Introduction it could be argued that EVA is “a

 

Introduction

The purpose of this essay is to critically
assess the view that quantitative performance measures are more closely linked
to shareholder interests compared to non-financial performance measures and whether
these methods are favoured as bases for managerial planning, control and
decision-making. During this essay I will judge the significance of quantitative
and non-financial performance measures and draw upon existing literature to
support my views. “In the field of
financial management, it is generally accepted that the primary objective of a
company should be centred on shareholder value” (Brigham and Davies,
2010, p.4). This is consistent with shareholder theory whereby management have
a responsibility to maximise shareholders’ interests of profit maximisation and
dividend growth (Mansell, 2012).

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Quantitative performance measures such
as the EVA model and return on investment are used by management to evaluate
investment opportunities, monitor strategic goals and safeguard the long-term
interests of the business (Panigrahi, 2017). This essay is split into four main
sections: Economic Value Added (EVA) model, Quantitative performance measures,
Non-financial performance measures and Conclusion.

Economic
Value Added model

Bahri et al (2011, p.605) recognised
that the EVA model is a “global financial
measure that provides an assessment of the level of achievement of the firm’s
strategic goals” and as a result, managers can ascertain whether they are
meeting shareholder objectives. However, it could be argued that EVA is “a poor indicator of value changes for
organisations that derive a significant proportion of their value from future
growth” (Merchant and Van der Stede, 2003, p.422). This denotes that
quantitative performance measures do not take into account future changes in
cash flow and hence shifts management focus away from future performance which
shareholders are ultimately concerned with. Costin (2017, p.170) illustrated
that the EVA model promotes “long term
thinking at all levels of the business organization by changing the mindset of
managers and employees towards shareholder perspective”. As a result,
management understands that any investments that they undertake should have
returns which exceed the cost of capital (Jakub et al, 2015). However, Keys et
al (2001) suggested that the EVA model is an absolute measure which lacks
versatility and therefore “cannot be
applied as a criterion to compare commercial company or units which are in
different sizes” (Babaei et al, 2013, p.1887).

 

Cadbury’s applied the EVA approach in
their business model as it helps measure economic profit and also takes into
account the total cost of capital used to create those profits (Bhimani and
Bromwich, 2010). Scapens et al (2007, p.264) identified that another benefit of
the EVA model is that it capitalises “some
of the most important types of discretionary expenditure that managers might be
tempted to cut if they were pressured for profits”. Therefore, it
reduces the likelihood of creative accounting by management and provides a “single value-based measure that can be
used to evaluate business strategies, value acquisitions, measure performance
and pay bonuses” (Scapens et al, 2007, p.267). On the other hand,
Trapp (2011) argues that EVA focuses on instant results and restricts managers
who want to pursue innovative strategies, thus limiting the growth of the
company and potential profits in the long-term. Overall, it is evident that the
benefits of the EVA model outweigh the drawbacks and it is an effective aid for
management; as it focuses on profit maximisation which is the primary goal of
shareholders (Switzer and Cao, 2011).

Quantitative
Performance Measures

Friedman (1970, p.133) believed “there is one and only one social
responsibility of business- to use its resources and engage in activities
designed to increase its profits so long as it stays within the rules of the
game, which is to say, engages in open and free competition without deception
or fraud”. The Friedman argument states that companies should prioritise
profit maximisation, instead of financial outlay on responsible trade
activities. Therefore, return on investment enables management to focus on the
most profitable investments which could lead to increased shareholder value
(Gunasekaran et al., 2015). Parida et al. (2015) contended that quantitative
performance measures limit the competitiveness of the company because they are
based on historical data and could give misleading results. Shareholders can
also use this method to assess the effectiveness and efficiency of management (Bangchokdee
and Mia, 2016). However, Gupta and Sikarwar (2016) highlighted inherent restrictions
of this method such as managers whose remuneration is directly linked with this
measure acting in their own interests as opposed to that of the company. It
should be noted that the EVA model overcomes this goal incongruence and provides
a measure of wealth creation that aligns the aims of management with that of
the whole company (Yuval et al., 2016).

