USING STOCK VALUE AS THE PERFORMANCE MEASURE IN A BUSINESS SIMULATION GAME Developments in Business Simulation & Experiential Learning, Volume 27, 2000 USING STOCK VALUE AS THE PERFORMANCE MEASURE IN A BUSINESS SIMULATION GAME Lee Tangedahl, University of Montana ABSTRACT This paper proposes that the stock value may be used as the sole measure of student performance in a business simulation game. Note that for the course as a whole, assignments (e.g. papers or presentations) may provide additional grading criteria. A simple stock value model may be used and has certain advantages, but financial theory suggests a more complicated model, based on the present value of future cash flows should be used. It is suggested that students be provided with a planning model that enables them focus their planning in conjunction with the stock value model used in the simulation. INTRODUCTION Using stock value (i.e. value of an individual share of common stock) as the sole performance measure in a business simulation game poses at least two questions. First, does stock value adequately measure the factors indicating student success in a simulation game? Second, can stock value be accurately computed in a simulation game? An affirmative answer to the first question implies that the stock value directly reflects how well the students have mastered the important concepts of the business simulation game. The game should be constructed to reward good decisions with additional cash flow and therefore a higher stock value. Certainly an instructor may want to emphasize other, non cash flow aspects of the game and other measures would then have to be used. Also, the course may include other assignments (e.g. papers, presentations, etc.) that may provide the instructor with the opportunity to measure other concepts beyond the business simulation game. The second question may be more difficult to answer. The financial theory is fairly clear, basing the stock value on the present value of future cash flows. Applying this theory to a business simulation game, or the real world, may not be as clear. The mathematical complexities, besides making the simulation itself more difficult, may also make it more difficult for the students to focus their planning on aspects that will lead to a higher stock value. THE COURSE AND GRADING The business simulation game discussed in this paper is a total enterprise, two-product game with marketing, production, and financial variables. This game has been developed for a semester capstone course in which student teams (3 to 5 students) compete during in a 4- year (16-quarter) game. The course emphasizes teamwork, planning, and oral and written communication. The course provides students with experience in applying the knowledge from previous courses, in using technology, and in meeting deadlines. Course grading is based in team performance in the game (50%), written annual plans (25%), a marketing plan presentation (12.5%), and individual presentations (12.5%). The number of points for team performance increases each year as more variables come into play. Peer evaluations may be used to modify the distribution of team points. THE SIMPLE STOCK VALUE MODEL The team performance (50% of the total grade) is measured by the stock value at the end of each year. A simple approach would be to 122 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 compute the stock value with a simple formula using the earnings per share and the dividend payout ratio for each of the four quarters of the current year. The earnings per share are weighted evenly and the payout ratio is measured against a target (e.g. 40%) that is set by the instructor. The Advantages While this formula for stock value favors simplicity over reality, with obvious shortcomings, it does have some favorable aspects. First, the students have two perfectly clear goals – maximize total earnings per share for the year and hit the target payout ratio. All decisions and strategies can be based on maximizing total earnings per share for the year. Second, the payout ratio serves as an indicator of planning accuracy. The difference between the actual and target payout ratios indicates the accuracy of a team’s forecasted demand, productivity, etc. Third, stock value is not biased in favor of teams with larger capacity. A team that purchases additional capacity through issuing stock or increasing debt must increase income to match the additional shares outstanding or the increased interest expense in order to maintain their stock value. It should be noted that cost of borrowing must be properly tied to the debt equity ratio to make this model work. Fourth, the design criteria for the game can be generalized into rewarding good decisions with increased revenue or decreased expenses while penalizing all bad decisions oppositely. For example, good labor practices can be rewarded with higher productivity while bad cash management can be penalized with increased cost of borrowing, and each should have an appropriate effect on stock value. The Disadvantages Even though this stock value model may be appealing in its simplicity, its flaws cannot be overlooked - serious finance students have frequently complained about the inaccuracies. First, the model ignores the time value of money, dividends or earnings are valued the same for the first quarter as for the last quarter of a year. Second, the model does not consider the potential for future earnings and dividends. Teams are discouraged from expanding because their stock value will reflect the current expenses incurred from expansion but not the potential for future income. Third, the simple stock value model is too far removed from either “commonly accepted” theoretical models or from reality. Such comparisons (between simulation results, theory, and reality) are common, and may be controversial, but should not be overlooked. Fourth, the simulation game should reinforce the appropriate financial decisions made by the students who are serving as managers of a company. Rather than focusing only on the current “bottom line”, students should consider instead the accumulated wealth of the stockholders. Students should be aware of what they are earning as return on the stockholders’ investment and should seek to invest the company’s earnings in a manner that will maximize that return in the future. THE REVISED STOCK VALUE MODEL Corporate financial theory indicates that stock value should be determined by the net present value of the cash flows, e.g. Ross (1995). Applying this theory to a simulation model requires estimating each team’s future earnings, taking past team decisions and future economic conditions into account, and then discounting that future earnings stream back to present value using the team’s weighted cost of capital. The model must also react correctly to factors in the game such as issuing or buying back shares of stock. Two excellent discussions of stock value models that are based on future team earnings are provided by Goosen (1994) and Brooks (1999). Applying the Revised Model The key to successful student performance in a simulation game must be based in planning. 