By Rick Wartzman and Kelly Tang 

"What in the world were you thinking?"

More than any other reaction -- though often in terms not quite so polite -- that's what we heard last year after General Electric Co. came in at No. 18 out of 752 large, publicly traded companies that we ranked using the Drucker Institute's measure of corporate effectiveness. Roughly the upper third of the firms that we evaluate each year make up the Wall Street Journal Management Top 250, which had its debut in December 2017.

At the time, GE was in a tailspin. The company was on its third chief executive in two years. Its balance sheet was in shambles, and its dividend had been slashed. What's more, GE had just disclosed that federal prosecutors had opened a criminal probe into its accounting practices. GE has denied wrongdoing and said it is cooperating with the investigation.

Surely, the fact that GE landed in such a lofty spot on our list meant that our entire model was flawed.

Actually, not at all -- and more on that in a minute. But the reaction helped lead to what we hope will be a welcome, if simple, change to this year's presentation: a visible "red flag" warning given to any company in the Management Top 250 that scores in the bottom 25% of our larger universe of assessed firms in any of the five areas that we explore: customer satisfaction, employee engagement and development, innovation, social responsibility and financial strength.

Roots of imperfection

Developed and tested over four years, our rankings are designed to reveal how effectively a company is managed according to the core principles of the late Peter Drucker, a professor, consultant, author and longtime Wall Street Journal columnist. Mr. Drucker defined "effectiveness" as "doing the right things well."

For our 2019 analysis, we examined 820 companies in all, using 34 indicators across the five categories. Corporations are compared in each of the categories, as well as in their overall effectiveness, through standardized scores with a range of 0 to 100 and a mean of 50. (Our methodology, data sources and other details can be found here.)

So why do we sometimes miss the mark?

It could be because of a time lag. Many of the metrics that we use in our model are collected by our data providers months in advance of when the year's rankings are published.

But there are also bigger issues at play. For one thing, our rankings fall into the realm of management science. By this criterion, our model is highly dependable and durable. The statistical correlations among the variables that we track are very strong and indicate that a holistic appraisal of corporate effectiveness can, in fact, be derived from the data. Still, that doesn't mean that our system captures every factor -- or even most factors -- that lead to an individual company's success or failure.

Indeed, it should worry you if we got it right 100% of the time. That would be magic, not science.

For another thing, most of the companies we rank don't perform evenly across the five categories, and an outstanding showing in one area can lift a firm's overall effectiveness score, obscuring weakness elsewhere.

This is, in part, why we wanted to highlight with a red flag those companies with extremely low scores in any given dimension. It's a signal that at least one aspect of a company's operations may be misfiring so badly it could undermine the whole enterprise.

Had we used red flags last year, GE would have been slapped with one. Its total effectiveness score was 74.2, putting it in the top 2% of all the companies that we scrutinized. This was driven, to a great degree, by an astronomical innovation score of 109.9, which was in the top 1% of all firms. Yet its financial-strength score was plainly in the danger zone; at 38.6, it was in the bottom 7% of the companies we covered.

Another change

As we move forward, we will keep looking for ways to improve our model while continuing to adhere to Mr. Drucker's key tenets. In addition to the red flags, we made a major change this year in how we calculate financial strength by leaning heavily on a set of metrics related to economic value added. EVA gauges a company's underlying "economic profit" -- its operating earnings minus the opportunity cost of the capital tied up in its business -- not its "profit" in a purely bookkeeping sense, offering insight into how well the business is managed.

The revision made the correlations throughout our financial-strength category even more robust than they were before.

It also reaffirmed GE's precarious position in this area. The company, which slipped to No. 100 in the rankings, is now in the bottom 2% of all firms in financial strength, with a score of just 32.2. And that made it among 54 companies in the Management Top 250 to earn a red flag.

Mr. Wartzman is the head of the KH Moon Center for a Functioning Society, a part of the Drucker Institute, and Ms. Tang is the institute's senior director of research. Email them at reports@wsj.com.

 

(END) Dow Jones Newswires

November 22, 2019 10:45 ET (15:45 GMT)

Copyright (c) 2019 Dow Jones & Company, Inc.
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