Cockpit
Statements
Value-Based Management
Value-based management, or VBM, is an approach to performance management that evolved over the past twenty to thirty years. It is closely related to what is often called the shareholder revolution, and arose from the recognition that traditional measures of accounting profit, based on GAAP (Generally Accepted Accounting Principles), do not always accurately represent true economic profit. Thus traditional performance management may not always lead to the increases in shareholder value that it could—and that it is meant to do.
Value-based management is an attempt to rectify this situation. VBM aims to more accurately measure financial performance in order to more successfully manage financial performance—with the ultimate goal of improving economic profit, and thereby increasing shareholder value.
In order to accomplish this task, value-based management requires new financial metrics for measuring performance, profit, and value creation. Most importantly, all of these new metrics take into account the economic cost of capital employed in the business, which traditional accounting does not. One particularly popular value-based metric is EVA (Economic Value Added).
VBM also aims to more closely align the financial interests of managers with those of shareholders. In addition to advocating performance measurement metrics and performance management practices that create shareholder value, VBM involves motivating managers to create value by instituting incentive compensation systems that explicitly link executive bonuses, or performance pay, with those very same value-based metrics.
In sum, value-based management coordinates all of the elements of a comprehensive performance management system toward the goal of increasing shareholder value, as measured by share price increase and value-based metrics. Next in this section is more information on the history of VBM and its metrics, followed by a detailed account of EVA in particular, and the disaggregation of value-based metrics into their sub-metrics: the value drivers of operating performance. This section concludes with a review of value-based incentive compensation systems.
Following the VBM section is a final section about Obermatt’s unique contribution to the field, which represents the next step in value-based management: Indexing Operating Performance to measure Operating Alpha.
Recommended Readings: EVA by Stephen F. O'Byrne, The Value Cockpit by Hermann J. Stern