During the last five years, there has been a dramatic rise in interest in the measurement and management of shareholder value. Driven by increasingly competitive and global capital markets, less tolerant institutional and personal investors and corresponding demands for increased accountability by boards and senior management, the creation (and destruction) of value has become an increasingly important ingredient in annual shareholder meetings, analyst reports and in the media.

In this intensifying focus on shareholder value, "metric wars" have broken out to claim supremacy in correctly measuring shareholder value and with claims that these are superior to the traditional accounting measures they purport to replace. Similarly, a growth industry has developed around what can be loosely termed "value-based management", a management tool whose purpose is to align metrics, business models, activities, performance measures and compensation into a unified management style.

We have learned much from the evolution of these measures and management practices. However, it is interesting to view the interest in value from a different perspective. Specifically, instead of relying on metric merchants and promoters of management models to prescribe what measurement and management practices should be, it would be interesting to speak directly to Canada’s senior managers and ask them what they measure and what they feel are the critical elements that must be managed to create value. For example, despite the literature on this subject, some key questions have, as yet, remained, largely unanswered.

1. What measures do executives use to monitor their company’s ability to generate shareholder value?
2. According to executives, what are the critical factors for creating and sustaining shareholder value?
3. How well are they succeeding in managing these critical factors?
4. Are there differences between the "top" and "bottom" value creators with respect to the importance of and satisfaction with each critical factor?
5. What are some of the "best" practices that organizations follow to create value?

We asked these questions to 136 senior executives (CEO, CFO, and VP levels) of 32 large, publicly listed Canadian companies representing six different industry sectors. The responses enabled us to identify the "best" practices that organizations follow today. CMA Canada and the Financial Research Foundation of Canada supported our research.

Question 1: When you think of shareholder wealth, which financial performance measure(s) are most important to you and your organization?

Executives were given a choice of commonly cited measures, including traditional accounting as well as value-based measures. Since we knew of no consensus on this issue among practitioners, our goal was to determine if senior executives have an unambiguous choice for measuring value-creating performance.

The results were informative. Total Shareholder Return (TSR), defined as change in price plus dividends) is the one measure that executives use most often – and by a huge margin. The next two measures were Return on Equity and Earnings Per Share (EPS) growth. Interestingly, despite the apparent popularity of measures such as EVA, EBITDA, and CFROI, only a very small number of executives mentioned them.

We concluded that executives appear to measure performance according to both external (market-based) and internal (non-market, accounting-based) metrics. The external measures are in turn dominated by TSR; the most important internal measures are returns based on equity holders’ investments and the earnings that accrue to them.

Question 2: List the three to five critical factors that you feel are essential for your firm’s ability to create shareholder value

Managing a publicly traded corporation is a complex task with no simple or single magic bullet for success. While there exist numerous prescriptions and management theories, the purpose of this question was to have executives describe their view of the critical factors necessary to wealth creation in their firms. (Note: the question made clear that, at this point, we were not interested in how satisfied executives were with their ability to achieve success on these factors – simply to indicate what those factors were).

We used a Delphi technique to analyze this question. As expected, the question elicited close to 500 responses. Also, as expected, there were many common themes in the responses and we found we could distill them into a list of less than a dozen, separate, key factors. Executives were then asked to rank the importance of the factors on this revised list. Column (a) of Exhibit 1 is the result of this exercise.

One might expect that there would be differences in how each industry sector ranked the relative importance of each key factor. However, we discovered that there was a remarkable similarity not only across all sectors but also across all types of managerial positions and all firms. More specifically, respondents rated three factors very highly: Managerial Leadership and Vision, Customer Service, and Employee Skill Set/Motivation. On the other hand, technological innovations and information systems were ranked considerably less highly. This latter finding may not be surprising. Relative to other economies, many economists have pointed out that Canadian industries tend to be lagging in terms of innovations and contemporary information systems.

Question 3: How satisfied are you with your firm’s ability to achieve success on these critical success factors?

