures-what-works-and-what-doesnt/> Accessed 28December 2017.
