Executive Briefing: questioning the paradigms of financial performance in the age of disruption

How to measure performance and evaluate a company in an era of digital, environmental, social and societal issues? In an ever-transforming world, are financial theories inherited from the sixties obsolete?
In the first part of the Performance 21 e-book, Philippe Foulquier, PhD, CIIA, Professor of Finance at EDHEC Business School, Director of the EDHEC EMBA in Paris and of the EDHEC Value Creation Research Centre, questions the paradigms of financial performance. In doing so, he lays the first stone of a broader reflection on financial and extra-financial performance, as well as value creation in the 21^st century.

When selecting financial indicators to measure the performance of a company, one realises that finance has been based on the same theory for decades: the Modern Portfolio Theory. Conceptualized in the fifties and sixties, it was celebrated in 1990 when the Nobel Prize in Economic Sciences was awarded to Harry Markowitz, William Sharpe and Merton Miller, considered the founding fathers of Modern Finance. This theory defines the performance of an asset portfolio based on a risk/reward: for each level of risk there is a portfolio that can maximize the expected return.

A 65-financial indicator taxonomy for measures with 1, 2 or 3 dimensions

In the first part of Performance 21, Philippe Foulquier makes a taxonomy of financial performance measures (65 indicators were studied) and classifies them in 3 categories based on their sophistication: indicators focusing on one dimension (margin), two dimensions (margin and capital) or three dimensions (margin, capital, risk). This taxonomy leads him to conclude that more than 99% of companies in the world have not yet integrated the Modern Finance theories from the sixties into their decision-making process, both at strategic and operational level!

Questioning financial paradigms in the age of disruption

But in an economic environment that hasn’t much in common with the world of the sixties, is this Modern Finance theory still relevant?
One thing is certain: the context has changed. Of course, digitalization has transformed business models. The economic weight of intangible goods keeps growing. But other things have shifted. Historically, performance measurement was based on the idea that capital was both rare and expensive, and that other resources – human and environmental resources – were less so. In a world with negative interest rates, money has proven less rare. On the contrary, the environmental and human issues are of growing importance and value. Besides, cultures have evolved deeply, and the mere definition of performance has changed along the way: “For example, millennials have arrived on the job market with new expectations and values, explains Philippe Foulquier. Their aspirations are an invitation for companies to transform, so they can better integrate and manage the social, societal and environmental dimensions of their activity, especially if they want to keep attracting talents.”
In the face of such profound changes, many critics are questioning the relevance of the Modern Finance from the sixties. But what if the answer is elsewhere? In Peformance 21, Philippe Foulquier expresses what could almost sound like a provocation in this age of permanent disruption: what if the transformation of business to integrate digital, social, societal and environmental issues, actually is an opportunity to adopt at least of the three dimensions of Modern Finance, rather than a revolution? Because even today, a large majority of companies only use a centenarian, unidimensional approach of margin.

“If 100% of listed companies have fully integrated the importance of margins, capital and risk into the measure of their performance for a long time – sometimes under the pressure of their shareholders – we see that more than 99% of unlisted companies are totally missing out, using only one dimension of this tryptic: margins.” Philippe Foulquier

The dangers of a unidimensional performance measure, based on margins only

Even the companies who claim a more sophisticated approach, using the EBIT margin (while a lot of them stopped at the EBITDA margin), only answer this elementary question: “how much profit has the company generated?” Integrating the second dimension, capital, is a way to go further and answer a more complex question: “how much profit has the company generated, in view of what it has invested?” The third dimension, risk, completes the tryptic. The questions becomes: “how much profit has the company generated in view of what it has invested and of the risks it has faced?”
Although risk has always been the cornerstone of the Modern Portfolio Theory, it has been neglected by companies in their performance measurement. And most of the time, the reasons are less technical than… cultural. To illustrate this, Philippe Foulquier uses real and recent cases of bad strategic decisions made by global companies who were considering margins without integrating the notions of capital and risk in their performance measurement.

A holistic approach to release the strategic potential of finance

In order to rise to the digital, social, societal and environmental challenges of our times, most companies should start by adopting the three dimensions of the Modern Finance theory. For Philippe Foulquier: “It is about seizing digital transformation and its challenges as an opportunity to question and reconsider financial culture and vision of performance measurement.”
This questioning is also an opportunity to rethink performance measurement with a holistic approach of a company – from the capital allocation angle, and not in silos anymore. This is why this cultural (r)evolution can only be led by General Management and/or the board: it has to start with work on the company’s purpose, values and strategy. This holistic vision is a necessary condition for the integration of social, societal and environmental issues into performance measurement (NB: these issues will be the focus of the next studies of the EDHEC Value Creation Research Centre).

Building on real cases, from companies he advised on these topics, Philippe Foulquier demonstrates how this transformation is within the reach of firms of all sizes, values and purpose (including non-profit)… providing that they ask themselves the right questions. With Performance 21, he supports leaders in this change by giving them food for thought, so they can objectify the current debate. To have a direct impact and be useful to the business world and future generations: this is the mission of Research as it is done at EDHEC. A vision summed up by one motto: “Impact future generations”.

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Consulter aussi les articles : 
"Expert Talk - Philippe Foulquier : Quand la finance éclaire la prise de décision" 
"Executive briefing : Quelle disruption pour les paradigmes de la performance financière ?"

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