Introduction shareholder wealth (Worthington and West, 2001; Friedman,

Introduction A widely accepted financial postulate is the primary responsibility of managers is to maximise shareholder wealth (Worthington and West, 2001; Friedman, 2007). This is pursued via planning, decision-making and control. Performance measurement systems help identify areas of excellence and improvement in employee, managerial and organisation performance, therefore helping firms achieve shareholder wealth.Traditional measures of financial performance such as productivity ratios and ‘return on investment’ are easy to understand and calculate. However basing remuneration on such measures is recognised as encouraging short-termism (Hayes and Abernathy, 2007) and anachronistic (Dixon et al., 1990). Furthermore, they are easily manipulated, allowing managers to maximise personal returns over the long-term gain for the company (principal-agent problem) (Fitzgerald, 2007).Recognition that measurement-managed firms outperform non-measurement managed firms (Fitzgerald, 2007), has driven evolution in performance measurement. In the late 1980s to early 1990s, two dominant approaches emerged; the stakeholder approach and shareholder approach.In this essay I will first outline the shareholder approach using a measure termed Economic Value Added (EVA), then the stakeholder approach using the Balanced Scorecard (BSC). I will conclude by discussing which approach is most aligned with shareholder needs, therefore most appropriate for undertaking planning, control and decision-making.The Shareholder Approach The principle of the shareholder perspective is measuring and incentivising activities that increase shareholder value, drives management to create shareholder wealth (Fitzgerald, 2007). Several shareholder perspective models were developed but EVA emerged as the popular choice, adopted by major companies such as Coca-Cola and Lloyds (McLaren et al., 2016). EVA is a residual income variant, which is a corporate performance measurement to which incentives can be linked (Ehrbar, 1998). Stewart (1991) claimed EVA is the only performance measure that ties directly to a stock’s intrinsic value, has compensation plans superior to traditional accounting-based plans (Adimando et al., 1994), is simple (Stern et al., 1995) and superior for certain management scenarios and decisions (Bhimani et al., 2015).Responding to Short-termismEVA aims to resolve the problem of short-termism associated with financial indicators, by extending the evaluation period beyond 12-months through adjustments (Stewart, 1991). Adjustments made to ‘net operating profits after tax’ recognise the long-term benefit of current expenditure (e.g. capitalising research and development costs), converging shareholder and manager needs and making EVA more economically meaningful (Jalbert and Landry, 2003). Aligning performance-evaluation and reward systems instigates behavioural change (Simons, 1987), and distortive accounting policy removal increases goal congruence (Wallace, 1997; Riceman et al., 2002). This reduces principal-agent problems and drives management pursuit of shareholder wealth. However, with as many as 164 adjustments (Fitzgerald, 2007), performing adjustments is time-consuming, complex, subjective and possibly erroneous (Keys et al., 2001; Jalbert and Landry, 2003). Merchant and Van der Stede (2017) conclude EVA does not reflect economic income and remains historic, showing the purpose of the adjustments may be unfulfilled. Many adjustments are insignificant as approximately only 15 adjustments are made in practice (Worthington and West, 2001), showing EVA may overload management with unnecessary information. Furthermore, behavioural changes instigated by inappropriate implementation could drive management to shareholder value-destroying activities. Another solution to short-termism is ‘bonus banks’ (Stewart, 1991). Bonuses can be paid out over several years and lost if performance declines. This drives management to make long-term beneficial decisions for shareholder wealth. Still, managers may manipulate results over a longer period (Keys et al., 2001). Those who earn large sums may adopt profit satisficing policies, cautious about investments which may adversely impact bonuses (Brewer et al., 1999). This would exacerbate principal-agency problems, diverging management and shareholder needs.Performance under the Model EVA can improve performance. Per Brewer et al. (1999) EVA is a valuable measure of wealth creation and Gupta and Sikarwar (2016) concluded EVA is a significant explanatory factor in market returns. EVA adopters have increased profitability relative to their peers (Ferguson et al., 2005). Kleiman (1999) showed EVA adopters outperformed median non-adopters stocks by 28.8% over a four-year period. Riceman et al. (2002) observed managers under EVA bonus-plans outperformed those on traditional bonus plans, demonstrating EVA drives management to create shareholder wealth. However, Riceman et al. (2002) limited findings to only managers who understand EVA, showing EVA complexity (Wallace, 1998). Furthermore, Riceman et al. (2002) analysed performance improvements may actually be attributed to increased consistency in the evaluation system, rather than EVA. In addition, Chen and Dodd (1997) and Sparling and Tuvey (2003) found little correlation between EVA and shareholder returns. Given the complexity of EVA, training is required to improve understanding with resource