Columns (c) and (d) of Exhibit 1 indicate how executives responded to this question. Overall, the firms appeared to be only "somewhat satisfied" (4.95) with their ability to achieve overall success on the nine factors. However, there are some interesting observations. First, executives are generally highly satisfied with their firm’s rating for the factors that they believe are the most important in building shareholder wealth. It is encouraging to note that the degree of satisfaction on the first four factors is also among the highest: Managerial Leadership and Vision, Customer Service, Employee Skill Set/Motivation and Pricing, Quality and Distribution of Products. This relatively high satisfaction indicates that organizations devote most of their limited resources to ensuring that they will succeed on those factors deemed most important.

While the satisfaction level on these four factors is high, "somewhat satisfied" also means that there is still considerable room for improvement. Each executive was also asked to compare its company’s success on each factor against how they felt their closest competitor would rank its satisfaction on the same factor – column (e). While it is clear that one can never rest one’s laurels, satisfaction on critical success factors is at least partially dependent on whether executives believe their performance is relatively better than their competitors.

Respondents are least satisfied with the quality of their information systems. With a factor score of 4.11, there are clear opportunities for improvement. However, for such improvement to take place, Canadian executives will have to rethink how important IT is to them. For example, in the USA in 1995, the average percent of revenue spent on I/T was 2.5% of revenue. By 2005, this is expected to increase to 5.8%. Our results show Canadian firms are not thinking in these terms. Continued lack of managerial interest in systems and consequent dissatisfaction may severely impede Canadian organizations’ ability to capitalize on wealth-generating activities.

Question 4: Are there differences in how organizations respond to these factors and their ability to create shareholder wealth?

At this stage, we have learned that there is a powerful consensus among Canadian senior managers about which factors are most important in creating shareholder value. We have also learned that, in general, they are only "somewhat satisfied" with their abilities to achieve success on these factors and that, in general, there is a higher level of satisfaction on some factors than on others.

Beyond these general findings, it is interesting to determine if the importance and satisfaction rankings of a specific firm correlates to its ability to generate shareholder wealth? To determine if there were any differences, we divided the sample in two, based on respondents’ actual wealth-creating performance. Firms were categorized in "Top" and "Bottom" wealth creators based on the total returns their shareholders received. Total shareholder returns were calculated for each firm (capital gains plus dividends) between 1993 and 1996. Excess returns for each company were calculated by subtracting the returns of the TSE300 sub-index for their respective industry. Companies that out-paced the returns for their industry were classified as "Top"; the rest fell into the "Bottom" category.

Exhibit 2 highlights the results from this analysis. There is an obvious difference in what "top" and "bottom" groups see as the most important factor for success and their level of satisfaction for that factor. Top Performers chose Management Leadership/Vision as their most important factor; they also indicated a high level of satisfaction (5.4). Bottom Performers satisfaction level for their most important factor – Customer Service - was much lower at 4.86.

Top Performers identified Customer Service as the second most important factor. They also expressed a level of satisfaction (5.26) that was higher than the Customer Service satisfaction score for Bottom Performers, even though the latter chose it as their most important factor.

The two groups also differed on their choice of – and satisfaction with -- their third most important factor. Top Performers chose Employee Skill Set/Motivation and had a relatively high score (5.13) in achieving success. On the other hand, Bottom Performers chose Pricing, Quality and Distribution of Products as their third most important factor. The indicated level of satisfaction, however, was considerably lower, 4.70.

Empirically, it has been difficult to demonstrate how attention to certain management practices impacts on wealth creation. However, these results offer partial support for the view that the difference between "top" and "bottom" performing organizations is the ability to achieve a higher level of satisfaction on the factors they deem most important.

Question 5: What are some "best" practices identified by executives?

Three themes kept appearing throughout the analysis. Across the board, respondents underscored the importance of understanding, communicating and measuring what matters to the organization.

