‘Big Israeli firms get it all wrong’

Joel Stern, creator of Economic Value Added theory: Israeli businesses are unwilling to consider changing methods for measuring performance.

Big Israeli companies are getting it wrong in the way they measure performance, yet they are resistant to change, visiting economics professor Joel Stern said Sunday.
Stern, creator of the Economic Value Added theory of corporate performance, criticized Israeli firms for their unwillingness to even contemplate changing methods of calculating both return and investment that he said are outdated, inaccurate and limit their profitability.
Israel is the only place in the world where all the major business leaders Stern has met with have rejected the services of his consultancy firm Stern Stewart & Co., he said in an interview with The Jerusalem Post.
The firm has 866 clients in the United States and around the world, including big names such as Coca-Cola and Goldman Sachs, Stern said.
The theory of Economic Value Added, or EVA, has been shown to have the highest correlation to an increase in the value of the stocks of companies that have adopted it, he said.
“We solved the problem [of performance measurement] in the USA; we can solve it here, too,” Stern said. “I said to [Israeli business leaders], you give me one company to work with and I’ll show you how successful it can be, and then you’re going to want to line up and do [the same with] all the other companies. But they don’t even want to try with one.”
Consumers were also bearing the cost of poor management strategies, he said.
Citing Israeli supermarket chain Shufersal as an example, he said: “If the store was being managed properly, they would be able to reduce their prices and they’d make it up on volume. That’s the secret behind [big American retail chains] Costco and Walmart.”
Stern, who is scheduled to deliver a lecture at the College of Management in Rishon Lezion on Monday, teaches at six graduate schools, including the University of Chicago and Columbia University.
During a three-year teaching stint at the Interdisciplinary Center in Herzliya in the mid-2000s, he met with leaders of some of the biggest Israeli firms. But he long ago lost faith in Israeli business, thanks to his past experiences here, he said.
Stern’s Economic Value Added theory covers three main areas of corporate governance: using a scientific formula, it provides a method for deciding where to make investments, a method for measuring performance, and it introduces a bonus scheme tied to improvements in the EVA.
The theory is based on the principle that traditional methods of measuring return on investment are flawed because there are no intangibles on the balance sheet, such as investment in people, brands or research and development.
“If you make return on investment the right measure of performance, you have to get the return and investment right,” Stern said. “But the accountants get them both wrong because intangibles aren’t written off on current year.”
Another important aspect of the theory is that it measures return on investment compared to risk, by coming up with a required return on investment based on the riskiness of the investment.
Finally, the bonus scheme is tied to improvements in the EVA because, Stern said, “If this method is right, then the right way to measure performance is by improvements in EVA year-on-year.”