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Source: The Harvard Law School Forum on Corporate Governance and Financial Regulation, November 26, 2019 posting

Measures of Corporate Effectiveness and the Management Top 250 Rankings

Posted by Rick Wartzman and Kelly Tang, Drucker Institute, on Tuesday, November 26, 2019

Editor’s Note: Rick Wartzman is head of the KH Moon Center for a Functioning Society, a part of the Drucker Institute, and Kelly Tang is senior director of research at the Drucker Institute.

After the Business Roundtable announced last August that the CEOs of many of America’s largest companies were making a “fundamental commitment to all of our stakeholders”—and would no longer stand behind the notion that shareholders’ interests should be placed ahead of everyone else’s—the reaction from many quarters was swift: That sounds great. But how are we going to be able to tell if any of this is real?

“As every member of the Business Roundtable assuredly knows, accomplishing anything depends on defining terms, setting goals, and measuring progress,” Gallup observed. “Simply, the members of the Roundtable need new metrics.”

The old approach—relying heavily on stock price and other financial indicators to drive key corporate decisions and establish executive compensation—has brought steep costs for society and even for capitalism itself. “There’s a growing realization that a focus on one key stakeholder or metric is as flawed as using your cholesterol level as the only measure of your health,” corporate sustainability consultant Andrew Winston wrote in Harvard Business Review after the Roundtable issued its statement.

Likewise, a Forbes commentator noted, “As we change our collective goals, we have to change the metrics by which we measure success.”

Six years ago, as part of our own effort to encourage executives and investors to reject shareholder primacy and embrace stakeholder capitalism, the Drucker Institute set out to do just that. Our aim was to come up with a credible alternative to short-term financial metrics—one that would provide a much more holistic picture of how well a company is managed.

The result is our Drucker Institute company rankings, which seek to assess the performance of a group of large, publicly traded U.S. corporations across five areas: customer satisfaction, employee engagement and development, innovation, social responsibility, and financial strength.

Our model, which is transparent and adheres to the rigors of sound data science, is guided by the core tenets of the late Peter Drucker, widely considered the father of the field of management. In his landmark book The Practice of Management, published in 1954, Drucker laid out the kind of comprehensive, stakeholder-oriented philosophy that the Roundtable is now advocating.

Specifically, he expressed that companies had to satisfy their customers’ needs because “it is to supply the consumer that society entrusts wealth-producing resources to the business enterprise.” Drucker also believed that a corporation must take care of its employees, maintaining that if “worker and work are mismanaged” it will, “by creating class hatred and class warfare, end by making it impossible for the enterprise to operate at all.”

In addition, he wrote, companies must constantly pursue innovation so as to serve their function as society’s “specific organ of growth, expansion, and change.” What’s more, Drucker asserted, management must “consider the impact of every business policy and business action upon society” and even go so far as to “make whatever is genuinely in the public good become the enterprise’s own self-interest”—a forerunner of the concept of “shared value.”

Importantly, Drucker held that none of this was in conflict with ensuring a company’s financial health. Management’s “first responsibility,” he declared, “is to operate at a profit” so as to fulfill the role of business as “the wealth-creating and wealth-producing organ of our society.”

The challenge for the Drucker Institute was to capture and express these nuanced principles in consistent, numerical terms at an individual company level—and then combine all of that data into a model that would make sense of the entire picture.

Thus began a four-year development project involving a lot of trial and error, debate and discussion, calculation and recalculation. One of the first tasks was to distill Drucker’s 39 books and some 1,500 articles into something you could wrap your arms around. Eventually, our team homed in on 15 central principles spread across the five categories.

The next task was to find the right data sources that would serve, in effect, as empirical proxies for these underlying principles. We wound up settling on 37 sets of data from third-party sources. Finally, it was time for the biggest step of all: creating the statistical model itself. This assignment fell to our colleague Lawrence Crosby, a data scientist with a great deal of industry experience.

Our hypothesis—based on Peter Drucker’s writings—was that each of the five key areas should be highly correlated, rising and falling together to a statistically significant degree.

Although this might seem obvious to those who have a “stakeholder” mindset, few, if any, studies had approached the matter in a scientific way.

Would social responsibility really correlate with innovation? Would financial strength show a statistical relationship with, say, employee engagement and development? We really didn’t know.

By 2016, Crosby had assembled five years of data on a few hundred companies. It was now time to test the hypothesis. And, sure enough, the correlations between each of the five dimensions and the measure of total effectiveness ranged from 0.51 to 0.83, which are exceptional figures in the realm of management science.

For the first time, Peter Drucker’s worldview—that all of these different areas of corporate management are deeply interrelated—had been borne out statistically.

Today, our rankings are the foundation of the Wall Street Journal’s Management Top 250 list of the “best-run U.S. companies,” which is published late each calendar year. Meanwhile, S&P Dow Jones Indices has turned our model into a financial index that demonstrates the investment value of a stakeholder approach. And First Trust Portfolios now has an investment product based on the index’s methodology.

“The measurement used determines what one pays attention to,” Peter Drucker advised 65 years ago. “It makes things visible and tangible. The things included in the measurement become relevant; the things omitted are out of sight and out of mind.”

If business leaders are sincere about meeting the needs of all stakeholders, they need to take into account stakeholder metrics—whether the Drucker Institute company rankings or another broad-gauge measure—just as they do earnings and share price.



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