Week 4

Measuring the Performance of CorporationsFaisal AlSager

MGT 427 - Corporate Governance

Objectives

✤ To emphasize the importance of long-term value

✤ To list different number of performance measures, and know when they are used and what their drawbacks are

Measuring Performance

✤ It’s impossible to predict the future impact of the company’s strategy on the shareholder value

✤ Again, when we measure the performance of the company, we make the ultimate purpose of the corporation: “long-term value creation”

✤ This determines how directors (and sometimes shareholders) should be organized, how they should be motivated and how they should be evaluated

Long-term? Value?

✤ There are many interpretations to “long-term value”

✤ Somebody might say, “after I am gone”

✤ Thus, most used to measure it are: financial formula concepts for measuring economic performance

✤ However, measuring performance should be flexible and changing concept

Establishing Goals and Measuring Success

✤ The best entity for establishing goals and evaluating the performance of any corporation is its board of directors, as long as they are genuinely independent and not so beholden to management that they cannot be objective

✤ The best entity for measuring the success of the corporations would be shareholders

GAAP

✤ Generally Accepted Accounting Principles (GAAP)

is a language by which the assets and liabilities of corporations are recorded in balance sheets and their functioning is stated in income statements

✤ Disadvantages:

1.Flexibility in interpretation

2.Not suitable for day-to-day functions

Market Value

✤ Market value is equity capitalization

✤ Fortune Magazine has different lists: Fortune 100 - Fortune 500

✤ Helpful for the public

✤ Issue: Enron

Earnings Per Share (EPS)

✤ We use the share price here and the earnings to calculate it

✤ The problem is that it’s higher emphasis on short-term

✤ Other ratios used: ROI, ROE, ROCE, ROA, ROS, ROT

EVA: Economic Value Added

✤ “the real ‘economic’ profit after subtracting the cost of capital”

EVA = (ATOP - WACC) X TC

ATOP: after-tax operating profit

WACC: weighted average cost of capital

TC: total capital

✤ EVA is used by many companies worldwide like Coca-Cola, Sprint, and Premark

✤ Critiques find other measures like operating income and residual income more correlated to corporation performance

Other Performance Measures

✤ Human Capital which is measuring how much is the company participating in developing a “knowledge society.”

Knowledge society is an integrated global economy whose central economic activity is the provision of knowledge services with more fusion of producer and consumer

✤ The “Value Chain”: the fundamental economic process of innovation that starts with discovery of new products, services or process, proceeds through development and the implementation phase of these discoveries and establishment of technological feasibility, and culminates the commercialization of new products or services

The “Value Chain”

Other Performance Measures

✤ Knowledge Capital: includes assets like patents, brands, and research and development.

✤ The Value of Cash: the company must be able to generate positive cash. Its capacity to survive and prosper is not based on its fame! It’s based on its ability to obtain the capital necessary to conduct its business at a competitive price

Financially Successful Company: a company with the ability to generate returns from new investment in its business that are substantially greater than the cost of obtaining the funds, on a continuing basis

References

✤ Corporate Governance (4th Edition): Monks, R. and Minow, N. 2004. (Publisher: Wiley-Blackwell)