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Economic profit and performance measurement in banking

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  • Ralph C. Kimball

Abstract

Successful bank operation requires managers to weigh complex trade-offs between growth, return, and risk. In recent years banks increasingly have adopted innovative performance metrics based on the concept of economic profit, rather than accounting earnings to assist managers in making such difficult and complex decisions. Banks hope in this way to elicit better decision-making by managers and also too align managerial behavior more closely with the interests of shareholders. This article analyzes the use of economic profit for measuring the performance of banks, focusing on the allocation of equity capital to products, customers, and businesses. The author reviews the use of economic profit to evaluate performance, to price transactions, and to reward managers. He describes in detail one performance measurement and incentive system and then goes on to discuss the shortcomings of performance metrics founded on economic profit, which may distort banks' investment and operating decision-making. He concludes that banks need to recognize the ambiguities of such calculations and be prepared to create and apply multiple specialized performance measures.

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Bibliographic Info

Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

Volume (Year): (1998)
Issue (Month): Jul ()
Pages: 35-53

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Handle: RePEc:fip:fedbne:y:1998:i:jul:p:35-53

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Related research

Keywords: Bank management;

References

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  1. Hannan, Timothy H & Hanweck, Gerald A, 1988. "Bank Insolvency Risk and the Market for Large Certificates of Deposit," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 20(2), pages 203-11, May.
  2. Wruck, Karen Hopper & Jensen, Michael C., 1994. "Science, specific knowledge, and total quality management," Journal of Accounting and Economics, Elsevier, vol. 18(3), pages 247-287, November.
  3. Jeffrey M. Bacidore & John A. Boquist & Todd T. Milbourn & Anjan V. Thakor, 1997. "Eva And Total Quality Management," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(2), pages 81-89.
  4. James A. Brickley & Clifford W. Smith & Jerold L. Zimmerman, 1997. "Management Fads And Organizational Architecture," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(2), pages 24-39.
  5. Robert C. Merton & André Perold, 1993. "Theory Of Risk Capital In Financial Firms," Journal of Applied Corporate Finance, Morgan Stanley, vol. 6(3), pages 16-32.
  6. Jerold L. Zimmerman, 1997. "Eva And Divisional Performance Measurement: Capturing Synergies And Other Issues," Journal of Applied Corporate Finance, Morgan Stanley, vol. 10(2), pages 98-109.
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Citations

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Cited by:
  1. Victoria Geyfman, 2005. "Risk-adjusted performance measures at bank holding companies with section 20 subsidiaries," Working Papers 05-26, Federal Reserve Bank of Philadelphia.
  2. Andrew Worthington & Tracey West, 2000. "A Review and Synthesis of the Economic Value-Added Literature," School of Economics and Finance Discussion Papers and Working Papers Series 075, School of Economics and Finance, Queensland University of Technology.
  3. Simon Feeny, 2000. "Determinants of Profitability: An Empirical Investigation Using Australian Tax Entities," Melbourne Institute Working Paper Series wp2000n01, Melbourne Institute of Applied Economic and Social Research, The University of Melbourne.
  4. Sinha, Pankaj & Taneja, Varundeep Singh & Gothi, Vineet, 2009. "Evaluation of riskiness of Indian Banks and probability of book value insolvency," MPRA Paper 15251, University Library of Munich, Germany.
  5. Yoram Landskroner & David Ruthenberg & David Zaken, 2005. "Diversification and Performance in Banking: The Israeli Case," Journal of Financial Services Research, Springer, vol. 27(1), pages 27-49, February.
  6. POPA Gabriela & MIHAILESCU Laurentiu & CARAGEA Codin, 2009. "EVA – Advanced method for performance evaluation in banks," Economia. Seria Management, Faculty of Management, Academy of Economic Studies, Bucharest, Romania, vol. 12(1 Special), pages 168-173, July.

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