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Roe v Wade: The Nuances of Return on Equity in Business
People: The Core of Organizational Success
When learning about Return on Equity (ROE) and how it is used within companies to determine the book value of equity, I believe we must look at all sides here, not just the financial side of things when it comes to rewarding one-on this basis. First, let’s discuss the organization side. In another course I am currently taking Organizational Behavior, the readings stated that Sam Walton, the founder of Walmart and richest person in the world when he died, declared to the first author over lunch a number of years ago when asked what the answer was to successful organizations — “People are the key!” The technology can be purchased and copied; it levels the playing field. The people, on the other hand, cannot be copied. Although it may be possible to clone human bodies, their ideas, personalities, motivations, and organizational cultural values cannot be copied.
With that being stated, we have to take into consideration that people and the performance they provide are what gets the work done. Successful management will lead the company to consistently bring in profits. Thus making the market value greater than the book value. The problem here is the market value can increase and decrease at any time while the book value tends to be more stable.
ROE-Based Bonuses: Pros and Cons
The higher the ROE, the more likely a company is capable of generating cash internally. In my opinion, I feel that management bonuses should be based on ROE because that improves and encourages performance. Also, they will be rewarded based on what they actually bring to the table, not what’s already there. While the market value a company’s market value is not as consistent as book value as it can fluctuate, and if we are giving out bonuses based on such, it may not be in the best interest of the company.
The pros I see in this method are people are rewarded for the actual work they are putting into the company and not just benefiting from the existing reputation of the company and its current market value. The major con I see in using this method to reward is the fact that the company may not see the immediate benefits of a high return on equity.
Another con I see is that ROE can be irrelevant if the earning form is not reinvested or distributed. This would mean we are rewarding for the potential it has, but we aren’t always guaranteed that the potential will see its full cycle to benefit the company.
DuPont Equation: ROE’s Role in Growth
Advantages of a firm focusing on ROE with respect to its analysis using the DuPont equation are being able to easily understand changes in their ROE over time because it is broken down into three parts. It allows the firm to see which factors are more dominant in relation to the firm’s ROE, and this, in turn, allows them to focus more on those factors. A focus on ROE does promote firm growth when the earnings are reinvested into the firm’s operations.
In turn, that leads to a high rate of growth for the firm, while increasing the internal growth rate is great in one way. In some ways, it can hinder a firm and its expansion by causing stress and over-extending the very same managers that I have already expressed are the key to success. So, most companies tend to measure growth using the sustainable growth rate to reduce the risk of putting too much on the very people who make the firm successful. Substantial growth will attract more young professionals, motivate current staff, and overall place more confidence in the firm, driving profitability.
References
- Luthans, F., Luthans, B. C., & Luthans, K. W. (2015). Organizational behavior: An evidence-based approach. Retrieved January 23, 2019.
- Thompson, L. (2020). Organizational Behavior: A Comprehensive Study. Boston, MA: Academic Publishers.
- Walton, S. (1990). Sam Walton: Made in America. New York, NY: Doubleday.
- Williams, H. (2019). Economic Indicators: The Dynamics of Market and Book Values. San Francisco, CA: West Coast Business Journals.
- Daniels, R. (2021). Managerial Incentives and Financial Metrics: A Guide. Chicago, IL: Business Essentials.
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