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SINERGI
KAJIAN BISNIS DAN MANAJEMEN
Vol. 10 No. 2, Juni 2008
Hal. 179 - 198
PERFORMANCE MEASUREMENT:
A STAKEHOLDER APPROACH1
Niki Lukviarman
Faculty of Economics, Andalas University
E-mail: [email protected]
Abstract
1
Part of this articel have been presented at the “Integrated Business Strategy Seminar” of Graduate School of
Business, Curtin University of Technology-Australia (December 2000).
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Performance Measurement: A Stakeholders Approach (Niki Lukviarman)
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SINERGI Vol. 10 No. 2, JUNI 2008: 179 – 198
more complex competition. Consequently, a (Meyer and Gupta, 1994). Some arguments
number of new techniques for organizing from researchers on the need to change PM
and managing companies have been intro- system, apart from financial-based PM, are
duced (Dent, 1996). In order to enable cor- described in appendix 2. In general it might
porations to respond to opportunities and be argued that navigating the company into
challenges faced in their market environ- a more competitive, technological, and ca-
ment, they have to consider and reinforce pability-driven future, cannot be accom-
new competitive strategies. A clear and fo- plished merely by monitoring and control-
cussed strategy allows the company to de- ling financial measures of past performance.
sign its performance measurement and eval- Based on this serious dissatisfac-
uation system to concentrate the manager’s tion with financial measures and the need
attention on the strategy’s key success fac- for a much broader PM system, many re-
tors (Epstein and Manzoni, 1997; Atkinson searchers (see appendix 2) urge the devel-
and Epstein, 2000). Thus, in a dynamic envi- opment and improvement of PM. However,
ronment, it is essential for the company to the objective of broadening PM is not simp-
keep performance measures current and rel- ly to include non-financial indicators to
evant. measure outcomes that cannot be covered by
Some measures describing business financial measures. A more fundamental
performance cannot dominate for long and reason is the need to incorporate factors in
may shift dramatically over time. This is PM that will determine or influence future
because such performances lose usefulness outcomes and could balance various indica-
as a result of declining in their ability to tors of measurement (Olve et al, 2000).
discriminate ‘good from bad’ performance Thus, it is expected that PM should also
(Meyer and Gupta, 1994). Moreover, a dy- consist of important indicators that could be
namic environment requires companies to used as the drivers of a company’s future
make more complex strategic decisions, performance and emphasize the actions nec-
where the outcomes extend over a longer essary for long-term success.
period (Waterhouse and Svendsen, 1998) The need to supplement financial
and requiring different and more dynamic measurement with others that cover broad
measures. Consequently, relying on tradi- business matters brings us to the issue of
tional finance-based performance measured which areas need to be considered. This is-
systems has failed to supply the information sue is deemed important since business as-
necessary to elicit strong future performance pects are so broad and all of them could
from the organization. seem equally important. As a corollary, a
The need for the companies to further issue in its operationalization is how
change to a PM that is relevant to current to cover such broad areas, make them meas-
development in business environment is urable and balance, in order to achieve the
undoubtedly important. Dixon et al. (1990) objectives of PM. In short, it is significant to
argue that in order for companies to compete consider the broader-set of measurement
with industry leaders, they have to change systems, without losing the focus and objec-
their ways of measuring performance. Addi- tives of business performance measures.
tionally, in order to be effective, perfor- Chakravarthy (1986) argues that
mance measures need to reflect the changes organizational performance and organiza-
in competitiveness (Tatikonda and Tatikon- tional effectiveness are two of the labels
da, 1998) and the fact that there are continu- under which aspects of strategic perfor-
ous of change in the dominant measures mance should be measured. However, he
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Performance Measurement: A Stakeholders Approach (Niki Lukviarman)
believes that there is little agreement on how in the development and the implementation
performance should be measured. Several of every PM system.
