Choosing between Measurable and Meaningful

Feb 17, 2014

How Useful a Measure Is GDP?” is a thoughtful and thought-provoking article by Diane Coyle. She observes that the concept of GDP has come under fire recently by those who argue that it doesn’t really measure well-being – that it doesn’t measure, for example, happiness, or income distribution, or sustainability.

This is a valid objection, but Coyle observes that GDP was never intended to measure these “softer” values, that those values are hard to measure, period, and that in any case, GDP is at least correlated with many of these values. Also valid.

This debate is analogous to the one about the metrics we use to evaluate business performance or determine incentive compensation. For example, EPS has been harshly criticized as a basis for C-level executive bonuses because it promotes a short-term focus and is prone to manipulation in the short run. Defenders argue that it is extremely difficult to manipulate over multiple accounting periods and, more important, it perfectly aligns management’s and stockholders’ interests. Who is right?

For my money, I’m a big fan of these metrics, when properly used – that is, when the criteria for choosing these metrics are, in roughly the following order of importance:
  1. Is the metric reasonably well-correlated to mission-level objectives, like maximizing revenues or shareholder value or customer satisfaction?
  2. Can it be measured objectively, and presented and reported in a ways that is comprehensible to stakeholders?
  3. Is it prone to manipulation?
  4. Is a metric available that better meets criteria 1, 2, and 3 above?

Unfortunately, few metrics can score perfectly on the above criteria. But never let “perfect” be the enemy of “good.”

“Painting with Numbers” is my effort to get people talking about financial statements and other numbers in ways that we can all understand. I welcome your interest and your feedback.

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