Academic journal article
By Ballou, Brian; Heitger, Dan L.; Schultz, Thomas D.
Management Accounting Quarterly , Vol. 11, No. 4
Management personnel from firms in nearly every industry face heightened expectations from executives, boards of directors, business partners, and--most of all--investors to consistently take actions that contribute to the success and stability of the business. Not surprisingly, many stakeholders rely heavily on various economic performance measures to gauge the extent to which favorable results have been achieved, including Wall Street's determination of value--stock price. Yet based on our interactions with hundreds of executives whose experiences range from plant manager to company president, one of the most common challenges faced at all levels is a clear understanding of the relationship between managers' behaviors and the creation of long-term value within their organizations: "How do my actions create value for investors?"
Attempting to estimate the direct impact of one's actions on stock price (or other measure of long-term organizational value) is overwhelming for most managers and not especially practical. What is needed is a broad-based tool, or framework, to help managers better understand the series of relationships that connect their actions to the ultimate creation of value and to help motivate them to effectively and efficiently demonstrate such behaviors.
The Actions-to-Value framework we present illustrates the pathway from managerial behavior to long-term value through an easily understandable, informal, causal chain of direct effects on each intervening variable. This framework has been well received by dozens of managers and executives participating in executive education courses we have delivered on this topic. Several of the executives participating in the courses commented that they struggle to grasp whether and how their daily actions affected economic-value-based measures, which had recently become the sole variable upon which their annual bonuses were based.
understanding the effect of one's actions on net income or, better yet, cash flows is critically important to managers in almost any business situation. For example, a quality inspection manager estimates the eventual financial impact of reducing defect rates, including those related to inspections, rework, recall, and scrap. A vice president of sales determines if, how, and when improving the responses of an international call center will affect the organization's ability to grow revenue by a significant percentage each year. Alternately, a chief risk officer estimates how various risk-response actions, such as implementing process controls or forming strategic alliances, eventually reduce inherent risks to a lower residual level often measured in financial terms. In fact, the risk division of one major distributor of medical products has used net operating profit as its financial measure of interest. Nevertheless, a solid understanding of how reported profits and cash flows reflect efforts to control costs, increase revenues, or manage risks still does not sufficiently convey to managers how such actions ultimately impact a company's long-term value, particularly in an era in which accounting rules often dilute this relationship.
Although organizations can create formal statistical models of these internal cause-and-effect relationships, survey data reported in 2003 by Christopher Ittner and David Larcker reveals that only a minority of firms (less than 25%) consistently build and verify such models. (1) As a result, managers are forced to construct their own informal "mental" models. Therefore, there is a strong need for a relatively simple tool that managers can use to better understand these relationships in the absence of a formal statistical causal model developed internally. This article and the Actions-to-Value framework should help managers identify how their decisions are ultimately reflected in key measures of long-term organizational value. The broad-based approach of the Actions-to-Value framework makes it appropriate in a wide variety of managerial decision-making contexts. …