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It's Time to Rebalance the Scorecard

James M. Higgins and David M. Currie

The headlines have been frequent and the allegations of misdeeds numerous. Major corporations and their senior managers have violated shareholder and societal trust. Sometimes they have even violated the law. These companies brought a whole new meaning to the term “creative accounting,” and when cooking the books failed to provide enough cash for their purposes, some firms and their senior managers just flat-out lied about how well they were performing, what their sources of revenues were, and how expenses were incurred. Senior managers in a few firms even misappropriated corporate funds for their own personal uses, thereby supporting a lavish lifestyle at the expense of shareholders. Some corporate boards loaned their senior managers outrageously large amounts of money, then turned around and forgave these loans when stock prices plunged. There are instances of senior managers selling stock on the basis of negative insider information about the firm's future at the same time they were telling their employees, stock analysts, and investors that the company was financially healthy.

The names of the more prominent of the corporations associated with some or all of these misdeeds are familiar: Enron, Tyco, WorldCom, Qwest, and Adelphia Communications, to name a few. But other firms engaged in some of these same practices in a lesser fashion: Xerox, Lucent Technologies, Peregrine, AOL, and Bristol-Myers, for example, all had questionable accounting practices. And let's not forget that at least one major accounting firm failed to derail the runaway train at Enron even though the firm was aware of Enron's questionable accounting practices. Alas, Arthur Andersen paid the ultimate price since, for all practical purposes, it exists no more. The new managers of at least one of these firms, Adelphia Communications, sued its accounting firm, Deloitte Touche Tohmatsu. These managers charge, among other things, that Deloitte knew about the accounting irregularities but failed to inform the board of directors.

Enron, Tyco, Adelphia Communications, and WorldCom have all filed for bankruptcy protection. Qwest may have to follow suit after its financial statements were recently significantly restated, and it apparently hedged on future earnings. Political pundits who believe in the market as the correction mechanism for business can point to these bankruptcies as evidence that the market works. Investors with bankrupted 401K accounts would probably not disagree with that statement but would argue that more controls should be in place to protect the innocent. The thousands of employees who lost their jobs and their pensions as a result of these shenanigans would certainly echo similar sentiments.

Additional firms were directly affected by, and even helped cause, this financial-performance-at-all-costs scenario. Financial institutions failed to maintain control over interactions between their investment banking and research divisions. For example, at Merrill Lynch, analysts hyped stocks to investors while privately unloading these stocks. And in a somewhat different version of this theme, at Citigroup hot initial public offerings (IPOs) were allocated to clients who had borrowed heavily from Citigroup.

So what has been done to improve the way business does business?

THE CORRECTIVE ACTIONS TAKEN SO FAR

Several corrective actions have already taken place, with more on the horizon:

• The federal government has successfully prosecuted several senior corporate managers for their roles in these offenses, but only one CEO from among the most offending firms has been prosecuted.
• The federal government has also settled on an agreement for the separation between the investment banking divisions and the stock research departments of banks and brokerage houses.
• To that end, Citigroup CEO and Chairman Sandy Weill has done just that for his firm's beleaguered Salomon Smith Barney division, dropping the Salomon name from the division title as well.
• Merrill Lynch agreed to pay $100 million for settling charges regarding hyping stocks that were trashed internally.
• Major senior managers have been replaced at Enron, Tyco, WorldCom, Qwest, and Adelphia Communications.
• Numerous organizations not involved in any of these shenanigans have voluntarily made corporate governance changes. At many firms CEOs are personally required to certify their firms' financial results.
• At AutoZone Inc., senior managers will not sign off on division financials until division managers have certified the financial results for their divisions.
• The chairman of the Securities & Exchange Commission resigned amid charges of lack of disclosure of information pertinent to one of his appointees.
• Both public and private officials have begun to examine the value and risks of deregulation.
• Congress passed the Sarbanes–Oxley Act, which mandated a sweeping overhaul of corporate securities law.