 

 

 

 

 

Non-financial
Performance Measures

Kaplan and Norton (1992) proposed the
balanced scorecard (BSC) as a means of appraising corporate performance from four
different perspectives being: financial, internal business process, the
customer and learning, and growth. An example of learning and growth includes
employee satisfaction; if an employee is more motivated to work for the company
it is likely that productivity will increase (Abbott, 2003). If productivity
increases, the business will, in turn, make more revenue and this leads to
better financial performance. Sharma and Gadenne (2011) believed that the BSC
is a useful tool for implementing and communicating strategic plans; as it
enables employees to align their goals with the organisational strategy. It
allows a more concentrated approach to be taken into key performance indicators
affecting performance and has flexibility in order to fit numerous organisations
(Kanji and Sa, 2002; Ritter, 2003). Furthermore, the balanced scorecard takes
into account the link between the mission statement and routine trading
activities of the business. Botek and Pechá?ková (2013) argued that managers
and directors may be unwilling to invest in this approach due to a lack of
strong governance, which would result in a lack of effectiveness. Another
drawback of this method is the vast amounts of information surrounding this
topic which could be overwhelming for managers and directors (Budde, 2007).
Additionally, choosing the most appropriate key performance indicators is a
subjective process and there may be differing opinions regarding this; it could
be a time-consuming process and there is an opportunity cost because this time
could be spent on profit-making activities. 

Market share is another non-financial
measure that is used by businesses to evaluate business performance as it
measures their revenue as a percentage of the total industry revenue (Coatney
et al., 2012). Laverty (2001) highlighted this as a key measure because it can
be used as a benchmark against other competitors and enables companies to set
future goals and targets in relation to their current market share position.
Furthermore, the size of the market share enables companies to obtain better
deals with suppliers due to the quantities ordered. This leads to another key
non-financial measure being supplier relationships and the value-added chain
(Giannakis, 2007). It is essential to maintain good supplier relationships so
companies are not reliant on one supplier for all their orders and they can use
this affiliation to negotiate better trade deals. If companies obtain better
deals with suppliers, they can offer more competitive prices to customers and as
a result, customer satisfaction will increase. Hill et al. (2007, p.2)
advocated that “there is a strong
relationship between customer satisfaction and profitability of the
organisation”. Investments in customer satisfaction can improve the
economic performance of a business by attracting new customers, expanding the
existing customer base or increasing brand loyalty.      

Subsequently, Wiersma (2008) believed
that the benefits of using non-financial measures are improved communication of
objectives to employees and more motivated managers to address long-term
strategy. Non-financial measures can also be superior indicators of future
financial performance. As these non-financial measures are less susceptible to
external factors such as government pressure or changes in the economy; they
could develop manager’s performance by generating a specific assessment of
their actions (Moxham, 2009). 
Conversely, the disadvantages associated with this include significant
investment cost, time and resistance to change from employees. There is also an
element of subjectivity in relation to non-financial measures which could lead
to inaccuracies.

Conclusion

Based on the critical assessment of
quantitative and qualitative performance measures previously discussed, we can
conclude that quantitative performance measures are better aligned with
shareholder interests as opposed to non-financial measures. Scapens et al
(2007), Bahri et al (2011) and Costin (2017) all supported the EVA model and
demonstrated that it is an effective aid for management; as it focuses on
profit maximisation which is the primary goal of shareholders. However, using
purely financial measures to assess the future actions of a company would not
be recommended as these predominantly focus on historical data and can provide
a limited view as identified by Parida et al (2015). Futhermore, Gupta and
Sikarwar (2016) highlighted inherent shortcomings of return on investment and
Yuval et al (2016) recognised how this can be overcome by the EVA model. In the
current business environment to function efficiently and effectively, businesses
must appreciate the importance of the EVA model and also incorporate
non-financial performance measures. As they can provide improved clarity in
regards to managerial decision making and enhanced performance analysis. It is
crucial that the measures chosen are continuously evaluated and reassessed as
part of a dynamic process, to survive, evolve and prosper in the fast-moving
environment.

 

 

 

 

 

 

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