Accounting Profit vs. Economic Profit. the Necessity of a Management Performance System to Boost Organization’s Performance

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INTRODUCTION
Accurate information is a critical input in a decision making process that targets real value creation for shareholders. The objective of this paper is the analysis of two articles of Stern Steward Research, namely “Accounting is Broken. Here’s How to fix it. A Radical Manifiesto” and “The capitalism Manifesto. The Transformation of the Corporation - Employee Capitalism –“.

Both papers propose a roadmap to fix the conventional accounting shortness through the use of Value Based Management (VBM) as a real and effective management system of value creation and measurement. Economic Value Added (EVA) plays the main role in this management approach, as a very effective performance metric in the alignment of the organization with its ultimate goal of shareholder’s value creation. VIEW OF THE READING

In the first paper “Accounting is Broken. Here’s How to fix it. A Radical Manifiesto”, the accounting related aspects of EVA are discussed, providing a comparison between accounting earnings and economic earnings. Weaknesses of accounting standards are exposed here. The authors suggest a serie of radical reforms for the conventional accounting in order to align conventional with economic accounting in order to provide managers with the information that really matters and avoid mispreactices to deceive shareholders.

The paper proposes EVA as a rock solid measure that provides a very clear picture of the organization’s performance. According to the paper accountants should start using economic profit (EVA) to better reflect the economic reality of the organization. Economic earnings underpin the decision making process, clarifying the economic objectives and setting up a target for value creation. The paper highlights the capability of EVA measure to fix some weaknesses of the accounting earnings perspective and proposes some reforms: •Cost of equity must be brought into the light of day as a key element for the economic profit. Shareholders need and deserve to be compensated for the risk they are taking by investing in a company. •Operating decision must be separated from investment and financing decision to avoid manipulation. •Intangible assets should be capitalized as investments aimed at the creation of economic profit. •Stock options have to be expensed and depreciation and amortization must be better measured. The second paper “The capitalism Manifesto. The Transformation of the Corporation - Employee Capitalism –“ analyzes the role of EVA measure as a metric of the total organizational productivity and the role it plays or can play in a pay-per-performance incentive plan to align the interest of the owners with the interest of the employees to enhance organization performance. Empowerment and accountability are seen as the basis to boost employee’s performance and the basis to set up incentive programes to stick the gains.

The paper presents a deep analysis on the implementation of effective business management and incentive systems down to the shop floor in the European Union. Some examples are presented to explain the potential role of EVA in the implementation of a European policy for incentive plans. According to the paper, executives and frontline employees can or should unify their efforts within the EVA proven management system, to maximize value creation within the organization.

The authors propose that decision making process at all levels should be implemented within a management framework where short- and long term incentive plans will be linked to results in form of value creation. Incentive plans should also be linked to cash and equity to guarantee the sustainability of the organization. If the employees can invest in the organization, they will start acting like owners taking right decisions and fostering sustainable growth. MY POINT OF VIEW

Both papers assume a shareholder’s value perspective: the first and foremost purpose of a Corporation is to maximize shareholder value. This...
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