Despite all of these well-intentioned improvements in the operating rules for businesses, these improvements are necessary but not sufficient; they fail to focus on the bottom-line motivations of the individual.

To understand why these actions are not enough, we need to examine the principal causes of the unethical and illegal behaviors that have shaken the foundation of business these past couple of years.

SOME CAUSES OF SUCH BEHAVIORS

When one examines the causes of such behaviors, it becomes evident that several key factors played a role – the business climate of that time, human nature, the societal climate, the competitiveness of the global business environment, and the nature of competitive organizations. Let's take a look at each of these factors in turn.

The Business Climate

The business climate within which these misdeeds and crimes occurred is reminiscent of the climate that characterized the roaring ‘20s – a booming economy buoyed by inflated stock prices. A euphoria existed that defied rational explanation, at least on a historical perspective. Judged by their actions, many investors, analysts, and top corporate managers apparently believed that this boom period would never end. So what if historically price to earnings ratios had been pegged at 12 to 1? “This was a new paradigm,” cried the boom's proponents. Acceptable P/E ratios soon became 16 to 1 and then 18 to 1. Finally, businesses, investors, and society became comfortable with P/E ratios in the 30s and 40s, numbers comparable to those of the Japanese market during the investment bubble of the 1990s. And in this new paradigm, companies didn't have to pay dividends to increase stock price levels; the upward momentum of stock prices was sufficient to justify investment. Momentum investing replaced technical analysis and the more conservative fundamental analysis. The era of irrational exuberance was at hand.

Coupled with this new enthusiasm, and perhaps fomenting it, was the trend toward deregulation following the collapse of the Soviet Union. Capitalism became the remaining viable economic philosophy, which seemed to relieve markets from their responsibility for prudence. Industries such as telecommunications, airlines, meatpacking, energy, and banking were freed from regulation or supervision. The disadvantage of abandoning supervision and regulation is that it places greater reliance on managers to act responsibly and represent society in their decision making. The unfortunate fact is that not all managers behave in a socially responsible manner.

Human Nature

The causes of such behaviors included more than just the business climate, however. Another major cause was human nature. People have always wanted more. They want to achieve more. They want to have more. They want more power. Barring rules and regulations that prohibit certain behaviors, and often even in the face of such rules and regulations, some people will take whatever actions are necessary to achieve and have more. Often these behaviors violate the shareholder and public trust. They may be illegal, unethical, or immoral.

The Societal Climate

And then there's the societal climate. A lot has been written about this climate, and much of the anecdotal evidence suggests that the moral and ethical standards acceptable in our society have slipped a notch or two in the past few years. What used to be clearly “right and wrong” is at least a shade of gray now. Ethics involving “acceptable” industry or societal practices don't carry the same moral clout as morally right and wrong behaviors. And even what is right and wrong has changed. Society has become permissive. Religion, whether you personally practice it or not, does provide society with a set of moral standards. As the practice of organized religion has declined, by most measures so has our nation's morality.

The Competitive Global Environment

There is also the competitive global environment to consider. Firms based in the United States finally began to awaken to the competitiveness of foreign firms in the 1970s. Most dramatically, Japanese firms were proving to be wily and efficient competitors in virtually every market they entered. U.S.-based firms responded slowly at first, but competitiveness accelerated as it became obvious that long-term economic survival was the issue in automobiles, steel, and electronics. Being globally competitive has brought U.S. firms a sense of urgency – either they must become competitive or they will be forced out of the industry. Now, Chinese, Southeast Asian, and European firms all vie with U.S.-based firms for their share of the global marketplace. Firms from these countries often have a different set of ethical standards, further compounding an already difficult environment for U.S. firms.

