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Economic Value Added: A Conscience for Business

R&L: In your opinion, what are the primary responsibilities of ethical business people in a free market society?

Shiely: In my mind, there is one primary responsibility of business people in a free market society and that is the creation of value. The expectation of value creation is the primary reason society allows firms to exist. By value creation I mean the creation of value through integrative (pie expanding) relationships with the primary corporate constituencies of shareholders, lenders, customers, employees, suppliers, and the communities in which the firm does business. No sustainable economic value has ever been created by unethical business people.

R&L: How would you defend the free market against critics who call for higher governmental regulation of the economy?

Shiely: In the words of my friend Mervyn King, former Chief Justice of the Supreme Court of South Africa and an acknowledged international expert on corporate governance: “conformance destroys performance.” As author of the King Report in 1994, Mervyn was a voice crying in the desert for more attention to corporate governance in the face of the excesses of the 1990s. Now that we have Sarbanes/Oxley, you’d be surprised at Mervyn’s observation. Once again, he submits, we’ve got it wrong in that we’ve tried to reduce effective corporate governance to “ticking a series of boxes.” The cornerstone of effective corporate governance is intellectual honesty, and that cannot be achieved through box ticking. It must be instilled in the agents in the free enterprise system. Moreover, economic value is created only by firms with unique value disciplines. All of the great value creators—Sam Walton at Wal-Mart, Bill Gates at Microsoft, and Herb Kelleher at Southwest Airlines—have been more than a little different. The kind of conformance enforced through this box ticking process seriously impedes the value creation process and is misplaced, as is the case with all excessive governmental regulation.

R&L: What challenges face the free economy now and in the future?

Shiely: I think two of the key challenges facing the free market economy in the future are globalization and corporate governance. The political environment is ripe for the zero sum crowd to push for protectionist trade regulations and enterprise smothering solutions. The key agents in the market economy, particularly CEOs, must do a better job of communicating the extraordinary benefits of global free enterprise and the dangers of taking the wind out of our economic sails through wrong-headed corporate governance initiatives.

R&L: What has been your personal experience of how business executives and laborers understand capitalism and business?

Shiely: My experience has been mixed. As I view the quality of understanding of business through the prism of economic performance where the rubber meets the road, I do not draw a distinction between managers and shop floor folks. I have met very senior executives whose only real competence is “carving up the pie” in an effort to simply protect their positions until they qualify for a comfortable retirement. At the same time, I have met shop floor workers who understand the real life value creation process much better than the deans of many prestigious business schools.

R&L: Some contend that competition primarily foments antagonism and is therefore wholly corrupt. How would you respond to this contention?

Shiely: Most people misunderstand competition. Competition is a process that forces us to refine our value disciplines and causes improvements in efficiency and effectiveness that cannot be achieved any other way. Those who view competition as “killing the other guy” most often compete away their own profits and often hurt the health of their industries. The most successful competitors are those firms which stake out a particular turf in their industry and practice the corresponding value discipline so keenly that other industry players avoid a knockdown confrontation with that firm as long as it continues to maintain the special competence in its niche. The most serious corruption occurs when there is no competition—in other words, a monopoly, which results either from government mandate or market failure. Those who say that competition is corrupt either don’t understand the challenge of competitive positioning or are industry value killers claiming victimhood in the face of their own incompetence.

R&L: Does competition play a positive or negative role with respect to ethical business practice in the free market? Why?

Shiely: Competition, practiced the way I set forth in the answer to the previous question, most certainly plays a positive role with respect to ethical business practices. The ham-fisted, wrong-headed competitor with a very short-term focus is most certainly subject to ethical lapses.

R&L: Have you ever encountered an example in which adhering to moral values did not facilitate the best economic interest of the company? How did you handle this circumstance?

Shiely: I have encountered many examples where someone else’s concept of moral values conflicted with the best economic interest of my company. For example, unions will often assert that we have a moral obligation to continue to support operations that destroy economic value, and they will resist any efforts to develop an integrative solution. In so doing, they abrogate their responsibility to continually re-deploy their membership in operations that produce a positive economic result. I can honestly say I’ve never faced an irresolvable conflict between my moral values and the economic health of my firm.

R&L: You have co-authored a book entitled The EVA Challenge: Implementing Value-Added Change in an Organization. Of foundational importance to this book is the concept of Economic Value Added or EVA. How would you define EVA?

Shiely: My favorite subject. EVA stands for “economic value added.” It is a version of the concept of economic profit based on the work of Nobel Laureate Merton Miller and developed by well-regarded financial consultants Joel Stern and Bennett Stewart. It is fundamentally a microeconomic concept in which we develop performance metrics and incentives that produce behavioral changes, which cause employees to make decisions as if they were owners. In Wealth of Nations, Adam Smith observes that the “invisible hand” only works in practice where industry agents are owners. With the rise of professionally managed and widely held firms in the early twentieth century, there was a disconnect. The EVA discipline attempts to remedy that disconnect by charging company employees at both corporate and divisional levels with the cost of capital, forcing them to manage the company’s assets as if they were their own. A more colloquial observation that makes the point is “who do you know that takes their Hertz rental car in for a car wash or oil change?”

R&L: Why do you advocate for the implementation of an EVA approach in determining a company’s value?

Shiely: The value of any financial asset is the present value of all the future cash flows expected to be received from that asset. With its key focuses on cash-adjusting earnings and capital stewardship, EVA is a very effective tool for driving behavior in the firm that translates into a higher stock price. Extensive statistical research has proven that EVA bears a dramatically higher correlation to stock price changes than traditional measures such as earnings per share or return of equity.

