In this essay, the author critically assesses the view that quantitative performance measures (QPM) are linked more directly to the needs of the shareholders than non-financial performance measures (NFPM). Whether shareholders and managers prefer the same performance measures as a basis for planning, control and decision making will also be assessed. The literature reviewed revolves around Economic Value Added (EVA), which will represent the QPM and customer metrics and Social, Environmental and Ethical (SEE) Reports which will represent the NFPM. From the literature the author concluded that QPM were preferred by the shareholders to measure firms’ performances, however it is crucial for some shareholders to supplement the QPM with additional NFMP to deduct a firm’s true success and progress.
Performance measures are beneficial for both the managers in planning, controlling and making efficient decisions, and also, shareholders whereby they will use these measurements to assess their investment or any potential investment. However, is there a particular performance measurement that is best for shareholders and in turn, managers? In this assignment I will be critically assessing the quantitative performance measures (QPM) in addition to the non-financial performance measures (NFPM) in terms of their superiority from the perspective of shareholders. However, is it fair to assume that shareholders’ needs match the needs of the managers? Following the critical assessment, I will explore whether this assumption is warranted.
Critical Assessment of QPM
Many academics (Forker & Powell, 2008; Maditinos, Sevic, & Theriou, 2006; Houle, 2008; Issham, 2013) agree with the idea that Economic Value Added (EVA) is a superior performance measurement and in turn support Stewart (1994, pp. 75), whom I quote, “EVA stands well out from the crowd as the single best measure of wealth creation on a contemporaneous basis and is 50% better than its closest accounting-based competitor … in explaining changes in shareholder wealth”. I believe it is important to highlight that Stewart (1994) only stated it is 50% better than its closest accounting-based competitor and therefore excludes non-financial performance measures from that gap. Most academic research has deemed EVA to be the best performance measure of the financial performance measurement group (Ferguson, Rentzler & Yu, 2005; Worthington & West, 2004; Ghanbari and More, 2007; Irala, 2005; Biddle et al., 1997). Therefore, I will concentrate on EVA when critically assessing financial performance measures.
Firstly, it is easy for shareholders to analyse. Shareholders need quick and easily understandable information about their investment to make efficient and effective decisions. Mamun, Entebang & Mansor (2012) explain that EVA can inform the shareholders about the capital market, capital budgeting and net assets at the same time, making it easier for shareholders to collect information. Therefore, in terms of the view in question, shareholders need information that they can find in one place and can easily digest and EVA delivers these needs. However, Baker, Deo and Mukherjee (2009) argue that EVA is only useful in short-term decision-making (Kramer and Pushner ,1997 and Anastassis and Kyriazis, 2007). Therefore, EVA could be argued to be less effective than potentially, NFPM.
Contrastingly, Paredes (2003) who focuses on the psychology behind decision making of shareholders, counters this point. His research argued that information overload could lead to less efficient decision making because shareholders “adopt less complicated decision strategies in an effort to simplify their investment decisions” (Paredes, 2003, pp.69). Therefore, research indicates that the information gained by EVA only accounts for the short-term. However, this can be deemed as a benefit since it avoids any issues of overloading and over complicating decision making by the shareholders, thus helping shareholders to make efficient decisions.
Secondly, EVA acts as a monitoring tool to the shareholders’ advantage. Irala (2005) explains that in situations where EVA is linked with the managers’ bonuses, managers employ a firm’s assets more productively and as a result, align shareholders’ and managers’ interests. Additionally, Biddle et al. (1997) support this claim and conclude that EVA based incentives increase income of a firm. Therefore, shareholders benefit from sharing a mutual interest with managers in maximising wealth. However, academic literature suggests that this may lead to manipulation of the accounting numbers in order to increase the managers’ bonuses (Oberholzer-Gee & Wulf, 2012; Zang, 2012 and Moradi, Salehi & Zamanirad, 2015). On the other hand, Young (1997) argues that EVA is hard to manipulate and that there is less scope for managers to do so. Resultantly, shareholders need accurate accounting numbers and managers with the same interests as them and these are the benefits that can come from using EVA as a performance measure.