The Nature of Competitive Organizations

The competitive organization is driven toward the achievement of a vision, a mission, and related strategic objectives. To achieve these purposes, the competitive organization utilizes performance-management systems. Most of these systems derive strategic objectives from the vision and mission of the organization. Strategic objectives are heavily influenced by the values of top management and the values of the organization's culture. Once determined, strategic objectives are then parceled down through the organization by means of the performance-management system.

During the late 1990s, irrational exuberance drove not only the stock market but also the companies listed on the major stock exchanges. Inside many firms the pressure to raise stock prices became excessive. The higher the stock price achieved, the higher the target stock price set by management. Greed had raised its ugly head. Top management decreed that the stock price had to go up regardless of corporate and competitive fundamentals. Long-term strategy was planning a quarter ahead in far too many organizations. Before long, irrational exuberance led to irrational performance expectations.

Sometimes when objectives must be met regardless of how excessive they are, top management behavior becomes irrational, unethical, or even illegal. To achieve objectives they have set, and in order not to disappoint Wall Street and have it lower the stock price, some executives cook the books. This happened at America Online (AOL) where financial performance results were inflated in order to keep the stock price high before the merger with Time Warner.¹ This also happened at Bristol-Myers.²

Sometimes when unobtainable objectives must be achieved, lower-level employee behavior may also become irrational, unethical, or illegal. The pressure to increase bottom-line results becomes unbearable. The performance-management system is used as a whip rather than as a performance-management tool. Some employees feel compelled to lie and cheat in order to keep their jobs. They say to themselves, “You want these objectives met? I'll meet them in a way that gets you off my back. I'll do whatever it takes.” This clearly happened at Lucent Technologies, where lower-level managers and staff reported inventory movements as sales in order to meet unobtainable financial performance objectives.³

If you examine the illegal and unethical behaviors that have taken place, and if you examine some of the corporate violations of the law and of ethical standards that have occurred in the last few years, you find that much slips through the corporate control system. What is fundamental to solving this type of situation is for the organization to make a serious commitment to issues beyond the financial performance of the organization.

Some responsibility for the focus of U.S. corporations on short-term financial results falls on the shoulders of U.S. business schools. Since the 1950s, U.S. business schools have modeled the firm on returns to stockholders, and the goal of maximizing stockholder wealth has become embedded in the curricula of business schools and the psyche of corporate managers. Analytical techniques were developed to assess the firm's performance according to the financial criteria deemed most relevant to investors. Because of the triumph of the capitalist system, it was easy to fall into the trap that financial performance was the only way to evaluate an organization's success.

WHAT GETS MEASURED GETS DONE – ENTER THE BALANCED SCORECARD

It's a truism that “what gets measured gets done.”

Robert S. Kaplan and David P. Norton first introduced the balanced scorecard concept to business with an article in the Harvard Business Review in 1992.⁴ The underlying concept of the balanced scorecard is that financial measures are too narrowly focused and that additional measures of organizational performance are necessary in order to drive the future performance of the firm. Kaplan and Norton suggested four cornerstone measurement perspectives. Typically, several specific objectives are identified for each of these perspectives:

1. Financial – How do we look to shareholders?
2. Internal Business – What must we excel at?
3. Innovation and Learning – Can we continue to improve and create value? (Later changed to Growth and Learning)
4. Customer – How do customers see us?

Subsequent to publication of this article, Kaplan and Norton changed the title for perspective number 3, Innovation and Learning, to Growth and Learning. More important, they have focused their writings and their consulting practice on the role of the scorecard in successful strategy execution rather than on its role as a performance-measurement system. Obviously it is both, and any good performance-management system should be both.

Kaplan and Norton are to be applauded for their introduction of a multiple-criteria strategy execution/performance-management system. A number of other corporate scorecards also exist, and several firms offer consulting assistance in developing and implementing these scorecards in an effort to help organizations successfully execute strategy. But the collective emphasis of scorecards is still primarily on translating strategy into financial performance. These scorecards do nothing to translate financial performance into performance of the corporation at a broader level than just the interests of stockholders and corporate management. Corporate scorecards are badly in need of rebalancing.

