By Eleanor Bloxham
December 9, 2010

Companies are often slaves to irrelevant performance metrics. Despite recent criticisms, perhaps the UK has the right idea in developing a happiness index.

By Eleanor Bloxham, contributor

People are naturally mesmerized by metrics. Like a child with a shiny toy, a number or a graph can hold people spellbound, no matter what is being measured. When readily available and often repeated, like a drug, people attach to measures; insidiously, they invade the mind.

Think about how many people watch the value of stock indices and individual stock prices on a frequent basis, (daily, hourly) even if they have no inclination to take any action based on that knowledge. Short term stock price movements, now debunked as tied to any real measure of long term value, still mesmerize.

Because they are so powerful, measures must be chosen with care. For example, a recent story in the New York Times explained that the USDA measures the success of Dairy Management (a creation of the USDA) using measures contrary to USDA’s own work “at the center of a federal anti-obesity drive”. In measuring Dairy Management’s success, the USDA “tallies Dairy Management’s successes in millions of pounds of cheese served,” while in its federal anti-obesity drive, it “discourages over-consumption of some of the very foods Dairy Management is vigorously promoting.”

Metrics drive behavior.

In the U.S. corporate world, in addition to stock price, the fixation on short term corporate earnings and earnings per share have also led to short term behavior — and many attempts over the last decade to change that course.

Why have those attempts, especially at the top of organizations, failed?

After all, earnings is a measure that was not designed to manage business performance at all. It’s laid down by the Financial Accounting Standards Board (FASB) or the International Accounting Standards Board (IASB) to report the performance of a company to its shareholders — and can be, and is, changed, based on their discretion.

Yet boards and companies use this equation, one that is not under their control, all too often as a primary guiding force in managing the performance of their business. And they do this whether or not the result of that equation makes sense for the way the business operates or the way it needs to be managed.

Why? The earnings number is sticky. It has to be produced anyway. It’s handy; it’s around. It’s like looking for your keys under the lamplight. They may not be there but at least it’s easy to see.

As a result, organizations and whole societies can get used to using numbers to represent something they don’t represent.

In the mid-90s, the accounting method for mortgage servicing rights was changed by the FASB. The economics of the business hadn’t changed, just the way it was accounted for. But despite the fact that it was only an accounting change, it fundamentally changed the way people thought about the business.

The change in measurement by FASB drove their view of their brokerage and servicing businesses. One CEO even remarked to me back then that “now my business is losing money.” Yet nothing had really changed.

As a result of this change in accounting, many institutions exited the mortgage servicing business and, based on analyses I did at the time, actually created more risk for their businesses and for the mortgage markets.

And as a result of those changes by mortgagers, the issues we have encountered in the current crisis have been concentrated and exacerbated. And it all stemmed from the use of “earnings,” a hand-me-down measure from the FASB. A simple change in the “accounting” metrics rather than a change in real economics created a cascading effect of much larger proportions.

So I applaud the UK for taking on the challenge of constructing a happiness or well-being index, rather than simply sticking with the hand-me-down measure of GDP. Going through the process of thinking through what should be included will yield at least half the benefit. Then, what they’ll have to guard against is the issue with all measures — making sure people remember what the metric is really measuring — and what it is not.

Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance, a board advisory firm.

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