1.Understanding what matters to the organization means clarity of purpose, management vision and the ability to plan for the organization’s future success. Best practice firms understand this environment, define their particular expertise, make trade-offs and choose strategies that lead to enhanced shareholder wealth. Best practice companies also exhibit a sense of direction that flows from high levels of leadership, discipline and continuity of purpose. Core competencies are reinforced and executives spend time setting the boundaries -- both business and ethical -- that define the organization.

2. Best practice firms also understand the importance of communicating what matters. Research informs us that that most firms under-communicate by a factor of 10 so getting the "what’s important" message out is one of the major challenges for organizations. We found many executives consciously trying to reinforce the organization’s purpose, goals and objectives, and developing training programs, regular meetings, and internal publications to make sure that employees and other stakeholders receive, understand and internalize them.

3. Measuring what matters was the third theme that kept re-appearing throughout the analysis of best practices. Measurement at the overall firm level refers to the ‘primary’ or financial measures a firm could use to compare itself to competitors or with an index such as the TSE 300. At functional levels, such as Customer Service and Operations, measurement more often meant secondary, non-financial, metrics of performance.

This concern for measurement has at least three implications.

• First, best practice respondents attempt to link hard measures of financial performance to soft aspects of decision-making such as vision and the effectiveness of leadership. This is a welcoming sign, since these yardsticks measure outcomes as opposed to inputs, and the effectiveness of processes rather than departmental efficiencies.

• Second, respondents also directly linked non-financial measures to specific key factors, such as customer satisfaction, employee turnover and process improvement. This finding is consistent with the recent popularity of the balanced scorecard and the growing tendency to view the organization from a multi-stakeholder perspective.

• The third implication is that best practice organizations have realized that what gets measured gets managed.

Conclusions

What can we learn from this study?

1. Despite a wide variety of performance metrics from which to choose, Total Shareholder Return (TSR) remains most executives’ first choice to measure shareholder value. As a result, we expect that this measure (possibly with a benchmark index return) will be prominently displayed in each annual report. The absence of such mention should send investors some warning signals.
2. If an organization is serious about creating shareholder value, then it must critically (and continuously) examine and improve its commitment to Management Leadership/Vision, Customer Service, and Employee Skill Set/Motivation.
3. Unless executives assign a high degree of importance to a specific capability, it is going to be difficult to create high satisfaction.
4. The best practices and the underlying reasons for them provide a checklist that all firms can use to compare their own performance.
5. One sure path to creating shareholder value lies in understanding, communicating and measuring what matters to the organization. These three elements may be self-evident, but our respondents indicate that successfully implementing them is what separates the best from the rest.

 

Exhibit 1

Importance Rankings and Level of Satisfaction with Key Success Factors

Key Success Factors               (a)	Importance Ranking* (1 – 11)           (b)	Level of Satisfaction Raw Score (1 – 7) 7 = completely satisfied     (c)	Level of Satisfaction Ranking (1 – 11)         (d)	Level of Satisfaction Compared to Closest Perceived Competitors Level of Satisfaction (e)
Managerial leadership and vision	1	5.48	1	Higher
Customer service	2	5.12	2	Higher
Employee skill set/ motivation	3	4.89	4	Higher
Pricing, quality and distribution of products	4	5.11	3	Higher
Marketing ability/marketing leadership	5	4.65	7	Lower
Operational capabilities/efficiency	6	4.64	8	Lower
Organizational culture	7	4.70	5	Higher
Technological leadership/innovation	8	4.68	6	Same
Information systems	9	4.11	9	Lower
Average satisfaction score		4.95

 

Exhibit 2

Most Important Factors and Degree of Satisfaction

By Ability to Create shareholder wealth

 

Grouping	Most Important Factor	Level of Satisfaction	Second Most Important Factor	Level of Satisfaction	Third Most Important Factor	Level of Satisfaction
TOP	MLV	5.44	CS	5.26	ESS	5.06
BOTTOM	CS	4.86	MLV	5.54	PQD	4.70

Factor Key

MLV - Managerial Leadership / Vision

CS - Customer Service

ESS - Employee Skill Set /Motivation,

PQD - Pricing, quality and distribution of products