Firm Performance Measures: Temporal Roadblocks to Innovation?

Abstract

This study identified four performance measures often employed in corporate analysis and examined their relationship with the firm's expenditures in research and development over different periods. These measures reflect both the profitability of the firm and the market value of the firm's total capitalization. This inquiry is motivated by numerous attempts made in the literature to define an ideal measure of corporate financial performance. Repeated surveys and several financial studies [Mechlin and Berg (1980), Watts (1986), Dubofsky and Varadarajan (1987), and Obi (1994)] have revealed that in spite of their empirical shortcomings, the most frequently employed measures are those based on the firm's profitability, essentially, return on equity (ROE), profit margin on sales and return on total capitalization. These measures are handicapped by the fact that they reflect only the historical pattern of the accounting data generating them. In this study, we contend that a reliable measure of performance should reflect the market's perception of the riskiness and timing of the expected returns on the firm's current investments.