The key gauges of performance.

• Author: Schwarz, Marc S.

In a recent survey conducted by the National Association of Corporate Directors, corporate performance emerged overwhelmingly as the top business priority in the minds of CEOs. More than 50% of the respondents in the corporate governance survey now recognize corporate performance as the top governance issue in 1995, a five-fold increase from the results in 1992.

While always a priority for management, only recently has corporate performance -- specifically, relative corporate performance -- achieved such elevated status. As shareholders have gained a stronger voice in governance, they have demanded increasing accountability from boards and management with respect to executive pay and performance. The SEC's proxy disclosure rules and the IRS ruling on the non-deductibility of pay in excess of $1 million have also been a catalyst for the evolution of performance-based executive compensation programs. As a result, management is more aligned today with its shareholders than ever before and the executive pay debate has shifted to a focus on corporate performance.

This shift has magnified the demands for effective management oversight. Boards have a responsibility to understand the business performance measures that are important in monitoring continuous improvement. Board members must understand the information that performance measures convey and the circumstances under which they are appropriate to evaluate management. Are they being used to assess continuous improvement? Are they being used as objectives to motivate management? Are they being used to make a case to the "Street"?

There are three guidelines that are essential when evaluating corporate performance.

1. Performance Evaluation Should Be Based on Expectations. The ideal approach to corporate performance evaluation begins with the question, "How are expectations for my company today different from what they were a year ago?" or, "How are expectations for my company today different from expectations about my company's competitors?"

   Expectations are the basis for performance evaluation -- not historical accounting or economic measures. It is easy to fall into the trap of relying on the year end return on investment results or the increase in earnings per share as the basis for corporate performance evaluation since this data is readily available and easily measured. Historical results may help shape our expectations, but they are not always highly correlated to them.

   In a recent study sampling the results of more than 300 public companies from 1983-1993, Deloitte & Touche found only one measure, the growth in operating cash flow, to be statistically correlated to total shareholder return over comparable periods of time...