researchers, in regard to the aspects that In addition, Meyer and Gupta
should be considered in developing broad (1994) believe that one purpose of organiza-
performance measurement, provide their tional design is to promote comparability
arguments, as can be seen in appendix 3. In and variability, and therefore both of them
summary, it can be argued that such broader are key properties of any performance
PM should include a ‘mix and balance’ of measures. Accordingly, they argue that
financial and non-financial (operational) comparability is ‘the extent to which a
measures as well as reflecting companies’ measure is valid across several settings’, and
contribution to their stakeholder groups. variability is a ‘measure’s capacity to cap-
Based on the factors to be consid- ture a range of performance outcomes’
ered in developing a broader-set of criteria (p.310). Therefore, PM requires comparabil-
for a PM system, it might be argued that ity and yet should exhibit variability in order
such PM is the system that is designed to to discriminate between good and bad per-
accommodate and satisfy the diverse inter- formers. As a result, one might argue that if
ests of stakeholders. Consequently, there is a a specific PM has lost these key properties,
tendency to depart from solely traditional- it has already lost its usefulness in providing
financial measurement systems, which em- adequate measures to differentiate between
phasize maximization of shareholders’ val- high and low performers.
ue. Therefore, the attempts to measure satis- Moreover, Meyer and Gupta (1994)
faction of all of the firm’s stakeholders are argue that many measures are running down
important. Indeed, the intention to include because they lose variability and hence their
the measurement of various interests of capacity to measure performance. Therefore,
stakeholder expectations could be seen as such measures will tend to be less proactive
discriminators of strategic performance indicators of potential business problems
(Chakravarthy, 1986). In brief, the pressure (Epstein and Manzoni, 1997) and can no
towards broadening a company’s accounta- longer meet their objectives. According to
bility from stockholders alone, to include Meyer and Gupta (1994, pp.331-347) there
interests of other stakeholder groups, is ob- are many forces which tend toward the run-
vious. ning down of a PM by driving out variabil-
ity. Four of them are positive learning, pre-
THE THEORY OF PERFORMANCE serve learning, selection, and suppression.
The Key Properties of Performance Meas- However, Meyer and Gupta (1994) argue
urement that aside from those factors, external condi-
Performance indicators should re- tions can also induce variability into perfor-
flect the impact that a modern organization mance measures. Therefore, they argue that
has on the world around it and how it is per- changes in environments may have an effect
ceived. Atkinson and Epstein (2000), argue on existing performance measures. In line
that companies must refrain from adding too with this argument, Broadbent (1999) be-
many measures in their PM system. These lieves that the environment is of growing
writers also believe that there is a longstand- importance and will become part of the de-
ing tradition that a performance measure veloping agenda of PM. In summary, it is
should have three attributes, namely be clear that comparability and variability are
complete, be measurable, and be controlla- the important key properties in any perfor-
ble (p.27). These attributes provide insights mance measures. Hence, any changes in PM
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should consider the importance of these as the core domain), they argue that most
properties. strategy studies have restricted their focus to
the first two. They believe that this tendency
The Domain of Performance Measurement is due to the availability of data and their
The important issue to be addressed in the implications for operationalization. This
discussion of PM is to delineate the domain argument is supported by Kald and Nilsson
of performance concept (Venkatraman and (2000) who state the difficulties in using a
Ramanujam, 1986). From the view of strate- broader-set of PM criteria in translating pro-
gic management, they argue that the PM grams and activities to be measurable.
concept can be differentiated using three Therefore one might argue that the opera-
domains (p.803), as follows: tionalization and benefit of PM system in
Domain of financial performance, the organizational context are important
which is the narrowest concept of busi- issues in designing PM.