R&L: Is there any moral reason to use the EVA approach over traditional valuation techniques?

Shiely: With its primary mission of creating value and primary means of service to others, the practice of the EVA discipline that we call “managing for value creation” has very strong underpinnings in many of the commonly recognized principles of business ethics. Numerous elements of managing for value have clearly identifiable moral and ethical support such as: the stewardship of economic capital (parable of the talents), premium stock options (you must deliver value to customers and shareholders before you can claim value for yourself), and the concept of mutually enabling relationships. I should note that, early in the development of our EVA discipline, we were influenced by the fine work of the Acton Institute and Laura Nash, who coincidentally was featured in a recent Religion and Liberty interview.

Konosuke Matsushita is recognized as one of the most incisive entrepreneurs of the twentieth century. The creator of hundreds of thousands of jobs and one of the world’s leading consumer brands (Panasonic) probably said it best several decades ago: “If we cannot make a profit, that means we are committing a sort of crime against society. We take society’s capital, we take their people, we take their materials, yet without a good profit, we are using precious resources that could be better used elsewhere.”

R&L: Has Briggs & Stratton been able to implement an EVA approach? Why or why not?

Shiely: We began implementing our EVA program in 1989, have had a great deal of success with the program, and have gained a fair amount of notoriety in the corporate community for having done so. This has required a behavioral sea change in our organization, and, quite frankly, some of our folks could not make the transition. The key is that the uniform EVA decision making metric allows the organization to push decision making down to those levels in the firm where those decisions are best made. Most people are empowered by this new responsibility—a few don’t want it. Our success is reflected in the fact that we have achieved positive EVA in 10 of the last 11 years. This is a remarkable achievement in that only about forty percent of firms earn a positive economic return in any given year.

R&L: Are there any particular challenges to ethical business practice posed by being an executive in a multi-billion dollar, multi-national corporate enterprise?

Shiely: The greatest ethical challenge to large multi-national enterprises is the short-term focus of many of the market players. Anyone with any intellectual honesty should have known that the short term energy trading “ponzi” schemes and off balance sheet nonsense that was pursued by Enron executives in response to near term demands of the investment community and to the short term benefit of the perpetrators’ pocketbooks could not be sustained. The problem is that most large firms do not have a solid framework for ethical conduct, nor do many of their CEO’s have a well-developed early warning system for unethical conduct. Quite honestly, until the onset of Enronitis, few CEOs gave serious attention to ethical models. Under short-term pressure, ethical shading may soon turn into grand larceny. The first draft of my portions of the book, The EVA Challenge (which was published pre-Enron) included a chapter on the ethics of EVA. Most of that material was deleted from the final version of the book, as the editor doubted whether the material would resonate with the intended audience. I bet if we published the book today that would be a featured chapter.

R&L: Do corporations have any moral obligation toward society beyond simply maximizing profits for their shareholders? If so, what would these moral obligations be? If not, why not?

Shiely: The question is flawed as “maximizing profits” for shareholders is not the correct measure of performance in any event. The fundamental moral obligation of the firm (and the reason for its existence) is the maximization of delivered economic value. By my account, all other moral obligations pretty much fall in under that umbrella. The virtues of service to others, development of trust through consistency, empowerment, diligence, and such are all required for the creation of sustainable value.

R&L: You have commented that good entrepreneurs create value within society. How do they do this?

Shiely: The greatest value creators of the twentieth century have been those who have found a way to engage their corporate constituencies (employees, customers, suppliers, capital providers, and communities) in unique, mutually enabling relationships: e.g., Wal-Mart’s supplier network; Southwest Airline’s special customer relationship; Microsoft’s unique bargain with its employees. These are all integrative (pie expanding) relationships. Entrepreneurs who succeed are very different (sometimes weird and quirky) in that they must swim against the tide of the status quo players in the market economy (unenlightened governments, traditional unions, entrenched management) who are distinctly distributive (pie splitting) in their approach to the market.

R&L: How would you respond to critics who argue that entrepreneurs are motivated solely by greed and their own selfish interests?

Shiely: Self-interest (or what some call greed) is a driving factor in the market economy. It is in large part what forces us to get out of our beds every morning to face the day. But if properly directed, this motivation can be harnessed to produce a result that is both economically rewarding and morally defensible. I have been very close to several entrepreneurs who have been very successful in business; some listed in Forbes 400 list of the richest people in America. Surprisingly, pure monetary reward is way down the list of what rings these guys’ chimes. Creation of a successful franchise, superior customer satisfaction, positive community impact, and outstanding value creation are most likely to be at the top of their lists.

R&L: How does your faith affect your management policies regarding shareholders and employees, especially during periods of sluggish economy?

Shiely: I believe the direct introduction of faith concepts into management practices is largely unproductive. The claims of “Christian-based business” or adoption of a “what would Jesus do” approach is more likely than not to alienate some of the folks you need to achieve the economic success required to morally “earn your keep.” I believe your faith should be critical in the development of the ethics of your management philosophy. At that point, important faith concepts are embedded in your management practice and need not be specifically referenced in corporate decision making. I really like Pope John Paul’s practical but theologically sound take on decision making in the value creation process in a free economy from Section 32 of Centesimus Annus: “Important virtues are involved in this process, such as diligence, industriousness, prudence in undertaking reasonable risks, reliability, and fidelity in interpersonal relationships, as well as courage in carrying out decisions that are difficult and painful but necessary, both for the overall working of a business and in meeting possible set-backs.”