Introducing LIVA to measure long‐term firm performance

• Published date: 01 May 2020
• DOI: http://doi.org/10.1002/smj.3114
• Author: Nicolaj Siggelkow,Phebo D. Wibbens
• Date: 01 May 2020

RESEARCH ARTICLE

Introducing LIVA to measure long-term firm

performance

Phebo D. Wibbens

1

| Nicolaj Siggelkow

2

1

INSEAD, Strategy Area, Fontainebleau, France

2

Management Department, The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania

Correspondence

Phebo D. Wibbens, INSEAD, Strategy

Area, Boulevard de Constance, 77305

Fontainebleau Cedex, France.

Email: phebo.wibbens@insead.edu

Funding information

Mack Institute for Innovation

Management; Wharton-INSEAD

Alliance, Grant/Award Number: 2399-277

ABSTRACT

Research summary: This article introduces a new

measure of long-term firm performance: long-term

investor value appropriation (LIVA). This measure

helps to address a disconnect between the common the-

oretical assumption that managers optimize firm value,

and the widespread empirical practice of measuring

performance using short-term ratios such as return on

assets (ROA). LIVA can lead to markedly different stra-

tegic insights compared to commonly used measures

such as ROA and cumulative abnormal returns. For

instance, the widely cited finding of a U-shaped relation

between acquisition experience and performance turns

out to be largely driven by short-term stock price move-

ments and vanishes when using 10-year LIVA.

Managerial summary: Managers have a large num-

ber of performance measures at their disposal, such as

return on assets, total shareholder returns, and earn-

ings before interest and taxes. However, these short-

term measures do not capture well whether a firm

creates long-term shareholder value, which is one of

the primary objectives for most firms. Addressing that

gap, this article introduces a new measure called long-

term investor value appropriation (LIVA). LIVA can be

constructed using publicly available stock market data

Received: 12 September 2016 Revised: 20 September 2019 Accepted: 21 October 2019 Published on: 25 December 2019

DOI: 10.1002/smj.3114

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2019 The Authors. Strategic Management Journal published by Wiley & Sons, Ltd. on behalf of Strategic Management Society.

Strat. Mgmt. J. 2020;41:867–890. wileyonlinelibrary.com/journal/smj 867

and it can help managers to better analyze historical

long-term performance.

KEYWORDS

long-term performance, performance measurement, return on

invested capital, value appropriation, value destruction

1|INTRODUCTION

Core theories in the strategy field, such as the resource-based view, the positioning school,

transaction cost economics, and value-based strategy, posit that firms and their managers seek

to maximize appropriation of long-term value (Barney, 1986; Brandenburger & Stuart, 1996;

Porter, 1980; Williamson, 1979). Likewise, formal models in strategy usually assume some form

of maximization of profit or long-term value appropriation (e.g., Gans & Ryall, 2017; Jacobides,

Winter, & Kassberger, 2012; Levinthal & Wu, 2010).

This core theoretical assumption contrasts with how performance is usually measured in

empirical studies: an analysis of recent papers in Strategic Management Journal (SMJ) shows

that a significant majority of studies use short-term ratios such as return on assets (ROA),

instead of the long-term value appropriation in terms of absolute size (i.e., in dollars or other

monetary amounts) that managers are supposed to maximize, even though previous literature

has shown that optimizing such short-term accounting ratios in general does not correspond to

long-term value maximization. For instance, firms that create economic value for their investors

can actually have an accounting return on capital (ROC) below the cost of capital and vice versa

(Fisher & McGowan, 1983). Likewise, firms that invest in initiatives that have a positive net pre-

sent value (NPV) might decrease their ROC (Levinthal & Wu, 2010).

To address this apparent disconnect between the theoretical performance goal of firms and

the empirical measurement of it, we develop an empirical performance metric that measures

whether firms created value for their investors over long time periods: long-term investor value

appropriation (LIVA). We investigate its properties and derive how it relates to common perfor-

mance measures in the literature, such as total shareholder return (TSR), economic profit (EP),

and ROC.

In order to develop a measure that is consistent with the theoretical notion of value maximi-

zation, we define LIVA in terms of the backward-looking NPV of returns over time. We show

that the definition of LIVA based on NPV is equivalent to the discounted sum of excess stock

market returns times market capitalization, and moreover that in the long run LIVA becomes

approximately equal to the sum of discounted EP as calculated from accounting statements.

These two measures converge because short-term differences between stock returns and

accounting profits tend to cancel out in the long run when properly discounted. Essentially, the

use of different measures shifts profits forward or backward over time, but in the long run this

does not affect the total.

We perform three increasingly involved analyses to show how LIVA can bring new strategic

insights. First, to get a straightforward feel for LIVA relative to other performance metrics, we

compare rankings of the best and worst performing companies using LIVA and other common

performance measures. We find that top performers in terms of LIVA correspond to often-

lauded companies, such as Apple, Amazon, and Alphabet. These companies end up much

868 WIBBENS AND SIGGELKOW