Alternative Measures of Performance - Assignment Example

Financial Accounting Name Course Name and Code Instructor’s Name Date Table of Contents Table of Contents 2 Introduction 3 Critical analysis 3 Alternative measures of performance 7 Conclusion 8 Works Cited 10 Introduction Advancing the interests of shareholders only as suggested by the shareholder theory embrace Milton Friedman’s perspective that suggests that businesses are socially accountable to enhance business and ensure the interests of the shareholders in terms of value in their shares are basis for the goals and the objectives of the organization (Sumanjeet, 2011, p.1). Although stakeholder theory suggest that the management should consistently and fairly favor all the interests of all stakeholder groups other than the shareholder group, organizations are still split in deciding which argument to prefer and inform their systems, processes and work processes. Collison (1998:7) states that “Attention to the interests of shareholders above all other groups is implicit in much of what is taught to accounting and finance students. The very construction of a profit and loss account is a continual, and usually un-stated, reminder that the interests of only one group of stakeholders should be maximised. Indeed it may be very difficult for accounting and finance students to even conceive of another way in which affairs could be ordered, even at the algebraic level, let alone the moral.” Therefore, this report seeks to critically analyze this statement and provide current examples of companies that support the report’s point of view. Critical analysis It is important to note that the interests of both the shareholder group and the stakeholders group are attuned and they both are responsible for the sustainable efficiency and development of an organization and therefore both need to be integrated in corporate governance and should both be used as financial performance indicators. Nevertheless, there are valid and relevant arguments in support for either. Historically, shareholders have been at the receiving end of the effects and impacts of accounting and financial malpractices in corporations where they have been subjected to corporate and financial fraud (Sumanjeet, 2011, p.2). Since, they born the highest risks, legal and regulatory systems both within the organizations and by the government have been designed in such a way to cushion shareholders from such risks, which have in effect caused corporations, seem or in real sense become biased towards maximizing the interests of shareholder group alone. This has resulted in greater emphasis on profits as a performance indicator and more significantly, influencing accounting and finance students into perceiving that the interest of only one group of stakeholders, the shareholders, should be maximized (Sumanjeet, 2011, p. 2). Among recent corporate and financial frauds that can be linked to the increased application of shareholder theory or the maximization of only the interests of shareholders in expense of other stakeholder group. These includes the Nugan Hand Bank in Australia, Robert Maxwell in the UK, Barings Bank in the UK, Xerox in the USA, Enron in the USA, Bristol- Mayers Squibb in the USA, and Global Crossing in the USA. Others include Computer Associates in the USA, El Paso Corporations in the USA, Adelphia in the USA, Kmart in the USA, Dynegy in the USA and Qwest Communication in the USA among others (Sumanjeet, 2011, p.3). I agree with Collison. More often than not, shareholders bears the greatest risk as the main people that contributes the equity capital of the organization and who have the undisputed power on how resources are allocated through variables set out in official documents such as memorandum of association and official approvals they give to decisions made by the management. According to Alchian and Demsetz, (1972, p. 777), shareholders are responsible for the most fundamental process of an organization such as selecting the company’s directors and they often are the group of stakeholders to be the last in pecking order during the allocation of surpluses in case of winding up after all other claims have been met. This makes shareholders as the residual claimant in the corporate hierarchy eligible to having the organization and its management exclusively answerable to them as supported by the residual claimant theory (Demsetz, 1967, p. 347). Therefore, the fact that the highest risks and the most crucial responsibilities in the organization are taken up by the shareholders makes the interests of this group which is profit maximization, of utmost significance and thus, almost all actions and plans by the organization are meant to maximize the interests of this one group of stakeholders. According to Easterbrook and Fischel, other stakeholder groups that include employees, creditors and employees enter into explicit contracts with the organization, which gives them the right to fixed and regular payments. This entails remunerations and interests payments which does not apply for shareholder who have implicit contract which gives them the right and access to what remains subsequent to the company meeting its explicit responsibilities and paying all its fixed claims (Esterbrook & Fischel, 1991, p.5). According to Easterbrook and Fischel, the shareholder is the exclusive residual claimant and the sole residual risk bearer. For this reason, organizations must be operated by focusing primarily on maximizing the interests and profits for the shareholders (Esterbrook & Fischel, 1991, p.12). This means that with more emphasis being placed on one stakeholder group, more and more emphasis on profits will continue and the significance of other performance indicators will continue to deteriorate. However, perceiving shareholders as the only residual claimant is ill informed as argued by Blair, (1996, p.8). Just like shareholders, other stakeholders such as creditors, the government, suppliers, employees, the management and customers are also significantly affected when the performance and productivity of an organization is good or poor, therefore, this contradicts the argument that shareholders are the sole residual claimant (Sumanjeet, 2011, p.6). Since all stakeholders groups are influenced and impacted by the functioning of the organization, the company goals, objectives, operations, decisions and processes should be focused on maximizing the interests of all the stakeholder groups and not only one stockholder group and thus, rely on other alternative measures of performance other than profit maximization as supported by Blair, (1996, p.28). According to Boatright, (2006, p.106), an organization is fundamentally an executive entity through which numerous and varied people and groups try to attain their ends. On the other hand, the main goal of an organization is to