LEVEL OF GROWTH AND ACCOUNTING PROFITABILITY IN CORPORATE VALUE CREATION STRATEGY
By Erni Ekawati
This research examines associations between level of growth and accounting profitability drawn from corporate value creation strategy. Results demonstrate that although the accounting profitability measures generally rise with sales growth, an optimal point exists beyond which further growth contributes to value destruction and adversely affects profitability.
Investment industry demands that managers have to maximize the company’s sales or earning growth over time. This presumption is based on the belief that growth can increase the accounting profitability, and is synonymous with shareholder value creation. Corporate strategies can then be assessed in term of their expected effect on accounting profitability and growth. As a consequence, traditional incentive schemes of compensation is often tied to the manager’s ability to beat budgeted increase in sales or earnings as measures of growth and in turn increasing accounting profitability ratios, such as return on equity, return on assets, and return on investment.
This view contrasts with perspectives that accounting profitability ratios alone cannot be used as an indicator of a profitable business. As Hax and Majluf (1984: 214) point out that it is economic, and not accounting profitability that determines the capability for wealth creation on the part of the firm. It is perfectly possible that the company is in the black, and yet its market value is way below its book value, which means that, from an economic perspective, its resources would be more profitable if deployed in an alternative investment of similar risk. …