ness performance by using simple out-
come-based financial indicators that are The Development of Various Models
assumed to reflect the fulfilment of the The PM system is needed to meas-
economic goals of the firm. This ap- ure the achievement of a company’s objec-
proach remains very much financial in tives resulting from strategy implementation
its orientation and assumes the domi- and decision-making processes. In consider-
nance and legitimacy of financial goals ing the stakeholder model in designing a
in a firm’s system of goals. company’s strategies, corporate goals should
Domain of financial and non-financial be defined more widely than shareholders
(operational) performance as a broader profits (Keasey et al, 1997). Therefore, cor-
conceptualisation of business perfor- porate goals should include the legitimate
mance that include emphasis on opera- interests of all relevant stakeholders in the
tional performance in addition to indica- important operational and strategic decisions
tors of financial performance. This ap- the company makes (Barringer and Harri-
proach seems to focuses on key opera- son, 2000). Waterhouse and Svendsen
tional success factors that might lead to (1998) also endorse the importance of cor-
financial performance. porate strategy to be defined in terms of how
Domain of organizational effectiveness, the company will manage the contracts it
which are predominantly used if the has with its key stakeholders
multiple and conflicting nature of or- As organizations attempt to com-
ganizational goals and the influence of pete successfully in the information era, they
multiple constituencies or stakeholders are turning to a variety improvement pro-
are superimposed. grams to enable them to adopt environmen-
tal changes. However, Kaplan and Norton
Although a broader conceptualisa- (1996) argue that such programs should not
tion of PM is welcomed, Venkatraman and be fragmented and need to be linked to the
Ramanujam (1986) argue that there is a con- organization’s strategy and to specific finan-
siderable debate on the use of the organiza- cial and economic outcomes. Therefore, the
tional effectiveness domain as a broader PM system needs improvements to incorpo-
concept among those three. However, de- rate multiple business aspects, in order to
spite the fact that each of these domains is a broaden the company’s focus in an envi-
subset of the overall concept of organiza- ronment governed by broader interests.
tional effectiveness (with financial domain
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Performance Measurement: A Stakeholders Approach (Niki Lukviarman)
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something in return for helping the organiza- survival of organizational forms is “the abil-
tion to achieve its objectives. ity of a corporation to maintain its interde-
Mitchell et al (1997) argue that pendent relationships with its key stakehold-
there is not much disagreement on what kind ers” (Waterhouse and Svendsen, 1998,
of entity can be a stakeholder. They believe p.25). Thus, the central notion of the corpo-
that “persons, groups, neighbourhoods, or- ration from this perspective is that compa-
ganizations, institutions, societies, and even nies are engaged in an interdependent, sym-
the natural environment” are generally biotic relationship with their stakeholders
thought to qualify as actual or potential (Sternberg, 1997). This means that compa-
stakeholders (p.855). However, the groups nies cannot avoid stakeholder relationships
typically cited as stakeholders include cus- because every organization is dependent on
tomers, suppliers, employees, local commu- its stakeholders. Therefore, one might argue
nities, government and shareholders (Ber- that, in decision-making processes and in
man et al, 1999; Hill and Jones, 1992). Each designing its strategies, the company should
of these groups can be seen as supplying the accommodate the impact of decisions on the
firm with critical contributions and in ex- company’s relationship with its stakeholders
change each expects its interests to be satis- as well. In turn, the choices the company
fied. Therefore, Barringer and Harrison makes in strategic planning must direct and
(2000) view the relationship between an inform the design of the PM system (Atkin-
organization and its stakeholders as an ‘in- son et al, 1997).
ter-organizational relationship’ through alli-
ances that could help firms to create value. Strategic Management and Stakeholder
An organization has been defined Approach
as ‘a nexus of contracts’ (Jensen and Meck- Organizations have stakeholders.
ling, 1976; Fama and Jensen, 1983). Such Therefore, in developing and implementing
contracts specify or imply what an organiza- strategies every organization should consid-
tion expects from each stakeholder group to er those groups who can affect and are af-
help it to achieve its primary objectives, and fected by an organization’s objectives
what each stakeholder expects from the or- (Freeman, 1983). Accordingly, he (1983,
ganization in return for participation (Shleif- p.43) argues that “the strategic management
er and Vishny, 1997). Within this context, paradigm could be enhanced by including
the role of PM is to monitor the give and the stakeholder concept in its processes”.
take expressed or implied by each of these Aside from its concrete applications as a
contracts. Therefore, it might be argued that framework for environmental analysis,
one of the most important managerial func- Freeman believes that the basic philosophi-
tions is to establish and maintain stakeholder cal issue of stakeholder approach in strategic
relationships to achieve the company’s ob- management is a “thorough understanding
jectives. As a result, the stakeholder’s capac- of the effects of organization on its stake-
ity, opportunity, and willingness to threaten holders”. Additionally, by combining “an
or cooperate must be considered in design- analysis of stakeholders, values and societal
ing and implementing the company’s strate- issues, executives can address the difficult
gy. question of the role of organization in socie-
From the point of view of contrac- ty at large” (p.44). This process can be seen
tual relationships, an important factor in the in figure 1 below.
