Linking environmental uncertainty to non-financial performance measures and performance: a research note

Abstract

Several previous research studies have reported mixed results concerning the direct association between non-financial performance measures and performance. The presence of environmental uncertainty on this relationship has not been established. This paper makes a contribution to this area by proposing that it is in conditions of environmental uncertainty that non-financial measures are most useful in improving organizational performance. It analyses empirical data from a sample of New Zealand manufacturing organizations to test the hypothesis that non-financial measures of performance would lead to improved organizational performance under conditions of increased environmental uncertainty. Multiple regression analysis of the data suggests that performance should be a declining function of the size of the ‘mismatch’ between an organization's environment and use of the different combinations of non-financial performance measures. Further, the paper concludes that prior mixed results may be attributed to the omission of environmental uncertainty.

Introduction

The recent performance management literature (Lynch and Cross, 1991; Kaplan and Norton, 1996, 2001; Otley, 2003) suggests that when monitoring their firm's performance managers tend to place relatively less emphasis on traditional financial measures of performance such as return on investment or net earnings. This is usually explained in terms of traditional performance measures being unable to satisfactorily reflect firm performance affected by today's changing business environments. Stemming from these concerns, the academic community largely supports claims that since non-financial performance measures focus on a firm's long-term success factors such as customer satisfaction, internal business process efficiency, innovation and employee satisfaction they may lead to improved organizational performance (Lynch and Cross, 1991; Kaplan and Norton, 1996, 2001; Otley, 1999; Veen-Dirks and van and Wijn, 2002).

However, several recent studies linking the use of non-financial performance measures to performance have produced mixed findings. For example, Fisher (1995) found that organizations experienced difficulty linking the use of non-financial measures to performance. While Brancato (1995) found considerable use of non-financial measures, managers involved in her study could not quantify any links between non-financial measures and performance. Similarly, Ittner and Larcker (1998) found no positive and significant links between non-financial measures of quality and customer satisfaction and financial performance. On the other hand, Banker et al. (2000) found a positive association between customer satisfaction measures and financial performance. In another study, Ittner and Larcker (1996) provided evidence that hedge portfolios formed on the basis of customer satisfaction measures outperformed the stock market in subsequent periods. Anderson et al. (1994) found evidence to support their hypothesis that customer satisfaction in their subject firms was significantly and positively associated with financial performance, measured by return on investment.

These mixed findings may be explained by arguing that previous studies overlooked environmental uncertainty and that uncertainty was present. The major contribution of the current study is to examine the idea that it is in conditions of environmental uncertainty that non-financial measures of performance are most useful in improving organizational performance. This is because non-financial performance measures provide managers with a basis on which to manage the drivers of desired outcomes (Lynch and Cross, 1991; Shields 1997; Otley, 1999; Hoque and James, 2000; Veen-Dirks and van and Wijn, 2002). Against this background, the purpose of this research is to search for a contingent effect of environmental uncertainty on the relationship between the use of non-financial performance measures and organizational performance. It analyses responses to a mailed questionnaire obtained from a random sample of 52 New Zealand manufacturing companies to attempt to control for the possibility that increased environmental uncertainty moderates the impact of the use of non-financial performance measures on organizational performance.

The next section develops the study's hypothesis. Section 3 outlines the research method applied. The empirical results appear in Section 4. Section 5 discusses the results and concludes the paper.