New ways of measuring company performanceJune 2013
Written by Jeffrey Harrison & Andy Wicks, Darden Business School,
University of Virginia, US
Firm performance is a fundamental issue for scholars and practitioners alike. We need a way of understanding what it means to do well, and what indicates sub-standard performance or failure. Existing financial performance metrics used to determine performance are important, but they are often incomplete and oversimplify the value stakeholders receive.1 Financial measures can be especially problematic when management makes efforts to meet short-term financial goals that reduce the desire of key stakeholders to support the firm and may simultaneously decrease the firms’ ability to create new value for stakeholders.
Instead of focusing primarily on economic performance measures, a stakeholder-based performance measure challenges managers to examine the broad array of ways their firms create value. Managers need to understand the stakeholder goals and aspirations, both as a way of attracting them to the firm, keeping them engaged and performing at a high-level.
Adam Smith provides two important perspectives on “value”to consider. First, individuals know what is best for them – value is something that individuals should define and not allow others to choose for them.2 The emphasis of individual freedom and the individual differences in defining value are fundamental.3
Second, Smith emphasizes that healthy markets allow customers to choose: what they will buy, from whom and under what terms.4 The basics of markets say that people tend to make choices on what provides them the most value for what value they give up. When they can find a better deal, people tend to shift from their previous choice to this better deal over time. Financial performance is important, but it is not the only aspect of value that is important to stakeholders. Consistent with R. Edward Freeman’s idea that a firm should serve multiple stakeholders, firm performance can be defined as the total value created by the firm through its activities, which is the sum of the utility created for each of a firm’s legitimate stakeholders.5
A stakeholder-based perspective on firm performance is based on two ideas: that all of the firm’s legitimate stakeholders have customer-like power to engage with a firm, and the utility created for one stakeholder is dependent on the behavior of the other stakeholders.
This view is elaborated by four factors that emerge from a focus on stakeholders and the value they seek through relations with a firm. The model incorporates the tangible value stakeholders seek and the process for distributing value.6 The factors are:
1. Stakeholder utility associated with physical goods & services
Perhaps the most obvious source of utility for stakeholders is found in physical goods and services provided by the firm, where physical goods include financial remuneration. A reasonable goal for the firm with regard to its customers is to create goods and services perceived to provide a highly positive ratio between the utility received and the value given up.7
2. Stakeholder utility associated with organisational justice
Researchers from a variety of disciplines have demonstrated that most people operate within norms of fairness and reciprocation and seek to work with organizations that do the same.8 A firm that treats stakeholders well would be considered interactionally just. Organizational justice is essential to value creation because people value being treated fairly, and they are capable of reciprocating.9
3. Stakeholder utility associated with organisational affiliation
Stakeholders receive utility from affiliating with organizations that exhibit behaviours they value. For example, if the firm embodies characteristics that are considered valuable by its employees, organizational affiliation (or identifying with the firm) can provide feelings of connectedness, esteem and empowerment. As employees invest energy, effort, time and attention in the firm they develop feelings of “ownership,” which provides a sense of responsibility, shared interest, and motivation.10
4. Stakeholder utility associated with Opportunity Costs
Embedded within each of the previous three factors is the notion of opportunity costs.11 Utility is based on perception, and perception is influenced by whether stakeholders believe they are getting a good deal from one firm compared with other firms.12 Stakeholders continually evaluate the value they get in each domain and compare it to other alternatives.
Practitioner Measures of Value Creation
The utility stakeholders seek is complex and pertains to more than just financial measures. Collecting non-financial information on performance enhances communication, learning and coordination within firms.13
Understanding the value stakeholders seek, and finding innovative ways to provide it, is a key task for managers – both in terms of our ability to determine who has done well, but also in terms of the ability of firms to create value in the future. Given the critical role of stakeholder support for firm success, understanding what stakeholders value and how to provide it is vital to firms.
Some scholars argue that there is a risk that too many performance measures will reduce the influence of measure that managers focus on.14 Neglect of any one stakeholder could set off a downward spiral for the firm as other stakeholders respond to what they observe. The real risk is that managers will become focused on too few objectives representing too few stakeholder interests, rather than too many.
This article has been adapted from the journal article, “Stakeholder Theory, Value, and Firm Performance,” written by Andrew Wicks and Jeffrey Harrison in the January 2013 edition of Business Ethics Quarterly, Volume 23, Issue 1, January 2013, pp.97-124 (DOI:10.5840/beq20132314).
1 Barney, J.B. 2011. Gaining and sustaining competitive advantage. 4th Ed. Upper Saddle River, NJ: Pearson Education Inc.
2 Smith, A. 1776. An inquiry into the nature and causes of the wealth of nations. London: W. Strahan and T. Cadell.
5 Freeman, R.E. 1984. Strategic management: A stakeholder approach. Boston: Pitman.
6 Harrison, J.S., Bosse, D.A., & Phillips, R.A. 2010. Managing for stakeholders, stakeholder utility functions and competitive advantage. Strategic Management Journal, 31: 58-74.
7 Barney, J.B. 2011. Gaining and sustaining competitive advantage. 4th Ed. Upper Saddle River, NJ: Pearson Education Inc.
8 Becker, L. 1986. Reciprocity. Chicago: University of Chicago Press.; Cialdini, R.B. 1984. Influence: The psychology of persuasion. New York: William Morrow and Company.; Cropanzano R., & Mitchell, M.S. 2005. Social exchange theory: An interdisciplinary review. Journal of Management, 31: 874-900.; Fehr, E, & Gachter, S. 2000. Fairness and retaliation: The economics of reciprocity. Journal of Economic Perspectives, 14 (3): 159-181.; Rabin, M. 1998. Psychology and economics. Journal of Economic Literature, 36: 11-46.; Rawls, J. 1971/1999. Justice as reciprocity. In Freeman, S. (Ed.), John Rawls: Collected Papers: 190-224. Cambridge, MA: Harvard University Press.
9 Blau, P.M. 1964. Exchange and power in social life. New York: Wiley.; Simon, L. S. 1966. Industrial reciprocity as a business stratagem. Industrial Management Review, 7(2): 27-39.
10 Pierce, J. L., Rubenfeld, S. A., & Morgan, S. 1991. Employee ownership: A conceptual model of process and effects. Academy of Management Review, 16: 121-144.; Vandewalle, D., Van Dyne, L., & Kostova, T. 1995. Psychological ownership: An empirical examination of its consequences. Group and Organization Management, 20: 210-226.
11 Kerins, F., Smith, J.K., & Smith, R. 2004. Opportunity cost of capital for venture capital investors and entrepreneurs. Journal of Financial & Quantitative Analysis, 39: 385-405.; Spiller, S.A. 2011, Opportunity cost consideration. Journal of Consumer Research, 38: 595-610.
12 Barney, J.B. 2011. Gaining and sustaining competitive advantage. 4th Ed. Upper Saddle River, NJ: Pearson Education Inc.
13 Dossi, A. & Patelli, L. 2010. You learn from what you measure: Financial and non-financial performance measures in multinational companies. Long Range Planning, 43: 498-526.
14 Chatterji, A. & Levine, D. 2006. Breaking down the wall of codes: Evaluating non-financial performance measurement. California Management Review, 48(2): 29-51.