Value Based Management – which can be defined as running a company in such a way as to maximize value – has become the accepted approach for executives throughout the world. At INSEAD, Value Based Management is at the heart of our research and Executive Education, especially our Transition to General Management program, which is structured around the concept. Here is the view of two of our greatest researchers and teachers on the topic...
INSEAD Professors, Kevin Kaiser (expert on corporate finance and value creation, and co-Director of Transition to General Management) and David Young, recently co-authored a working paper that highlights common misperceptions of Value Based Management. In ‘Blue Line Management: What Value Creation Really Means’, they reveal that “the most serious error is the tendency to equate share price and other indicators of company performance with value.” The reason this is an error, they say, is that managing-by-indicators (as opposed to managing-for-value) has a tendency to both destroy value and result in indicators which are not indicating what management think they are indicating.
According to Kaiser and Young, one particularly common error is to confuse objective expectations with subjective management forecasts: “The value of any investment is a function of the actual expected cash flows, not the cash flow forecasts made by investors.” Another common error is to confuse the concepts of price and value. Price, said the INSEAD professors, “is simply the outcome of a market mechanism, or negotiation, between two or more parties.”
Kaiser and Young suggest a graphical representation of value as a blue line. While invisible to the human eye, the important thing for managers is to remember that the invisible blue line is still there and that their decisions drive it. Moreover, it mustn’t be confused with any ‘red lines’, such as the ups and downs of share price along the same axes.
They also claim that, in our generally efficient markets, a well-run, ‘blue-line company’ can simply manage for value and allow analysts and investors to determine its price. The problem, they say, comes when mangers are given stock options that can be liquidated in the short term or bonuses tethered to share price. They’re then motivated to organize the entire business around managing the red line. The result is usually short-termism, accounting games… and ultimately, explain the INSEAD professors, destruction of value.
A similar phenomenon occurs with other Key Performance Indicators. Kaiser and Young insist that indicators are extremely useful – if not essential – tools for successful management. But, they say, indicators are metrics to be used to aid understanding, not targets. And indicators are certainly not to be confused with value itself. The INSEAD professors cite the example of a high-tech company where a product-development manager incentivized on the percentage of innovations converted into products may reject a brilliant, potentially game-changing idea simply because there is a high risk of it not turning into a reality.
In short, according to Kaiser and Young, the more a company manages by KPIs or the red line of share price, the less trustworthy these become as indicators and the less useful for learning. Instead, they say, KPIs should be used as tools for feedback and learning, which is the key to managing today’s complex organizations and products. In the 21st century, managers cannot know everything they ideally should. However, conclude the INSEAD professors, today’s successful business culture is one where everyone is continuously learning, through trial and error, as well as triumph: “Only through continuous trial and exploration and, yes, failure, will we gather new, relevant information to help us to better understand the business and how to get more value from it.”
Professor Kevin Kaiser also teaches on INSEAD’s high-potential business training course, the Management Acceleration Programme, and its flagship course for senior business leaders, the Advanced Management Programme. He also directs a course on business valuation methods. As for Transition to General Management, the concept of Value Based Management, plays a central role in both these programs.
Click here to download the full working paper, ‘Blue Line Management: What Value Creation Really Means’
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