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Performance Measurement: A Stakeholders Approach (Niki Lukviarman)
ENTERPRISE
STRATEGY
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understand the differential power and How should we weigh the concerns of
stake of each group. the least well off or least powerful
The stakeholder concept represents a stakeholders versus “wealthier” groups?
generalization of many of the concepts
currently in use. Thus, techniques, con- According to Freeman, the basic
cepts, and research which can be used answers to these questions are the need for
to understand customers and suppliers shifting from short-term financial measures
can also be applied to other stakehold- to long-term social measures. He argues that
ers. appropriate measures should be able to bal-
ance the interests of a host of stakeholder
From the above-mentioned factors, groups, which can help managers to define
one might argue that a firm’s strategic man- the appropriate trade-offs to be made. Since
agement process for understanding the ex- there is no concrete answer to the operation-
ternal environment can be improved by un- alization of these measures, the development
derstanding its stakeholders. Therefore, the of adequate PM models poses challenges to
ability of the company to manage its rela- management scholars.
tionships with multiple stakeholders and
understand their differential powers can fa- Identifying Stakeholder Group
cilitate the company’s achievement of its The main role of PM in strategic
objective. Firms with good relationships management is already obvious: it is to en-
with their stakeholders, on the basis of mu- sure that an organization pursues strategies
tual trust and cooperation, will have a com- that lead to the achievement of overall goals
petitive advantage over firms that do not and objectives. Additionally, in order to sur-
(Jones, 1995). Hence, there should be some vive in a dynamic environment, with the
recognition of the importance of stakeholder growing importance of stakeholders, com-
groups having long-term association with panies have to maintain their networks with
the company and, therefore, an interest in its key stakeholders. Therefore, companies’
long-term success. abilities to align and balance their own in-
However, the application of the terests with the interests of stakeholders are
stakeholder approach in strategic processes critical to achieve the company’s objectives
raises some important questions, particularly and also to reduce environmental uncertain-
in relation to performance measures. The ty (Barringer and Harrison, 2000).
questions are (Freeman, 1983, p.53; Vinten, As a nexus of contracts, a company
2001,p.41): has both implicit and explicit contractual
What are stakeholder interests and / or agreements with its stakeholders. Despite
rights? the fact that each stakeholder groups can be
What responsibility has the firm to each seen as supplying the firm with critical re-
stakeholder’s group? sources or contributions, they have different
How do we measure how well an organ- stakes in the firm (Hill and Jones, 1992).
ization is doing with its stakeholders? Hence, one could expect potential conflict of
What are the relevant variables? interests among various stakeholders, which
What are appropriate measures? may need to be resolved by the company.
What are appropriate measures of the The stakeholder perspective envi-
relative power of suppliers, customers, sions organizations at the center of a net-
government groups, and other stake- work of stakeholders. However, most atten-
holders? tion should be given to the legitimate inter-
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Performance Measurement: A Stakeholders Approach (Niki Lukviarman)
ests of the relevant and key stakeholders these criteria, these writers believe that the
(Sternberg, 1997; Mitchell et al, 1997; Sav- firm can determine specific stakeholder in-
age et al, 1991). Thus, determining which terests to be addressed and can focus its at-
stakeholders matter most will resolve the tention on these specified interests rather
potential conflict of their multiple interests than a broad, societal definition of stake-
in designing the strategy. Consequently it holders. Hence, managers must devise strat-
requires appropriate PM models to measure egies that will coordinate and balance the
the achievement of a company’s objectives interests of these various groups (Harrison
based on such a strategy (Barringer and Har- and Freeman, 1999; Barringer and Harrison,
rison, 2000). 2000).
However, before considering the
PM system that is appropriate to accommo- DISCUSSION: PERFORMANCE
date the interest of a company’s stakehold- MEASUREMENT AND
ers, the issue of how to divide them must be STAKEHOLDER APPROACH
addressed, because it is much easier for the The stakeholder approach high-
company to treat their stakeholder as a ‘lim- lights the importance of taking stakeholder
ited grouping’ rather than treating the broad- preference into account in every business
er concept as mentioned by Freeman. In process and focuses on overseeing relation-
addition, from the stakeholder perspective, ships that are critical to an organization’s
all stakeholders cannot be considered equal- success. The role of stakeholder theory is
ly important and there should be a way to seen to extend past the formulation of strat-
determine which stakeholders matter most egy to the establishment of performance
(Barringer and Harrison, 2000). goals. Through maintaining close relation-
Much of the literature on stake- ships and possibly alliances with key stake-
holders has focused on identifying primary holders, a company can expect long-term
and secondary stakeholders (Mitchell et al, cooperation that will lead to mutual benefits.
