"VALUE, not size" is crucial in determining a firm's growth, says Joel Stern, chairman and chief executive officer of Stern Stewart & Co and creator of the economic value added (EVA) measure.
Speaking at a forum at the Singapore Management University (SMU) yesterday, he noted that "bigger is not better", as firms that base their performance solely on size metrics - such as turnover generated and employee headcount - often do not take value into account. However, he acknowledged that doing so was not easy as it required a "valuation paradigm" shift at the top management levels.
To measure such "value" in firms, Mr Stern developed the EVA model, which factors in intangible assets that are not taken into account by return on assets or equities, such as building brand value, product research and development, as well as human training and development. He emphasised that the goal "is not EVA, but EVA growth"; thus payoffs should be pegged to performance improvements.
Describing a new programme his firm developed last year where 20 per cent of all bonuses goes towards a collective fund for a self-betterment programme, he commented that its aim was to make everyone feel they are partners with each other. "Nobody is unimportant - the key word is inclusion," he declared.
He further recounted how a receptionist at a cosmetics firm in South Africa had thanked him for implementing the system at the firm, noting that the implementation of EVA must "cascade down throughout the organisation" to benefit all employees. Indeed, he believed employees should not be viewed as "corporate overhead", but rather as "value-change agents", and that the EVA system promoted "employee capitalism" that could bring out the "entrepreneur" in employees.
Mr Stern's faith in the free market is unsurprising, given that he is an alumnus of the University of Chicago and a student of Milton Friedman. He thus argued that the "seriousness and protractedness of the current recession was caused not by the private sector", but rather by government policy that forced banks to make loans to unqualified borrowers as well as the implementation of a zero interest rate policy by the Federal Reserve.
Mr Stern also believed that some problems in the economic recovery are caused by "bad behaviour that resulted from poorly designed incentive systems". He thus emphasised the importance of incentives, noting that the most crucial thing firms should do is use a "bonus bank arrangement", where employees receive their bonus payments over several periods rather than the full payment in the current year. This would ensure sustainability by "lengthening their decision horizon" and prompting them to "care about future consequences".
He also stressed the importance of training people to enable them to undertake necessary changes, and further highlighted three essentials in performance measures: proper measures from income statements and balance sheets that account for intangibles, as well as underlying risks of firm activities.
In closing, Mr Stern observed that changes in organisations could occur only if bosses valued all employees equally, and if employees were able to "earn, not negotiate, their variable pay", adding that EVA could help firms pick such "low-hanging fruit".