Primary navigation:

QFINANCE Quick Links
QFINANCE Topics
QFINANCE Reference

Home > Business Ethics Best Practice > Improving Corporate Profitability Through Accountability

Business Ethics Best Practice

Improving Corporate Profitability Through Accountability

by Marc J. Epstein and Priscilla Wisner

Table of contents

Executive Summary

  • Traditional measures of performance are of limited use to modern businesses, being rooted in evaluating past performance. They are a poor guide to true value, often missing the key factors that promote long-term worth.

  • It is essential to include the leading financial and nonfinancial indicators of performance that drive long-term value. This provides broader and more sophisticated information that highlights future trends.

  • Effectively managing and communicating a broader set of performance measures reduces uncertainty, ensures better relationships with stockholders and analysts, and enables improved financial performance.

  • Full accountability and disclosure, combined with improved measures and new systems to drive the process throughout the organization, create greater value for stakeholders, promoting future success.

 

Introduction

Improved governance requires the right employees, the right culture and values, and the right systems, information, and decision-making. Unfortunately, most organizations are attempting to steer their information-age businesses using industrial-age measurements. Managers have struggled for decades with accounting systems that fail to measure many of the variables that drive long-term value. The historical lagging indicators of performance that are commonly used by accountants are of limited value in determining the value of businesses for external stakeholders, and are of little use in guiding the business internally. Financial data on profitability and return on investment are valuable measures of corporate performance, but they are lagging indicators that measure past performance. A broader set of financial measures is necessary (for example, measurement of intangible assets such as intellectual capital and research-and-development value), in addition to an expanded set relating to customers, internal processes, and organizational measures.

The metrics must include the leading financial and nonfinancial indicators of performance that are the drivers and predictors of future financial performance. For example, fines and penalties may be a leading indicator of corporate reputation, employee turnover is a leading measure of future recruitment and training costs, and product quality is a leading measure of customer satisfaction, which in turn is a leading measure of market share. Each of these factors (reputation, employee-related costs, customer satisfaction, and market share) impacts financial performance.

Improved Internal and External Reporting

Just as companies expand their performance measurement parameters, they must also expand their performance reporting models. Employees, stockholders, financial analysts, activists, customers, suppliers, government regulators, and others increasingly demand detailed information about corporate activities, and the internet has made the dissemination of that information easier and faster. No longer can managers claim they don’t have the information. The data are easy to collect, and it’s essential to have broader and more forward-looking information to effectively manage the diverse issues that managers now confront daily. Managers should collect this broader array of information on activities and impacts both inside and outside the company, and select a set of data to provide adequate disclosure to their various stakeholders. External stakeholders need a broader set of information to effectively evaluate corporate performance, and voluntary disclosure of this information is critical for corporate accountability. This accountability, both inside and outside the company, through an effective corporate communications strategy, is an essential element of effective and responsible corporate governance.

Proactively managing external disclosures should be a fundamental part of corporate communications strategy. By externally disclosing a more comprehensive set of measures, company executives are seizing the initiative to describe the company’s strategy, set expectations, increase transparency, and ensure goal alignment between the company and a broad set of stakeholders. Disclosing performance measures allows investors and other stakeholders to view the company through the eyes of management. A clear, comprehensive communications strategy is highly valued by stockholders and analysts alike.

Case Study

The Campbell Soup Company has continually improved corporate governance.

Changes undertaken in the early 1990s required a majority of directors to come from outside the organization. All directors must stand for election every year and must own at least 6,000 shares of stock within three years of election. Among other provisions, interlocking directorships are not allowed and insiders are banned from certain key committees. In 1995, the board began a rotating yearly performance evaluation of directors, board committees, and the board as a whole. In 2000, the board approved a new director compensation program to closely link director compensation to the creation of stockholder value; only 20% is paid in cash (tied to attendance at meetings). The full set of Campbell Soup’s governance standards and current performance review are disclosed in the annual proxy statement to stockholders.

The Cooperative Bank, based in the United Kingdom and with 4,000 employees, has won numerous awards for the high degree of transparency and accountability the company has exhibited. The bank has identified six partners in its quest for corporate value: stockholders, customers, staff and their families, suppliers, national and international societies, and past and future generations of cooperators. The company surveys all stakeholder groups to determine the critical elements in creating value for each, and performance targets are set on the basis of this information. In 2003, 70 targets were established in three principal areas: delivering value, social responsibility, and ecological sustainability. The Cooperative Bank 2004 Sustainability Report states that 33 targets were fully achieved, acceptable progress was made on 22, and 15 were not achieved. The bank reports progress on each target, providing data and management commentary, and establishes targets for the coming year.

Back to Table of contents

Further reading

Books:

  • Epstein, Marc J., and Bill Birchard. Counting What Counts: Turning Corporate Accountability to Competitive Advantage. Cambridge, MA: Perseus, 2000.
  • Epstein, Marc J., and K. O. Hanson (eds). The Accountable Corporation. Westport, CT: Praeger Publications, 2006.
  • Monks, Robert A. G. The Emperor’s Nightingale: Restoring the Integrity of the Corporation in the Age of Shareholder Activism. Cambridge, MA: Perseus, 1999.
  • Ward, Ralph D. Improving Corporate Boards: The Boardroom Insider Guidebook. New York: Wiley, 2000.

Articles:

  • Botosan, Christine. “Disclosure level and the cost of equity capital.” Accounting Review 72:3 (July 1997): 323–349.
  • Epstein, Marc J., and Krishna Palepu. “What financial analysts want.” Strategic Finance (April 1999): 48–52.
  • Healy, Paul, Amy Hutton, and Krishna Palepu. “Stock performance and intermediation changes surrounding sustained increases in disclosure.” Contemporary Accounting Research 16:3 (Fall 1999): 485–520.
  • Hutton, Amy. “Beyond financial reporting—An integrated approach to corporate disclosure.” Journal of Applied Corporate Finance 16:4 (Fall 2004): 8–16.
  • Sengupta, Partha. “Corporate disclosure quality and the cost of debt.” Accounting Review 73:4 (October 1998): 459–474.

Report:

Back to top

Share this page

  • Facebook
  • Twitter
  • LinkedIn
  • Bookmark and Share