How should we assess companies’ performance?

How should we assess companies’ performance? From a ruthlessly commercial point of view, we could look to the bottom line – how much profit do they make? Another frequently touted proxy measure, for publicly listed companies at least, is the share price.

But applying a performance metric – particularly one that becomes linked to how organisational leaders get paid – inevitably leads to behaviour that maximises performance against that metric. It is no different to judging academic scientists by the number of papers they produce, or pharmaceutical firms by how fast they send compounds into clinical trials. The reality is more complex than can be distilled into a couple of numbers.

And share price, like most indirect metrics, is vulnerable to manipulation and over-interpretation. This is particularly true in the short term, for example when rumours of takeovers emerge, or if companies are overly optimistic in reporting their progress to investors. The people who profit from these short-term fluctuations are the financiers dealing in shares, not the companies or their customers, nor even their long-term shareholders.

Relying on these measures alone risks distorting our view of what a successful company does. While satisfying shareholders is important, it should not be to the detriment of the company’s future. Take, for example, the US chemical giants Dow and DuPont. Both have been accused of ‘underperforming’ by activist investors; not providing as much ‘value’ to shareholders as the activists think they should.

DuPont has countered by saying that in the last one-, three- and five-year periods, it has delivered total shareholder returns (including share price growth, dividend payments and share buyback programmes) that outperform both its immediate peers and the wider stock market index provided by the Standard and Poor’s S&P 500 companies.

In both cases, the activists suggest that Dow and DuPont should split into two or more smaller companies – one part focused on high-volume, low profit margin commodity chemicals, while the other parts develop more high-value innovative products to drive further growth. While these two strands of the chemicals industry do indeed require different management skills and strategies, it’s not necessarily the case that simply separating them will be beneficial in the long term.

Both firms have taken care to point out that their challengers have fundamentally misunderstood the nature of their business. Large, integrated chemical companies are complex beasts. They can (ideally) capitalise on their ability to feed products, byproducts and waste from one process directly into others, cutting costs and giving the firm an advantage over competitors paying market prices for their feedstocks.

But stopping short of drastic break-ups, there is certain to be room for improvement within any global company built through a combination of acquisitions and organic growth over more than a century. If pressure from investors increases companies’ focus on the ongoing process of reflection, renovation and transformation, then they will emerge stronger from their scuffles.

Phillip Broadwith, Business editor