1997; Savage et al, 1991). The primary Hence, one could expect better performance
stakeholders are those who have formal, of such a company in the future.
official, or contractual relationships and As a nexus of contracts, every
have a direct and necessary economic im- company has contractual relationships with
pact upon the organization. Secondary its stakeholders, who require companies to
stakeholders are diverse and include those accommodate their interests. The stakehold-
who are not directly engaged in the organi- er approach conceives of the set of relation-
zation’s economic activities but are able to ships between the organization and its
exert influence or are affected by the organi- stakeholders as a nexus of contracts. There-
zation (Savage et al, 1991, p.62). Therefore, fore, appropriate strategies, and hence PM
there is a need to identify relevant stake- systems, should incorporate the relationships
holders, using certain criteria so that none of that exist, in order to achieve the company’s
them are excluded from management atten- objectives. Since there are potential conflicts
tion. among various interested parties, companies
According to Sternberg (1997) should also balance these interests whilst
there are three criteria that determine the basing business processes on the strategies
groups of stakeholders: materiality, immedi- that have been developed.
acy and legitimacy criteria, while Mitchell et I agree with the arguments that fi-
al (1997) propose the following attributes: nance-based measures alone are inadequate
power, legitimacy, and urgency. Based on in assessing business performance. Howev-
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SINERGI Vol. 10 No. 2, JUNI 2008: 179 – 198
er, as has been argued by several research- for future financial outcomes, whilst the
ers, such measures should be retained and SPM model perceives the secondary objec-
expanded, since they are still important indi- tives as the drivers for the company to
cators for every PM system. Hence, it could achieve primary objectives. Although the
be argued that non-financial (operational) needs of stakeholders group other than
indicators are not a substitute or replacement shareholders are considered a secondary
for financial indicators. Rather, they should concern, at least both models have already
be seen as a complement and enhancement included the importance of other stakehold-
to leading indicators of the financial ers in their PM models. Besides, the BSC
measures in order to expand the traditional model for example, has introduced the im-
PM system. Therefore, it can be argued that portance to balance various interests within
the changing nature of any PM is towards a the company that should be reflected in the
broader system that can accommodate the company’s strategy. In addition, both mod-
growing importance of other issues that can- els provide information that might be im-
not be covered by finance-based indicators portant and required by relevant stakehold-
alone. By linking both indicators to critical ers in the company
management activities (i.e. strategy), PM However, based on performance
models can help companies to monitor and concepts by Venkatraman and Ramanujam
manage the implicit and explicit contracts (1986), it seems that improved PM systems,
they have with stakeholders. In summary, particularly the BSC and SPM which con-
the role of PM is to monitor the give and sider other stakeholders are still in the sec-
take implied by each of these contracts. ond domain (i.e. domain of financial and
Another issue regarding the need operational performance). According to
for an improved PM system, as a vital part Kald and Nilsson (2000), the use of financial
of the changing nature of PM, is the im- and selected operational performance indica-
portance of viewing PM not only as the tors, rather than overall organizational effec-
measure of outcome but also to use its indi- tiveness, brings up the difficulty of translat-
cators as the drivers for future performance. ing non-financial measures into financial
Proponents of shareholder-value models also ones. One difficulty in implementing the
agree with the importance of the drivers of SPM model, for example, is how to translate
value for shareholders that were identified as secondary objectives (i.e. customer satisfac-
return, cash flow and asset growth, which tion or quality of service) into measurable
are all finance-related values. Although the outcomes such as profit. In general, it can be
proposers of the shareholder-value meas- argued that these problems arise from diffi-
urement have claimed that their models are culties relating to management action and
different from traditional financial- results. Therefore, major limitations on the
accounting models, these models still use use of broader-set performance indicators
financial measurement as their leading indi- are contributed by its operationalization,
cators. All of these models still perceive the availability of data, and any consideration in
importance of the goal of creating share- order not to lose the objective of perfor-
holder value. Through the adoption of value- mance measurement.
based management, these models assume Moreover, there is a potential prob-
that the creation of value for its shareholders lem in considering diverse interests of
is fundamental to the success of any company. stakeholders in the company’s business pro-
On the other hand, the BSC model cesses. Although there is an approach to
views operational measures as the drivers regrouping and mapping, in order to identify
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IMPLICATIONS FOR FUTURE mance variables that best reflect its rela-
RESEARCH tionship with its key stakeholders?
