Summary by Antoinette L. Lynch
Ph.D. Program in Accounting
University of South Florida, Spring 2002
The objective of this paper is to foster research on recent innovations in performance measurement by providing a rich description of emerging measurement practices and suggesting directions for future research.
Many managers feel that traditional accounting-based measurement systems no longer adequately fulfill the need in developing strategic plans, evaluating the achievement of organizational objectives, and compensating managers. Perceived inadequacies in traditional accounting-based performance measures have motivated a variety of performance measurement innovations ranging from “improved” financial metrics such as “economic value” measures to “balance scorecards” of integrated financial nonfinancial measures.
Few studies have examined the new measures’ economic relevance, the implementation issues arising from their adoption, or the performance consequences from their use.
Using survey data collected by consulting firms and government organizations, the authors examine three measurement trends (1) economic value measures (2) nonfinancial performance measures and the balanced scorecard, and (3) performance measurement initiatives in government agencies.
Trends in Performance Measurement
Lingle and Schiemann (1996): The results of a survey of 203 executives in 1996 on the quality, uses and perceived importance of various financial and nonfinancial performance measures showed that while 82 percent of the respondents valued financial information highly, 98 percent of the executives responding to the survey agreed that financial performance measures are included in regular management reviews.
In contrast, 85 percent highly valued customer satisfaction, while only 76 percent of the executives responding to the survey agreed that customer satisfaction measures are included in regular management reviews.
While financial performance, customer satisfaction, operating efficiency, employee performance, community/environment and innovation/change were highly valued by most executives, less than half (with the exception of financial performance) were willing to bet their job on the quality of the information in these performance measures.
A study carried out in the automotive and other industries by Arthur Anderson (1991) found that in each industry and country, customer satisfaction measures became increasingly important for strategic planning, and nonfinancial measures such as reductions in customer complaints and process variability played a greater role in assessing process improvements.
(1) Economic Value Measures
Traditional accounting measures such as EPS and ROI are the most common performance measures. However, they have been criticized for not taking into consideration the cost of capital and for being unduly influenced by external reporting rules.
Stern Stewart (1991) trademarked economic value measure is called “Economic Value Added” (EVA®) and is defined as adjusted operating income minus a capital charge, and assumes that manager’s actions only add economic value when the resulting profits exceed the cost of capital.
“Cash Flow Return on Investment” (CFROI) is another economic value measure. CFROI essentially is the long-term internal rate of return, calculated by dividing inflation-adjusted cash flow by the inflation-adjusted cash investment.
A number of impressive claims have been made for each of the economic value measures. However, research on the extent to which they are superior to traditional accounting measures is limited and mixed.
Most studies to date have examined claims that EVA® is a better predictor of stock returns than traditional accounting measures: Milunovich and Tseui (1996), O’Bryrne (1996).
Other studies suggest that EVA® is predictive of stock returns, but is not the only performance measure that ties directly to a stock’s intrinsic value, one of the primary claims of EVA® advocates: Bacidore et al (1997); Chen and Dodd (1997): Biddle et al. (1998).
Managerial Implications of Economic Value Measures:
From a managerial accounting standpoint, the key question is not whether economic value measures are more highly correlated with stock returns than traditional accounting measures, but whether the use of economic value measures for internal decision-making, performance measurement, and compensation purposes improves organizational performance:. See Wallace (1998)
A related issue is whether the performance implications of economic value measures depend upon how the measures are used within the organization. See Stewart (1995); Biddle et al (1998); Wallace 1998)
A survey by Sibson & Co. showed that 41.2 percent of respondents used economic value measures for business planning and financial management purposes. However, only 61.7 used these measures in incentive plans, of which only 26.3 percent made economic value the sole performance measure in these plans.
Claims regarding the advantage of economic value measures, as well as the limited academic research on the topic, suggest a number of avenues for future studies.
What are the long-term performance benefits from the adoption of economic value measures? Wallace (1998) – results showed that the implementation of EVA® systems is considered by stock market analyst when recommending companies. Future research can determine whether the market’s expectation of higher stock returns from EVA® adopters is accurate.
What is the relative ability of different economic value measures (EVA®, CFROI, or variants of these measures) to predict stock returns?
What are the factors influencing the adoption and performance consequences of economic value measures for internal purposes/benefits?
