Chapter 13

Management’s Role

 

Management represents the interests of the shareholder. The shareholder’s interest is very simply phrased as a single monetary goal, namely, maximal share price. Management can most effectively represent the shareholder if management can evaluate its decisions in shareholder terms. This is the usual perspective of management. The management role under AFTF is a formalization and extension of this perspective. 

"Nobody can really guarantee the future. The best we can do is size up the chances, calculate the risks involved, estimate our ability to deal with them and then make our plans with confidence."

Henry Ford II

Oversight Role 

Management has overall responsibility for the company. One aspect of company operations is financial reporting. Management has a responsibility to see that financial reporting serves its purposes. Management’s first AFTF role is to implement and support AFTF as an accounting system. Without management support AFTF will not be efficient or effective. While it is possible to implement AFTF without the formal sanctions of the accounting profession, it is expected that AFTF (DVA) will be initiated, promoted, guided, and controlled by the accounting profession. Within the general framework of AFTF, as developed by the accounting profession, management has the responsibility to apply that framework in the most accurate and effective manner. 

In the case of AFTF, an essential purpose is to communicate relevant information. Management by its decisions and actions will determine what is relevant to the success of the company. Management is responsible for evaluating the financial consequences of its decisions, in order to make the best decisions. Management has the duty to communicate the financial consequences of those actions or decisions in a relevant manner to the shareholder. 

Management also has a direct active role in AFTF in that management selects alternatives, develops business plans, makes judgments, requests evaluations based on those plans and judgments, chooses among the alternatives, makes a commitment, directs the implementation, and monitors results. Management must state a commitment and provide a written business plan for each AFTF decision. 

 Specific Responsibilities 

In addition to the general responsibilities outlined above, management has specific responsibilities within the AFTF framework. These responsibilities reflect the realities of management opportunity and control so that management performance becomes clarified. 

Traditional accounting provides information about the past. In the AFTF world, all value resides in the future. This makes AFTF a decision tool for creating or changing the future. To do this we must imagine. 

Management, at all levels, has the duty to represent the shareholder’s best interests. As we have seen, this will be made easier and more visible with AFTF. The shareholder’s interest is to maximize the present value of future net cash flows. This is AFTF value added. Management has the responsibility to add value. This may take many forms. It may be new products, new lines, or acquisition. It may be product improvements, dropping unprofitable lines, or divestiture. It may be controlling the flow of funds to or from the capital markets through dividends or new equities. It may be research and development, pricing or marketing strategies, increased efficiencies, training, or automation. Management must use its experience, judgment, and imagination to produce proposals for action. 

Whatever proposal is produced, it must be evaluated by the modeler. If the valuation is positive then a positive management decision is justified; the proposal will satisfy the shareholder’s requirements. However, it is management, not a positive number, which will make the final decision. 

AFTF is used to evaluate not only new decisions, it can, indeed must, be used to evaluate older decisions. New decisions general add value, but older decisions may be changing values as well. An old line of business may be subtracting value (not meeting the cost of capital) and perhaps should be discontinued. A recent product may be very successful and perhaps should be expanded upon. The entire company needs to be periodically evaluated, not only for AFTF reporting purposes, but to see if course changes are desirable. AFTF encourages management to continuously review old decisions and to convert them into new decisions. 

Management also plays a direct and crucial role in the development of expected cash flows since those flows represent management’s imagination, objectives, and expectations. Management must formally express its imagination as expectations. Management must agree with and formally sign off on all assumptions that affect the expected cash flows. This responsibility can not be avoided and it can not be delegated. This level of management involvement and commitment is part of the discipline of AFTF. 

For new projects it may be management who develops the assumptions. Often these assumptions will not be based on past or known experience and will be highly judgmental. This is where management earns its keep. Management has the responsibility for making difficult judgments about the future and should have the ability and experience to do so. Reason and judgement are the qualities of a leader. Leadership is a central role of management. 

Management is aware that future events are unreliable and that our perceptions of the future are unreliable. Some projects will be less successful than anticipated and some will be more successful. This is to be expected and is the reason we use expected values. The risk of not meeting our expectations in risky endeavors, however, is not neutral. It is positive and should be embraced. The positive reward for risk assumption follows from two general characteristics: risk aversion and limited risk capacities and/or ability to diversify. Companies are formed to cope with and profit from risk assumption. Management must use its resources and abilities to profit from the uncertainty of the future. AFTF delivers the future. Ian Rolland, CEO, Lincoln National Corporation, stated in the 1995 Annual Report: "We understand risk. It’s our business." It’s every company’s business. 

Management must develop a formal business plan. The business plan is a descriptive summary explaining how management intends to implement its decisions. This plan must be sufficiently explicit and detailed to permit the modeler to model cash flows. This is needed at the proposal stage, but is also needed to produce an AFTF decision. A decision will be evaluated within the AFTF accounting framework only if it is informed and committed. An informed commitment requires a business plan. 

Management will be responsible for the initiation, execution, and successful completion of its plans. Not all plans, however, will be successful. Management must know which plans are failures so that they can be successfully terminated. Value will be added by terminating unprofitable endeavors. This requires monitoring the progress of projects or lines. AFTF provides powerful and flexible analytical tools which management should utilize. At the segment or project level, value added provides an initial measure of the value of decisions and ongoing measures of the continuing implementation and support decisions. 

Actual-to-expected cash flows measure how actual experience has deviated, but may also indicate that assumptions and/or models require revision. Value added from the Statement of Values will reveal general trends and may suggest action. The Value Added Analysis and Sensitivity Analysis can point to specific areas of opportunity or vulnerability. The Effect of Assumption Changes should be just as revealing and useful to management as it is to the shareholder. 

AFTF is a direct decision tool for dividend policy. If the company is adding value, the company should not pay dividends and perhaps should acquire more capital. If the company is losing value then dividends should be increased. Both decisions will maximize shareholder wealth. Management can ignore the needs of the capital market only for so long. With AFTF changes in shareholder wealth will be manifest and so will be the destiny of management. 

Debt financing is also a management responsibility. In the AFTF system, the decision to borrow money is evaluated from the shareholder’s perspective, like any other capital budgeting decision, except that the investment is negative. Management should be sensitive to interactions or relationships when evaluating debt financing, for example, the overall cost of capital may rise perhaps negating the apparent shareholder advantage of increased debt leverage. 

Management has the responsibility for producing the management certification. This certification will state that management has determined, or reviewed and approved, all significant assumptions used in determining expected cash flows. This is needed since we are specifically attempting to capture management’s expectations. In addition, management must certify that any new decisions are management commitments, for which a business plan has been submitted to the modeler and for which a cash flow projection has been made. This should not be a major problem since a normal cost/benefit analysis should be similar to the cash flow projection. Management must go on record with its assumptions, decisions, and plans; management will be answerable to the shareholder. This will encourage careful reflection.

 

Conclusions 

Management has a general oversight role for all phases of company operations. In particular, management will oversee AFTF to make sure that it satisfies accounting principles and its intended purposes. Management provides general leadership. In particular, management will provide its visions of the future. Each vision has to be made explicit through a business plan and appropriate assumptions. These visions have to be modeled, evaluated, and a decision and commitment must be made. When this is done, the effects are incorporated into AFTF financial reports. Management must understand risk enough to not be afraid of it. In addition to operational decisions, management must make financing decisions, such as, dividend or debt strategies. These decisions are facilitated by AFTF. Finally, management must publicly expose its general decisions, assumptions, and commitments to public scrutiny in management discussions and the formal management opinion.

   

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