THE
WALL STREET JOURNAL.
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Business |
Journal Reports: Leadership
Methodology for the Management Top 250 Company Rankings
How the Drucker
Institute identified the most effectively managed U.S. companies
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A total of 37 indicators are used in the
Management Top 250 rankings. PHOTO: ISTOCK IMAGES |
Dec. 5, 2017 9:05 a.m. ET
Management Top 250 ranking
is based on a holistic measure of corporate “effectiveness” that was
developed by the Drucker Institute, a part of Claremont Graduate
University in Claremont, Calif. “Effectiveness” is defined as “doing
the right things well.”
The ranking includes U.S. companies whose shares are traded on
the New York Stock Exchange or Nasdaq Stock Market, and which meet criteria,
described below, related to their value and prominence.
The measure seeks to assess how well a company follows a core set
of principles advanced by the late Peter Drucker, a professor, consultant,
author and longtime Wall Street Journal columnist. Mr. Drucker died in 2005.
These principles serve as touchstones for five dimensions of
corporate performance: Customer Satisfaction, Employee Engagement and
Development, Innovation, Social Responsibility and Financial Strength. For a
list of the specific Drucker principles underlying the measures, please visit
www.drucker.institute/rankings-principles/.
How
to Read the Rankings
All scores are expressed as T-scores. They are standardized so
that the range is 0 to 100, the mean is 50 and the standard deviation is 10.
If a company is one standard deviation above the mean (with a
score of 60), its results are in the top 15% to 20% of a larger universe of 693
companies that have been ranked by the Drucker Institute. (For the full list,
which includes U.S. and some Canadian companies, please go to
www.drucker.institute/rankings-2017/.) If a
company is one standard deviation below the mean (with a score of 40), its
results fall in the bottom 15% to 20% of that larger universe.
If a company is two standard deviations above the mean (with a
70) or two standard deviations below the mean (with a 30), its results are in
the top or bottom 2.5% of the larger universe. And if a company is three
standard deviations above the mean (with an 80) or three standard deviations
below the mean (with a 20), its results are in the top or bottom 1% of the
larger universe.
The fact that a firm is ranked toward the bottom of the
Management Top 250 does not mean that it is not managed effectively. The
lowest-ranked firm on the list is still in the top 40% or so of a much larger
group of companies that was analyzed.
How
“Effectiveness” Is Measured
Much like human health, intelligence or athleticism, corporate
effectiveness is a “latent variable,” meaning that it cannot be directly
observed. But it can be inferred from other variables that can be observed
(known as “indicators”).
Explore the Management Top 250
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Stephanie Dalton Cowan for The Wall
Street Journal |
|
In the case of the Drucker
Institute’s model, there are 37 indicators that fall under the five dimensions
of corporate performance.
In building the model, no one dimension of corporate performance
(or any of the 37 indicators) was judged to be more important than any other.
That said, because the scoring system is compensatory, a company with average or
low scores in one dimension (such as Employee Engagement and Development) but
exceptionally high scores in another (like Innovation) can end up highly ranked
overall.
In calculating scores, a slightly different weight was computed
for each dimension based on the degree to which it was found to contribute to
overall corporate effectiveness. Those weights were as follows: Customer
Satisfaction = 18%; Employee Engagement and Development = 20%; Innovation = 20%;
Social Responsibility = 23%; and Financial Strength = 19%.
Fundamentally, the model rests on the belief that all five
dimensions are interrelated and influence each other over time—what social
scientists call “reciprocal causation.”
While it might be possible to untangle those influences with
longitudinal data—and the Drucker Institute is actively conducting research to
better understand how different parts of the model relate to one another—that is
not the immediate goal of this measure. Rather, the main purpose is to provide a
“snapshot” of overall corporate effectiveness at a point in time.
Development of the Model
Development of the model began in 2014, and included several
prototype phases, with increasingly larger samples of companies included.
Lawrence Crosby, chief data scientist at the Drucker Institute’s KH Moon Center
for a Functioning Society, designed the model and, with the Drucker Institute’s
Rick Wartzman and Zach First, oversaw its development.
More than 100 indicators were analyzed before settling on the 37
that ultimately went into the model. All potential indicators were judged
against the following criteria:
• They needed to be rigorously developed based on sound
statistical methods.
• They needed to capture the essence of a specific Drucker
principle.
• They needed to have a sufficiently high correlation with the
other indicators of the same dimension—providing assurance that each one was
actually measuring the same aspect of corporate effectiveness. For example, each
indicator in the area of Customer Satisfaction had to correlate highly with
other indicators in that category.
The
37 Indicators
The indicators used in the model are based on data obtained from
a variety of third-party providers. Alice Korngold, an expert on sustainability,
board governance and measurement, who is chief executive officer of Korngold
Consulting in New York, developed the methodology for a portion of the Social
Responsibility category.
See a
list of the 37 indicators.
Population of Ranked Firms
Each company listed in the Management Top 250 represents one of
the highest scorers among a larger universe of 608 U.S. companies that met at
least one of the following criteria:
• Its market capitalization was $10 billion or greater as of
Sept. 16, 2016.
• Its shares were a component of the S&P 500 stock index as of
October 2016.
• It was a publicly traded component of the 2016 Fortune 500 list
published in June 2016.
