87. Measuring Executive Performance
In previous articles we assumed that a manager's performance could be
measured by the price of her company's publicly traded stock. However,
this method is not applicable to those companies that do not have stock
traded on an exchange, such as SOEs (State Owned Enterprises) and
privately held companies. So what gauge should owners use to measure the
performance of their managers?
In the case of SOEs, bonuses to managers (and employees) used to be
based on the volume of production. For example, the performance of a
transportation company would be measured by whether the number of
passengers or tons of cargo carried met or exceeded predetermined targets.
Subsequently, revenue, independent of expenses, became an alternative
method of measuring corporate performance.
Today, it is clear that neither production volume nor revenue adequately
(reflect a company's performance. For many people, net income is the most
attractive indicator. However, many high-tech companies which have
always had negative incomes enjoy exceptionally high valuations. This
suggests that net income can be misleading.
Firstly, the figure does not take into account a company's cash reserves.
A manager may offer generous credit to buyers in order to sell more at a
higher price, or purchase inputs with cash in order to secure a lower price.
While income may be high, the company may face bankruptcy because of a
lack of cash.
Secondly, placing too much emphasis on net income may also induce
managers to cut costs excessively. A manager who wishes to record high
income figures in the short term may scrimp on activities such as research
