Consulting » EDITOR’S LETTER – Back to the future for value creation.

We have met financial directors who believe that “shareholder value creation” basically means doing what the City wants – and since (so the argument goes) the City is short-termist in outlook, pursuing shareholder value can mean jeopardising the long-term future of a business. Equally, we have met industry commentators who have difficulty with the notion that shareholder value is consistent with stakeholder value. But since shareholder value creation is all about discounting future cashflows back to the present day, if you screw up your customer, supplier and employee relationships you soon won’t have any future cashflows to discount. So the shareholder value bandwagon comes back to basic principles. Indeed, a Mr David Allen recently wrote in Management Accounting that it seemed odd anyone should regard EVA, Economic Value Added, as a new concept, when it was really just residual income with a trademark symbol. He is, of course, absolutely right. Residual income was a measure used by (American) General Electric in the 1950s and – as this month’s cover story reveals – General Motors was heading in that direction in the 1920s. Perhaps the genius of Stern Stewart – the consultancy that rediscovered residual income and trademarked it as EVA – was to find a way of linking the performance measurement system to executive pay. Its thinking is that if you start rewarding managers on the basis of the yardstick you use to evaluate their companies, they will suddenly lose interest in so-called earnings-enhancing paper acquisitions that squander investors’ retained earnings. Perhaps, like Roman plumbing, we just forgot the basics during a financial dark age. Whatever the explanation, it is clear there are too few people today who know (a) the real value of a performance metric that is based on the need to generate a return on investment greater than you can get in a savings account, and (b) how to use such a measurement properly. “Sometimes,” wrote Alfred Sloan, “you have to invest just to stay in business”. Invest a little time in this month’s cover story. It’ll pay back more than you put in.