implications. Poor EVA understanding could lead to the pursuit of shareholder value-destroying activities. What’s more, EVA may not be responsible for value-adding activities (Riceman et al., 2002). The Stakeholder ApproachThe stakeholder approach is based on knowledge that purely financial measures can be a misleading reflection of corporate performance (Jalbert and Landry, 2003). Non-financial measures are linked to corporate strategy and capture qualities such as customer satisfaction, innovation and company reputation (Fitzgerald, 2007). The purpose is to help management focus on maintaining and enhancing non-financial areas which improve financial performance and therefore drive shareholder wealth. The BSC was developed by Kaplan and Norton (1992) and has been widely adopted. The BSC measures performance from four perspectives: financial, customer, business processes and innovation and learning. Organisations have built on BSC teachings and developed key performance indicators (KPIs) for each perspective. KPIs are tailored to individual organisations and must be consistent with the company strategy and mission (Jalbert and Landry, 2003).Responding to Short-termismNon-financial measures such as the customer perspective and innovation in the BSC can be indicators of future financial performance (Ittner and Larcker, 1998; Banker et al., 2000). When financial performance is a lagging indicator, management can assess the impact of implemented plans on non-financial success drivers (Ittner and Larcker, 2000). This helps discourage short-termism associated with financial measures (Sliwka, 2002; Merchant and Van der Stede, 2017). For example, supermarkets which failed to innovate by going online or respond to changing customer habits by not having smaller convenient stores (e.g. Morrison’s). Long-term profits were sacrificed for short-term gains, and now they are having to restructure to compete with competitors who invested earlier.Marginson et al. (2010) found diagnostic usage of non-financial performance measures encourages short-termism. Lau and Sholihin (2005) found no behavioural differences between non-financial and financial performance systems, indicating BSC models may not resolve the short-termism issues associated with financial measures.Even though the BSC model encourages broader perspectives and long-term thinking, management may still take a short-term view to evaluation. This encourages manipulation which reduces long-run shareholder value. For example, management may achieve quality targets by reclassifying items with flaws as acceptable (Ittner and Larcker, 2003).Performance under the ModelCrabtree and DeBusk (2008) found BSC adopting firms significantly outperformed their peers. This conclusion is supported by Davis and Albright (2004) who found BSC adopters in the banking industry outperformed their peers and Franco-Santos et al. (2012) who concluded the BSC positively influences performance.However, the BSC has been criticised for being time-consuming (Franco-Santos et al., 2012), having conflicting measures (McNair et al., 1990), and sending confusing signals (Pitman, 2003) which doesn’t allow management to make meaningful decisions (Jensen, 2010). Experts also argue the BSC needs further perspectives (e.g. employees) (Fitzgerald, 2007).Non-financial perspectives help management analyse financial indicator movements (Ittner and Larcker, 2000). Performance may improve due to the increased insight which allows for better decision-making. Although, without appropriate KPIs management chase the wrong metrics (Ittner and Larcker, 2003). Poor KPI selection, lazy management or a lack of challenging preconceptions can lead to reduced shareholder value (Ittner and Larcker, 2003).Conclusion No approach is consistently superior in measuring company performance and aligning employee behaviour to appropriate objectives. Studies show EVA and BSC performance varies under different constraints, but the longevity of the models suggests they both work.Overall, the system which is more directly linked to shareholder needs depends on a variety of factors. Management may not possess the technical capabilities to understand EVA, but still need to be analytically skilled to successfully implement the BSC. Market leaders may have greater resources to commit to the research required to implement BSC, whereas new and growing companies may need to focus on short-term results. Shareholder needs vary, with some invested for long-term low-risk returns and others invested for short-run high-risk returns, which EVA induces (Keys et al, 2001).KPIs offer increased insight on BSC perspectives which impact long-term financial performance, but when shareholder needs are narrowly defined as increasing the short-term share-value, EVA appears more directly linked with shareholder needs. This is because the simplicity of the BSC can mean it is easier to misjudge. Management may mistake the system as an off-the-shelf package and fail to adapt it accordingly (Ittner and Larcker, 2003).The best approach needs a balance of both financial and non-financial measures, ensuring management do not sacrifice the future of the company at the altar of a short-term performance measure. Along with this, it requires management buy-in. Managers can excel under either approach, when they truly care about shareholder value maximisation (Damodaran, 2012).


I'm Nicholas!

Would you like to get a custom essay? How about receiving a customized one?

Check it out