act as a vehicle for coordinating the interests of stakeholders as described by Evan and Freeman, (1988, p.101). From these two descriptions of an organization, it is safe to suggest that maximization of the interest of one group of stakeholder only is limited and the definition of an organization does not compliment the shareholder based perspective of an organization as an economic entity which assemble resources for the aim of making profits for the organization’s owners. Therefore, an organization based on its own definition, should not be biased towards maximizing the interests of only one stakeholder group and hence, should place less emphasis on profits and place more emphasis on other measures of performance (Chakraborty, et al., 2004, p.99). In so doing, accounting and finance students can not only conceive other ways and means in which work processes and organizational systems, structures and operations could be ordered to ensure all the needs, expectations and interests of all stakeholders are sufficiently, effectively and efficiently addressed and met fully. Also, ensure organizations will place more emphasis on alternative performance indicators and less on profit maximization (Sumanjeet, 2011, p.9). This generates an environment where every stakeholder is satisfied which translates into more accountability, taking ownership, commitment, collaboration and hard work from all stakeholder groups in ensuring the anticipated strategic and organizational outcomes are achieved (Chakraborty, et al., 2004, p.99). Alternative measures of performance According to Henderson (2005), doing business encompasses other things other than making money. For this reason it is important for an organization to measure success not only based on profits, which as discussed in the report results in maximizing the interests of only one stakeholder group. Also, by analyzing other alternative measures of performance since in modern global environment, organizations cannot be profitably and effectively managed in the long term against the interests of majority of its stakeholders (Sumanjeet, 2011, p.11). Alternative measures of performance ensure equal accountability of organizations to each stakeholder and include performance indicators such as corporate social responsibility where the firm’s success is measured based on its involvement in social causes and on its ability to neutralize the environmental impacts generated by their business activities as supported by Chakraborty, et al., (2004, p.105). Tata Steel is a successful Indian company that has relied on wealth sharing with the community around it while enriching its shareholders as highlighted by Chakraborty, et al., (2004, p.105). Another example of a company that has succeeded in meeting the interests of all stakeholders without necessarily relying on profit maximization and maximization of the interests of its shareholders only is the Matsushita Company as discussed by (Chakraborty, et al., 2004, p.105). Another alternative measures of performance is customer satisfaction where the success and the performance of an organization is measured by analyzing how satisfied customers are with the practices applied by an organization (Chakraborty, et al., 2004, p.107). other performance indicators includes measurement of how ethical an organization is in responding to the needs of all stakeholders by ensuring all stakeholders are safe and secure which ensures the organization generates a positive image which generates positive effect on profits and growth of the company. Calpers Fund is such an organization that measures its performance based on its ability to remain ethical where best practices are a condition for their investments (Chakraborty, et al., 2004, p.107). Collison’s comments does provide a justification for moves towards profit measures that incorporates full costs since the author brings to attention the impact maximization of the interests of one stakeholder group only, has on the future of corporations. Since as he mentioned, such views have impacted on the way accounting and finance students who are future managers, investors, customers, shareholders and accountants perceive the role and function of the firm. Conclusion The debates between the correlation between the interests of shareholders and the interests of other constituents or other stakeholders have been ranging for significant amount of time. Generating questions on whether organizations merely exist to enhance or maximize the wealth of shareholders or organizations should be designed in such a way to serve all the interests of all stakeholders who encompasses employees, suppliers, investors, creditors, the government, the community and more significantly the customers. The origins of the biasness towards advancing only the interests of one group of stakeholders, that is, the shareholders, can be associated with the increased focus and considerations that have been generated to safeguard the shareholder from unethical management practices and accounting malpractices. This has seen the shareholders lose money amounting to billions of dollars both in cash and in stock values. Be it as it may, as argued in the report, it is crucial for corporations to integrate and be accountable for all stakeholders and placing lesser emphasis on profit maximization. Among other performance indicators includes customer satisfaction, investing in corporate social responsibility and compliance to ethical standards and best practices. Works Cited Alchian, A. and Demsetz, H. “Production, Information Costs and Economic Organization”. American Economic Review, 62, (1972), 777-795. Blair, M. Wealth Creation and Wealth Sharing. Brookings: Washington, D.C. 1996. Boatright, J. “What‟s Wrong and What‟s Right with Stakeholder Management.” Journal of Private Enterprise, XXI.2 (2006) 06-119 Chakraborty, S.K., Kurien, V., Singh, J., Athreya, M., Mairta, A., Aga, A., & Gupta, A. Management paradigms beyond profit maximization. Vikalpa, 29.3 (2004) 97-117. Collison, D. Propaganda, Accounting and Finance: An Exploration. Dundee discussion papers, Department of Accountancy and Business Finance, University of Dundee. Demsetz, H. “Toward a Theory of Property Rights.” American Economic Review, Vol. 57, pp 347-359, 1967. Esterbrook , F. and Fischel, D.. The Economic Structure of Corporate Law. London: Harvard University Press. 1991. Evan, W. and Freeman, R (1988) “A Stakeholder Theory of the Modern Corporation: Kantian Capitalism”, in Beauchamp, T. amd Bowie, N. (Eds), Ethical Theory and Business, 3rd Edition, Prentice-Hall, Englewood Cliffs: New Jersey, pp 101-105. Sumanjeet, S. RETHINKING CORPORATE GOVERANCE: FROM SHAREHOLDERS’ INTERESTS TO STAKEHOLDERS’ INTERESTS. New Delhi: Department of Commerce. 2011. Accessible from http://www.icffr.org/assets/pdfs/December-2011/Sumanjeet-Singh---FINAL-paper.aspx Read More