The Management Top 250 includes U.S. companies, as well as
companies that have principal executive offices outside the U.S. but are listed
in the Fortune 500 or have stock that is a component of the S&P 500.
To be included in the larger universe of 608 companies, at least
two valid indicators had to be available for each of the five dimensions. Any
company for which fewer than two indicators were available in any dimension was
excluded from consideration.
Also excluded was any company that met the criteria noted above
but ceased to be a stand-alone entity because it merged or was acquired before
June 30, 2017.
Data Collection
The Drucker Institute obtained all of the data needed to produce
the 37 indicators during the first half of 2017. In all cases, this was the most
recent data available at the time.
The Financial Strength indicators cover the 12 months ending June
30, 2017.
Where available, data was obtained going back to 2012 on a
year-by-year basis. This historical information provides a baseline for
measuring change within each of the company’s five dimensions of performance and
in terms of its overall effectiveness, as well as for spotting longer-term
trends.
Scoring of Firms
Companies were scored by:
1. Standardizing the raw scores on the 37 indicators to have a
mean of 0 and a standard deviation of 1.
2. For each dimension, averaging the company’s two or more valid
indicators.
3. Restandardizing the average scores.
4. Transforming the standard scores to T-Scores having a mean of
50, a standard deviation of 10, and a range of 0 to 100 (except in unusual
circumstances).
5. Through factor analysis of those five sub-scores, computing a
factor score on overall effectiveness for each firm, which, in turn, was also
transformed into a T-Score.
Missing Data
The underlying data used to compute the 37 indicators was not
available in every instance for every firm being ranked. Where there was a
missing field, a score was derived by computing the average of that dimension’s
indicators for which the firm had a valid score. For example, the Customer
Satisfaction category has eight indicators. If a firm had a valid score for six
of those indicators, the firm’s Customer Satisfaction score became the average
of the six.
The Drucker Institute compared this way of handling missing data
against another method called “multiple imputation,” in which a computer
analysis uses all of the known variables across the entire model to fill in any
blanks. Both methods produced very similar results.
Testing and Validating the Model
To build the model, the Drucker Institute utilized structural
equation modeling, a technique that uses a combination of factor analysis and
multiple regression analysis to examine the relationship between measured
variables and latent constructs.
This approach allowed for the analysis of the entire model
simultaneously, including all proposed indicators, as well as all five
dimensions of corporate performance and overall corporate effectiveness.
A series of tests was run to ensure:
• Construct validity (the degree to which the indicators actually
measured what they claimed to measure)
• Reliability (freedom from random error)
• Goodness of fit (between the approach being taken and the data
being examined). The goodness-of-fit statistics are: Goodness of Fit Index =
0.92, Adjusted Goodness of Fit Index = 0.91 and Normed Fit Index = 0.90.
Safeguards were also built into the model so that if a single
source was used in various places (such as wRatings data going into both the
Customer Satisfaction category and the Innovation category), it wouldn’t be
overweighted.
In the end, the model confirmed that:
• Taken together, the five dimensions reflect a single
higher-level construct (corporate “effectiveness”) and that each has a
substantial factor loading on that construct. The following are the range of
loadings observed for each dimension using a variety of statistical estimation
methods: Customer Satisfaction is 0.56 to 0.68, Employee Engagement and
Development 0.51 to 0.66, Innovation 0.58 to 0.83, Social Responsibility 0.68 to
0.81 and Financial Strength 0.56 to 0.63.
• The selected third-party metrics serve as valid and reliable
indicators of those five dimensions. The average factor loading within each
dimension is 0.65.
A diagram of the structural model as specified in SPSS AMOS is
available from the Drucker Institute upon request.
In addition, during the prototype phase of the model’s
development, the Drucker Institute worked with PayScale to field a series of
survey questions to the employees of 41 companies. These questions aimed to
gauge how well these employees exhibited behaviors and mind-sets that were in
line with the various Drucker principles. An analysis of the results showed that
companies where employees self-reported that they were adhering to the Drucker
principles scored relatively high on the corresponding indicators used in the
model. This convergence gave further support to the model’s validity.
Tests were also conducted to determine how volatile the model is.
Too much volatility would suggest a high degree of randomness, while too little
would suggest that the model is insensitive to real change. To help address this
question, the Drucker Institute examined the percentage of firms that remained
in different performance bands (e.g., Top 25, Top 50, etc.) for two consecutive
years. Based on this, the model was found to have a level of volatility about
equal to other well-known “best of” lists produced by two business publications.
Future of the Model
The Drucker Institute is committed to a process of continuous
improvement. So while the principles that underlie the model are considered
sacrosanct and are unlikely to change, new indicators may be introduced if they
are determined to serve as better proxies for those principles.
The Drucker Institute will also continue to analyze its
computational methods to ensure that they deliver fair and equitable ratings and
rankings.
If you have any questions or comments, please email
rankings@drucker.institute.
The name “Peter F. Drucker” is a registered trademark of The
Drucker 1996 Literary Works Trust. The Drucker 1996 Literary Works Trust is not
a sponsor of and has not approved, authorized, reviewed or been involved in any
aspect of the Drucker Institute’s company rankings.
Appeared in the November 24,
2017, print edition as 'Firms Cut Buybacks As Stocks Become Expensive.'