This all-important tenet of business strategy is key to steering a business in the RIGHT direction!

Ethically Maximize Wealth

They say companies that abide by this rule ALWAYS show better financial results over long-term periods. Meanwhile, firms that do not live by this guiding principle comprise some of the worst financial performers ever.

Now…

Given the importance of this tenet to success, what are key performance measures that can guide and drive a firm’s execution toward superior results?

For Professor Litman and Dr. Frigo, lagging and leading indicators are described in disciplined performance measurement.

—lagging indicators help to understand what has happened in the past. Leading indicators provide insight to what may happen in the future.

That’s why they believe attention to and balance of these types of performance measures are important for any organization.

Besides, in ethically maximizing wealth, companies must ensure that its business activities are aligned toward maximizing shareholder wealth.

Such activities must be done within the ethical parameters of the communities in which a company operates, or undue risk can completely kill a company’s valuation and ability to stay in business.

So… what performance measures can help ensure a company’s attention to this all-important tenet of business strategy?

Allow us to share with you two for now:

• Discounted Cash Flows

  Professor Litman and Dr. Frigo say that if a firm is committed to maximize shareholder wealth, it must accept that valuation is a function of discounted cash flows or “DCF.”

Because of this, every business must employ methods for tracking its ability to generate free cash flows over time to increase its DCF-based valuation.

Two important financial drivers measure trend and level of cash flow performance:

First , whether publicly or privately owned, investors need to know how much asset or investment growth is being made by management period-by-period.

Second , investors need to understand how much cash the firm can generate over and above the investments it is making.

Depending on the industry and nature of the business, Professor Litman and Dr. Frigo say there are various ways of measuring investment and reinvestment in a firm.

… and there are also different ways of measuring the return on those investments!

The nature of these calculations must be dependent NOT on some theoretical basis, but on an understanding of exactly how the metrics will be used to ensure plans are executed.

• Wealth Commitment

  Certain measures are needed to ensure directional accuracy, such as for creating incentives in executive or employee compensation programs.

  After all, monitoring management compensation is key to understanding whether or not a firm will commit to maximize wealth.

  … but whatever the measures, Professor Litman and Dr. Frigo say they must be theoretically AND accurately consistent with the philosophy behind cash flow returns and asset investment rates.

  What else?

  To ethically maximize wealth, a firm must utilize the right incentives for executive, management, and employees.

  It’s important to ask similar questions:

  “Are metrics unintentionally leading to unethical activities and behaviors that ultimately lead to disaster?”

  “Is management being paid to do things that are truly in the best, long-term interests of the shareholders?”

  “Is the entire organization faithful to act on its commitments?”

  According to Professor Litman and Dr. Frigo, people do what they are paid to do. This means if their pay does not drive the first tenet of RDS, nothing else will.

Are you familiar with the Balanced Scorecard framework ?

According to Professor Litman and Dr. Frigo, this widely used framework is popular for directing management toward monitoring financial and non-financial measures of performance.

… and while the logic of the Balanced Scorecard is valid, management still must ensure that strategic objectives and performance measures reflect the first tenet of RDS, or a manager must question a firm’s ability to produce respectable returns for its shareholders.

After all, in well-designed Balanced Scorecards, certain measures explicitly target the tenet of ethically maximizing wealth.

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If you’re looking to gain a better understanding of Return Driven Strategy and Career Driven Strategy, we highly recommend checking out “Driven” by Professor Litman and Dr. Frigo.

Click here to get your copy and learn how this framework can help you in your business strategies and ultimately, in ethically maximizing wealth for your firm.

Hope you found this week’s insights interesting and helpful.

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