REBALANCING THE SCORECARD

Business serves at the pleasure of society. The historical role of business has largely been to provide goods and services for the marketplace. But there has been a growing feeling in our society over the past several decades that while businesses are providing those goods and services, they should also be good corporate citizens. The corporate scorecard needs to be expanded to include the broader issues with which businesses must cope, and for which they are responsible.

Legally, businesses are held accountable by society for providing equal opportunity in employment, their treatment of the physical environment, and obeying a host of laws that govern the conduct of business, for example, those governing contracts, relationships with unions, occupational health and safety, and mergers and acquisitions. Other issues that business has been asked to address by various constituencies include employee development and outplacement, plant closures and their impacts on the economic area, relationships with government, economic growth, education, urban renewal and development, support for culture and the arts, the development of an internal environment that supports diversity, and provision for employee health care.

If indeed “What gets measured gets done” is true, then it is no wonder that businesses have found themselves overly focusing on the financial aspects of the firm, because financial performance and its creators are what gets measured. Put another way, “If it's not on my performance appraisal, why should I care about it?” Many years ago, motivational speaker Larry Wilson stressed the importance of evaluating what you want done. His penetrating observation was, “People respect what you inspect, not what you expect.”

Society expects business to be socially responsible. But expectations are not enough. Business respects what is inspected. What gets measured gets done. A firm sets objectives to move forward to achieve its vision and strategy. If solely financially related issues become part of objectives, then that's what is measured. The individual is no different. He or she respects what is inspected. People respect what they are accountable for. It's true that some businesses and some individuals will do what is expected without inspection. Yet given the complex set of demands that confront businesses and individuals, and given so little time to achieve all that is demanded, the tendency is to work on those things that count – for the organization's future wellbeing, or for one's personal performance appraisal and the rewards and power that ensue.

Kathleen Black, while publisher of USA Today, was once asked why Gannett Newspapers had been so successful in providing upward mobility opportunities for women and ethnic minorities. Her reply was that “The CEO (Allen Neuharth) made it happen.” She went on to explain that Neuharth had made recruitment and promotion of all minorities an objective for all managers' performance reports. He tied bonuses and other rewards to success at this objective just as he did to more operationally oriented objectives. What got measured got done at Gannett.⁵

THE REBALANCING ACT

U.S.-based businesses operate within domestic and global environments. The complexities of these environments are enormous. The demands in various segments of these environments are often overwhelming. Business's first social responsibility is and must always be to make a profit. Beyond that effort lie many other equally important social responsibilities, and responsibilities of other sorts.

We propose that at a minimum a social responsibility performance perspective become part of the business scorecard. Some specific areas for which objectives should be set include the following:

• Satisfying all legal and ethical requirements for the conduct of the business, including

  1. Reporting performance results in an ethical and legal manner

  2. Ensuring responsible treatment of the external environment

  3. Providing equal opportunity employment

  4. Satisfying occupational health and safety requirements

  5. Meeting other relevant legal requirements

• Providing a climate supportive of diversity
• Providing financial performance information in a manner that is understandable and meaningful for the investor, and without any misleading approaches to accounting
• Committing to the communities within which the firms operate
• Committing support to nonprofit organizations
• Other local issues; for example, philanthropic actions

From Strategy and Responsibility to the Bottom Line

As with the traditional balanced scorecard, the rebalanced scorecard strategy execution and performance-management system would be concerned with parceling strategic objectives to each and every individual in the firm. Furthermore, each individual would have a set of social responsibility objectives that reflected an organization's performance commitment to society.