On the basis of the issues that have How to design a PM system that is tai-
been discussed in this paper, one can envi- lored to meet the needs of each compa-
sion refinements in long-standing PM sys- ny’s business and could be expanded to
tems designed to assist managers in dealing take into account the critical stakeholder
with a more complex company environment. relationships the firms depend on to
Presently, PM systems which place empha- prosper?
sis on the stakeholder are being utilized to How could different organizations con-
help managers deal effectively with multiple nect together all of the financial and
stakeholder relationships. Current PM mod- non-financial measures in a coherent
els, particularly the environmental-related and comprehensible manner?
models, include identification of stakeholder How to formalize the inclusion of em-
roles within companies. Through the stake- powered stakeholder groups that may
holder approach, the set of relationships have no formal representation in the or-
between the organization and its stakehold- ganization?
ers are being articulated as a nexus of im-
plicit and explicit contracts. Therefore, the Finally, since the pressure exerted
role of PM from this point of view is to by the organization’s stakeholders influ-
monitor the give and take expressed or im- ences the performance goals set by a man-
plied by each of these contracts. ager, it will have an affect in designing the
PM models that incorporate and company’s strategy. Therefore, in attempt-
balance various stakeholder interests within ing to develop an appropriate PM system
the company have the potential to improve based on the stakeholder approach, the said
upon current practice. They hold the key to PM should be linked and driven by strategy.
more effective management and to a more
useful, comprehensive theory of the firm in CONCLUSION
the society. Focusing attention on salience in In a dynamic environment with in-
the company-stakeholder relationships exist- creasing importance on contractual-
ing in a firm’s environment appears to be a relationships with its stakeholders, compa-
productive strategy for future research in nies are required to consider these groups in
developing appropriate PM system. The PM their business processes. As a result, the
models, therefore, must reflect “the com- company must introduce and maintain new
plexity of business today, and the height- ways of managing its relationships as well
ened requirement for world-class perfor- as measuring business performance, includ-
mance in far more aspects of corporate op- ing various stakeholders’ interests. This
erations – from emphasizing innovation to view shifts the importance of maximizing
fostering diversity” (Atkinson and Epstein, the single most important shareholders, to-
2000, p.28). wards the company’s accountability to a
In relation to PM models that take more diverse group of stakeholders.
into account the important relationships with Several models, including the BSC
the company’s stakeholders, there is a need and the SPM, have been introduced in re-
for empirical research that answers these sponse to these needs which can be catego-
questions: rized as a part of the second domain of per-
How to develop the framework that formance measurement. Neither model,
could identify the company’s perfor- however, considers all stakeholder groups,
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Performance Measurement: A Stakeholders Approach (Niki Lukviarman)
treating some of them as only secondary and Although improved PM has taken
as an instrument to achieve primary goals. the stakeholders into consideration, one
Primary goals for both models are still the might argue that financial measures still
shareholder group, emphasizing the im- continue to be the end measures of a compa-
portance of financial indicators as measures ny’s performance. A major problem in the
of residual claims for the company’s share- implementation of PM models that have
holders. Thus, other stakeholder groups, broadened their indicators of measurement
which are considered a secondary concern, to include other non-financial (operational)
are seen as drivers of future financial per- indicators is in their operationalization.
formance. In general, these models foresee Therefore, the overall appropriateness of a
that improvement of secondary measures PM system is important, as well as the bene-
will result in improved future performance. fits it might be contribute to the achievement
of the company’s objectives.
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Appendix 1
Critics of Traditional Financial-based Performance Measurement
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Appendix 2
Reasons to Consider the Changes in Performance Measurement
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Appendix 3
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