Stakeholder value disclosures: anchoring on primacy and importance of financial and nonfinancial performance measures

Abstract

In the growing debate about stakeholder values, there has been little discussion about information overload or whether the requested disclosures can be effectively used. Stakeholder advocates call for complicated and massive environmental and related social disclosures while not considering how information overload might affect the discourse about corporate performance. Stakeholders, including shareholders, plead for more transparency in financial statements, management discussion and analysis (MDA), and other corporate disclosures. As we know, shareholders and boards of directors are most concerned with the ‘Holy Trinity’ of earnings per share, dividends and market value changes. We believe that managers and stakeholders involved in performance evaluations have multiple interests that extend beyond traditional shareholder value measures. We note that the Balanced Scorecard (BSC) was developed as one tool to reflect and communicate these multiple measures. We test how managers use (or ignore) multiple performance measures and we posit that stakeholders will face many of the same constraints when using and processing multiple disclosures including Corporate Social Reports (CSR), environmental, or similar disclosures. While we do not directly test a wide variety of stakeholder disclosures, we examine eight (four for a single subject) shareholder values (financial measures) and four stakeholder values (nonfinancial measures). The eight measures included in our research instruments serve as proxies for the multiple concerns that might be of interest to many stakeholders. Note that stakeholders are likely to be extremely interested in nonfinancial performance measures, while many shareholders will likely concentrate on financial performance measures. Field research has reported managers tend to favor financial measures while discounting or ignoring nonfinancial measures when evaluating subordinates, making it difficult to align performance evaluations and incentives with corporate strategies (Ittner et al. Account Rev 78:725–758, 2003). In this study, we find the relative weights managers place on financial and nonfinancial performance measures are influenced by both (1) presentation order and (2) the relative importance of specific measures. When financial measures are presented first, the manager who performs better on financial measures is rated higher than the manager who performs better on nonfinancial measures. However, when nonfinancial measures are presented first, managers who excel on nonfinancial measures are rated higher. Reports that include financial measures that are relatively more (less) important also produce higher (lower) ratings for the manager who excels on financial measures. Thus, the relative weights that superiors place on financial and nonfinancial measures in evaluating corporate managers’ performance are substantially anchored both by the order in which measures are presented as well as by the importance of the specific performance measures employed. Other stakeholder disclosures are likely to be similarly anchored, perhaps biased, by primacy and a priori importance rankings.

Appendix

1.1 WCS inc. case

1.1.1 Background

Women’s Clothing Store, Inc. is a firm specializing in the retailing of women’s apparel. WCS has five subsidiaries, each directed at providing clothing to particular niches within the women’s apparel market. WCS operates throughout North America and is currently considering a foray into the European markets.

WCS’s largest subsidiary is RadWear. RadWear operates retail outlets specializing in apparel for the teenage girl. WCS operates its subsidiaries in a fairly decentralized manner. Each has a divisional manager who is responsible for the division’s performance and for providing communication between WCS’s central administration and his/her division. Each division, in turn, is organized into geographic operating regions.

Pat Jenks is the chief financial officer (CFO) of WCS Inc. In 2003, Pat attended a symposium at the Stanford Business School. Stanford professors introduced the symposium participants to a new management tool called Strategic Performance Evaluation containing a set of performance measures carefully chosen to represent important aspects of a business unit’s financial performance, customer relations, internal business processes, and personnel development. These measures should be drivers of the unit’s success and linked to its strategy and mission.

2003 was a rather lackluster year for WCS and Pat decided in early 2004 to try out the new strategic evaluation concept. Several steps were involved in doing this. First, Pat met with WCS’s top management team to define the firm’s overall mission. This team determined that the following mission statement was appropriately inspirational and captured the company’s goal:

We will be an outstanding apparel supplier in each of the specialty niches served by WCS.

The top management team then met with each divisional manager to communicate this firm-wide mission and to discuss the division manager’s role in developing a Strategic Performance Evaluation for his or her division. After the divisional evaluations were developed, each divisional manager met again with top management to explain his or her division’s performance evaluation, to answer questions, and to make necessary adjustments as requested by top management. The performance evaluations were developed in time for pilot testing in the last quarter of fiscal year 2004. Based on WCS’s experience in that quarter, the performance evaluations were adjusted for use in fiscal year 2005. Below is a description of RadWear’s experience in developing and using the Strategic Performance Evaluation.

1.1.2 RadWear

When the concept of the Strategic Performance Evaluation was explained to Chris Peters, manager of the RadWear division, Chris was excited by the chance to specify the drivers of performance in the division. Chris believes that the Strategic Performance Evaluation idea has the potential to propel WCS and RadWear to vastly improved performance.

In order to develop a Strategic Performance Evaluation for RadWear, Chris first met with Jim Taylor and Bob Graham, the managers for the division’s two largest geographical regions which produce 65 percent of the division’s annual sales, and with the divisional management team. This team includes the divisional controller, marketing manager, head buyer, personnel manager, and manager of store operations. The management team described the target customer for RadWear and determined the factors they believe cause this customer to shop at RadWear, to return to RadWear, and to increase the percentage of her clothing purchased at RadWear. All of the resulting measures are controllable by RadWear’s regional managers.

RadWear’s staff was enthusiastic about the resulting Strategic Performance Evaluation and eager to use this new management tool in fiscal year 2005. [RadWear’s targeted Strategic Performance Evaluation with selected performance measures and targets, as presented to participants in our experiment, are summarized in Table 1].

1.1.3 Performance in fiscal year 2005

The overall performance of WCS in fiscal year 2005 was good. Performance across divisions and regions, however, was somewhat uneven. The Strategic Performance Evaluation for RadWear’s two largest regions, including actual amounts and percentages above targets for 2005, are provided in Exhibits 2 and 3 [omitted from this paper, available from the lead author], respectively.

Chris Peters now has the difficult task of evaluating the performance of the regional managers for 2005. As managers of the two largest regions, Jim Taylor and Bob Graham will receive the most attention. WCS and RadWear use the results of year-end reviews in several ways. They are used in determining merit raises and year-end bonuses. They are also used in decisions regarding promotion or movement within or out of the firm. Additionally, the performance reviews are used as a method for providing feedback and guidance to the regional managers regarding their performance and future actions.

Although Chris will do an initial evaluation, the final written review will take into account the discussion Chris will have with the individual divisional managers. Thus, the initial evaluation may be subsequently adjusted due to additional information provided by the evaluatees. Chris, however, believes it is important to do an initial evaluation before meeting with the managers in order to maintain objectivity and high standards; Chris believes later adjustments provide for equity based on the specifics of the regions’ situations.

1.1.4 Your task

Please take the place of Chris Peters in evaluating the performance of Jim Taylor and Bob Graham, managers of Region 1 and Region 2, respectively. After reviewing their performance results in Exhibits 2 and 3 [omitted from this paper, available from the lead author], you should indicate an overall performance evaluation for each of the regional managers.