Research is need to examine (1) key implementation issues influencing the success or failure of various economic value measures, and (2) the extent to which the alternative metrics produce distinctly different functional and dysfunctional managerial behavior can shed light on the factors affecting the effectiveness of economic value measures.
A number of firms have tried and abandoned one or more of the economic value measures (Birchard 1994; Myers 1996). More detailed comparative studies using matched samples of successful and unsuccessful implementations can help determine the extent to which explanations provided by AT&T for abandoning economic value measures account for the effectiveness of economic value.
(2) Nonfinancial Performance Measures
Firms have also tried to overcome perceived limitations in traditional accounting-based performance measures by using nonfinancial measures for decision-making and performance evaluation, such as the “balanced scorecard.”
The balanced scorecard focuses on nonfinancial measures such as customers, internal business processes, and learning and growth (Kaplan and Norton 1992, 1996).
One stream of research focuses on claims that nonfinancial measures are “leading” indicators that provide information on future performance that is not contained in current accounting measures. Although the performance measurement literature claims that predictive ability is one of the primary benefits of nonfinancial measures, studies indicate that firms experience considerable difficulty linking these measures to future accounting or stock price performance.
Survey responses from vice-presidents of quality (Table 5) shows that 74 percent of the senior quality executives felt pressure to demonstrate the financial consequences of their quality initiatives, but fewer than 55 percent could directly relate their quality measures to operational, productivity, or revenue improvements, only 29 percent to accounting returns, and just 12 percent to stock returns.
Studies investigating the link between nonfinancial measures and future financial performance have produced mixed results.
A second research stream has emphasized the use and performance consequences of nonfinancial measures in organizations adopting TQM or other advanced manufacturing practices. Nearly all of these studies have found positive associations between the emphasis placed on TQM, JIT production practices, or manufacturing flexibility and the provision of nonfinancial measures such as defect rates, on-time delivery, and machine utilization. However, empirical support for the hypothesized performance benefits from these measurement practices is marginal at best.
A third research stream has examined the use of nonfinancial measures in compensation plans.
The primary research question arising from the use of nonfinancial measures and the balanced scorecard is the net economic benefits from these measurement practices. Despite increasing use of nonfinancial measures, many firms believe that performance measures should be purely financial in order to focus efforts on ultimate goals of the firm.
If nonfinancial performance measures are not beneficial in all settings, an important research topic is identifying the circumstances under which these systems do improve performance.
Another key issue is defining precisely what “balance” is and the mechanisms through which “balance” promotes performance.
It would be instructive to study the development and use of business models in a diverse set of organizations to determine whether the claimed success at Sears can be replicated in other settings, and to investigate how business models vary across organizational life cycles, competitive environments, corporate strategies, and other contextual factors.
Another important question is whether the same measures or scorecard used to develop strategic priorities and monitor strategic actions should be used to evaluate managerial performance.
A potential avenue for research is examining the relative value of different types of scorecards and performance measures for different purposes.
A final topic is the issue of trade-offs among multiple financial and nonfinancial performance measures. Although “balance” may require a manager to perform well on multiple dimensions, actions taken to improve one measure may lead to short-term declines in other performance measures. A key question is how to retain “balance” in managerial actions and performance evaluations in the presence of trade-offs.
(3) Performance Measurement Initiatives in Government
Government agencies depend primarily on support of external constituents and to a lesser extent on actual performance.
Recent efforts to reinvent the government have emphasized the important role performance measurement systems can play in improving the efficiency and effectiveness of government operations, and this has resulted in a special concern of the public sector about performance indicators.
One research topic prompted by the wide variations in governmental measurement practices is identification of factors influencing the adoption of results-oriented performance measures. Does the adoption of performance measures differ across different types of government organizations (e.g. municipalities, counties, state departments, school districts, etc.).
A second research question is whether the new performance measurement systems will actually improve governmental performance. There is a long history of unsuccessful management control initiatives in the U.S. government, ranging from management-by-objectives to zero-based budgeting.
The most fundamental question could be whether private sector notions of performance measurement and accountability are applicable in the public sector. Institutional theories argue that in organizations such as government agencies, whose survival depends primarily on the support of external constituents and only secondarily on actual performance, managers will implement the mandated systems in order to appear modern, rational, and efficient, but will not actually use the systems for improving performance.
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