Additional Possible Perspectives

An additional perspective for a rebalanced scorecard is the Employee perspective. The balanced scorecard treats employees as an asset in the Growth and Learning perspective, but this new perspective would go past that level of thought and be concerned with the employee as a human being, not as an asset for manipulation. Considerations for objectives here might include employee satisfaction with leadership, employee experiences with equitable treatment, the impact of internal politics, and employee appraisal of their managers. We aren't the first to suggest that scorecards need rebalancing, but clearly now more than ever circumstances call for this action.

WHAT ARE CORPORATIONS CURRENTLY DOING TO INCLUDE SOCIAL RESPONSIBILITY ISSUES ON THEIR SCORECARD?

A review of the literature turned up one study that was reported in the past four years that related closely to the concerns expressed in this article. This study, by Best Practices LLC,⁶ found that of 38 companies in their survey that used the balanced scorecard approach, most used only the four standard scorecard perspectives noted earlier, although several firms used an employee-oriented measurement area (for example, concern for employees or managing employees). None of these firms used a social responsibility perspective.⁷ We then undertook two data-gathering efforts on our own. The first examined self-reported scorecard perspectives taken from articles written by authors from within scorecard participant companies over the past four years. Twenty companies were found and examined. The second was a combination telephone and email survey of 80 firms known to use the balanced scorecard. Twenty usable responses resulted. One company overlapped our study and the Best Practices study.

Taking our two groups of firms together for a total sample size of 40 firms, we found that

• 29 firms reported having Financial objectives
• 29 firms reported having Customer objectives
• 37 firms reported having Internal Business objectives
• 20 firms reported having Growth and Business objectives
• 15 firms reported having Responsibility to Employees objectives
• 4 reported having Responsibility to Society objectives
• 2 reported having Other types of objectives

Our research indicates that about 90 percent of the companies that use a scorecard approach for the execution of strategy do not use social responsibility measurements of any kind, and ethics in particular, as focal points of such efforts. This was a slight improvement over the research results uncovered by Best Practices LLC.

IMPLICATIONS AND CONCLUSIONS

The implications of this exploratory study have the potential to be substantial in helping explain why firms are not behaving in ways that are more beneficial to society. If what's measured is what gets done, and ethical behavior is not being measured, then we should not be surprised that ethical behavior is lacking. If it's not on someone's performance appraisal, he or she is not immediately motivated to perform such a task. Certainly, morality and values play major roles in influencing this process, but if a firm is not focused on, and is not holding its employees accountable for this desired behavior, then we can't expect employees to place as much emphasis on this behavior as they should. Notwithstanding the role that other social responsibility awareness and response programs might have – for example, training in ethics, diversity management, or environmental awareness – it is a question of focus, and the opportunity to execute what is being focused on.

All firms use some type of objective-setting system. The scorecard methodology is just one, but an ever more common one. If firms want to succeed in ethical and social performance, then these critical areas must be included in the process that links strategy to individual performance. Those who create and supervise the development and usage of performance management and strategy execution systems must be ever vigilant to ensure that what gets measured includes more than just financially oriented perspectives.

NOTES

1. Peter Thal Larsen and Christopher Grimes, “AOL's Admission Risks Further Lawsuits,” Financial Times (October 25, 2002), p. 1.

2. Christopher Bowe, “Bristol-Myers to Restate $2bn in Sales,” Financial Times (October 25, 2002), p. 15.

3. Dennis K. Berman and Rebecca Blumenstein, “Phone Numbers, Behind Lucent's Woes: All-Out Revenue Goal and Pressure to Meet It,” Wall Street Journal (March 29, 2001), pp. A1, A8.

4. Robert S. Kaplan and David P. Norton, “The Balanced Scorecard – Measures That Drive Performance,” Harvard Business Review, January–February 1992, 71–79.

5. Kathleen Black in an address to the Academy of Management at its annual meeting, Washington, DC, August 14, 1989.

6. Best Practices LLC, as reported at BenchmarkingReports.com 9/18/02 and 9/05/02. The study was actually performed in 1996.

7. Telephone call with consultant at Best Practices LLC, on September 30, 2003.