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) and whether the same performance measure, preferred by the shareholders is preferred by the managers as a bases for planning, control and decision-making. The literature reviewed revolves around Economic Value Added, and customer metrics and Social, Environmental and Ethical (SEE) Reports as QMP and NFPM, respectively. From the literate the author concluded that QPMs were preferred by the shareholders as a bases of measuring the firms’ performance however, it is crucial from some shareholders to supplement the QPMs with additional NFMP to deduct the firms’ 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 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) and additionally the non-financial performance measures (NFPM) in terms of their superiority in 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 its 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, could be argued to be less effective than potentially, NFPM’s. Contrastingly, Paredes (2003) who focuses on the psychology decision making of shareholders, counters this point. Their research argued that information overload could lead to less efficient decision 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 only the short-run but this is a benefit because it avoids any issues of overloading and overcomplication and as a result, helps shareholders make efficient decisions.
Secondly, EVA acts as a monitoring tool to the shareholders’ advantage. Irala (2005) explains that in situation where EVA is linked with the managers’ bonuses, managers employ the firms’ assets more productively and as a result, align shareholders’ and manager’s interests. Additionally, Biddle et al. (1997) supports this claim and concludes that EVA based incentives increased income of the firm. Therefore, shareholders gain by aligning the needs of the shareholder of maximising wealth with the managers. However, it can be fair to assume that this may lead to manipulation of the accounting numbers in order to increase the managers’ bonuses (Oberholzer-Gee & Wulf, 2012; Kim et al, 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 number 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) which 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., 1998; 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). The results showed decreases in marketing spending of 68.3% and an increase of profitability by 41.5% (Thomas et al. 2004). Additionally, the use of CLV and CE provide a good basis to assess the market value of the firm (Gupta, 2004; Libai et al., 2005 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, most will not and they 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 because of 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?
Although we have successfully critically assessed both quantitative and non-financial performance measures, I will spend some time evaluating the assumption that performance measured preferred by shareholders are additionally preferred by managers. It can be argued that managers’ decisions are much more complicated than shareholders’ and therefore must consider much more sources of information. The relationship between financial performance and number of items of information 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). 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 know the consequences of these decisions.
In conclusion, quantitative and non-financial performance measures are useful to the shareholder and sometimes one is more useful than the other. QPM cater to the general shareholders’ needs by informing them of the company’s profit and other financial aspects, however for some shareholders, more information is need 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.