Critical Assessment of NFPM
Moving on to NFPM, we will look at customer metrics and social, environmental and ethical information. Customer metrics such as customer lifetime value (CLV) and customer equity (CE) are made up of customer acquisition, retention and cross-selling data. These indicators serve the firm, and indirectly the shareholders’, needs (Ittner & Larcker, 1998; Berger et al., 2002; Reinartz et al., 2005; Thomas et al., 2004; Gupta et al., 2006; Libai et al., 2005; Rust et al., 2004).
Firstly, when companies use CLV, they experience more optimal allocation of their marketing budget (Berger et al. 1998) and in turn, improved the financial performance of the company (Reinartz et al. 2005). Reinartz et al. (2005) results showed decreases in marketing spending of 68.3% and an increase of profitability by 41.5%. Additionally, the use of CLV and CE provide a good basis to assess the market value of the firm (Gupta, 2004; Libai et al., 2009 and Rust et al., 2004). Therefore, these metrics will fulfil shareholders’ needs to personally assess the direction of the company and evaluate any concerns with the possible issues highlighted by the CLV or CE. However, it has been mentioned previously that too much information can be detrimental to the shareholders’ decisions (Paredes, 2003). Thus, shareholders will potentially have issues with analysing the metrics that the company publishes.
Therefore, NFPM will be beneficial to the shareholders in terms of wealth maximisation and allowing an insight into the dynamics of the revenue made by the company. However, it may be fair to assume that a small group of shareholders will be able to analyse these metrics (Harris & Raviv, 2007). Those who cannot, will lose out on vital information that could otherwise be found within simple QPM.
Secondly, some companies will publish more information such as the company’s social, environmental and ethical (SEE) reports (Hummels & Timmer, 2004) and general metrics because they better describe the company’s success in terms of their specific industry (Cumby & Conrod, 2001; Rashid et al., 2012) or due to shareholders’ ethical principles. For example, Cumby and Conrod (2001) found that Biotech companies published QPM that were “relatively unimportant to their success” (Cumby and Conrod, 2001. Pp. 10) rather, shareholders would be more interested in product development milestones and platform technology etc. to analyse the success of a biotech firm. Following on, Rashid (2012) highlighted that more information would be published alongside Initial Pricing Offerings to ensure they were not under-priced. Thus, NFPM’s are more beneficial to shareholders in specific industries. However, these needs are specific to certain industries whereas for majority of firms and industries, the obligatory QPM would cater the shareholders needs to make quick decisions.
Are shareholders’ needs the same as managers?
Quantitative and non-financial performance measures have been critically assessed, and now the assumption that shareholders and managers maintain the same performance measurement preferences will be evaluated.
Managers’ and shareholders’ needs in terms of information are very different. Managers benefit from using more than just one type of performance measure in order to make efficient decisions. However, shareholders’ needs are very basic. Shareholders need to be informed about a firm’s performance and potentially any information that is related to their specific moral principles.
Following on from this, the relationship between financial performance and the number of informative items used is positive (Grinyer and Norburn, 1975) and therefore, managers should include all type of performance measures to make a decision. However, shareholders make less effective decisions when too much information must be processed (Paredes, 2003) and as a result, shareholders believe quantitative performance measures with some form of ‘hurdle rate’ of return, would be much more beneficial to indicate when to sell their share or buy more (Gopalan, 2011). Additionally, it is argued that shareholders lack the specific knowledge and expertise needed for making effective decisions (Harris & Raviv, 2007). Therefore, the in-depth information collected and sued by the managers would be beneficial for shareholders.
Contrastingly, PWC found, though a study, that 87% of the shareholder respondents said “that clear links between a company’s strategic goals, risks, KPIs and financial statements is helpful for their analysis.” (PWC, 2014). However, non-financial performance measures only support the annual report which remains to be “a valuable source document”.
Ultimately, it can be argued that manager and shareholders have fundamentally different needs. In order for managers to effectively plan, control and make decision they need all information available to them whereas shareholders just need to be informed about the consequences of these decisions.
In conclusion, quantitative and non-financial performance measures are useful to the shareholder for different reasons. QPM cater to the general shareholders’ needs by informing them of the company’s profit and other financial aspects. For some shareholders, more information is needed to make a well informed decision because sometimes they will need more than just financial metrics to decide whether they want to buy or sell shares of a company. Therefore, I would agree with Stewart’s statement and say quantitative, specifically EVA, is the best performance measure that gives the shareholders the basic information however, as we have seen through the literature in this paper, QPM are not enough and thus, metrics, KPI’s and other NFPM must be used.
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