123 Developments in Business Simulation & Experiential Learning, Volume 27, 2000 Therefore, to successfully apply this revised stock value model to the simulation game, students must be able to focus their planning to achieve a higher stock value in accordance with the revised model. Students must be able to look beyond the current bottom line to be aware of the effect that current decisions will have on future earnings, which, in turn, affect their stock value. Students must also be aware of the cost of capital, the return on investment, and the economic conditions and how all these factors will influence their stock value. To facilitate planning, students are provided with a comprehensive spreadsheet model to utilize in the planning process. This spreadsheet model records historic performance and current economic conditions and then projects future cash flows based on student decisions and forecasts. Students are able to experiment with the decisions and forecasts, observing the resulting cash flows and their possible effect on stock value. While the planning model provides ratios, pro forma financial statements, and other comprehensive information, it does not go so far as to make the decisions for the students. Furthermore, the information provided by the planning model is only as good as the forecasts (e.g. demand, productivity, credit rating) provided by the students. The planning model attempts to put the students in the realistic position of searching for optimal decisions that will maximize the wealth of the stockholders while in an uncertain environment. REFERENCES Brooks, LeRoy D. (1999), Fingame Online 3.0, Third Edition, Irwin/McGraw Hill. Goosen, Kenneth R. (1994), “Increasing the effectiveness of performance evaluation through the design and development of realistic finance algorithms, “ Developments in Business Simulation & Experiential Exercises (21), 63-69 Ross, S. A., Westerfield, R.W. & B. D. Jordan. (1995). Common Stock Valuation. Fundamentals of Corporate Finance, 3rd ed., Iwin/McGraw Hill, pp. 174-185. 124 Table of Contents Volume 27, 2000 Internet International: A Simulation Exercise for Understanding Technological Innovation and customer Service In a Rapidly Growing Internet Server Company Simulations and Learning: Dialog and Directions Endnote Activity: A Tool for Integration of Course Content and Communication Skill Practice Incorporating Video as a Teaching Strategy in Interpersonal Communication Vision Quest: An Alternative Approach to Industry Analysis for MBA Courses in Strategic Strategic Management: An Evaluation of the Use of Three Learning Methods Trainer, Mentor, Educator: What Role for the College Business Instructor in the Next Century? Using the Internet and Shareware to Facilitate Computer Simulation in Distance Learning Classes Visual Modeling of Business Simulations Teaching about Information with Management Games A Self-Evaluation Based on the Discussion and Decision in Experts' Business Gaming The Restaurant Game Using Journals to Enhance Computer Simulation Based Learning Exercises to Facilitate Better Student Writing in the Undergraduate Strategy Class Identifying, Resolving, and Managing Common Ethical Dilemmas in the Workplace: An Experiential Approach Integrating the Digital Revolution into the Classroom The Wheel of Learning: An Integrative Business Curriculum Experiment The Changing Nature of Simulation Research: A Brief ABSEL History Perspectives on Simulation & Gaming's Review Process Experiential Learning Across Disciplines: Mixing International Business and Accounting Simulating Governmental Effects on Economic Development Internationalizing the Introduction to Business Course Using an International Text and Domestic Simulation with a Twist Using Stock Value as the Performance Measure in a Business Simulation Game Introducing Cross-Elasticities in Demand Algorithms Validating a Model of Currency Valuation An Exercise for Exploring the Relationship between Jungian Psychological Types and Organizational Politics Exercise: Preparing Financial Reports Using the Group Categorizing Technique Effect of Trust and Cultural Beliefs on Negotiation Processes: Data from an Experiential Role Play Experiential Learning Gets Stamp of Approval From the Boyer Commission Talent Search 2000 - An Experiential Activity to Help Strengthen Skills in Employee Recruitment and Selection Clemson University's Collaborative Learning Environment Initial Data on a Test Bank Assessing Total Enterprise Simulation Learning Changing the Assessment Paradigm: Using Student Portfolios To Assess Learning from Simulations How We Learn and Why We Don't: The Cognitive Profile Model: A Workshop in Teaching to Reach Your Students Knowing Thyself: A Portfolio Approach to Student Self-Assessment Collaborative Learning and Web-Based Instruction in a Cognitive Apprenticeship Model Teamwork Attributes in a Classroom Simulation Virtual Teams: Meeting the Next Challenge for Experiential Education New Age Learning: Nuance or Nonsense Developing Charisma: An Experiential Exercise in Leadership Problems and Solutions in Going Web-based with an Agribusiness Simulation Creating a Comprehensive Web-Enhanced Classroom Your Class is in Session, Now What? The Challenges of Teaching On-line An Application of Process Control Charts for Attributes as a Form of Classroom Assessment for Experiential Learning Work Goals and Life Aspirations: Do You Have What it Takes to be an Entrepreneur An Exercise to Develop Initiative: Possible Dream? The Ball Point Pen Assembly Company Management Game Review System Development Total Enterprise Simulations and Optimizing the Decision Set: Assessing Student Learning Across Decision Periods Facilitating Learning in the New Millennium with the Complete Online Decision Entry, System (CODES) The Marketing Management Experience The Right Venue for Your Simulation One More Time: Overall Dominance in Total Enterprise Simulation Performance A Profile of ABSEL Conference Attendees Learning Readiness: An Underappreciated Yet Vital Dimension in Experiential Learning Active Learning in a Professional Undergraduate Curriculum The Problem Is - They Think Differently! Cultures Integration in Mergers and Acquisitions: Putting Managers Together in a Business Simulation The Global Business Game: A Strategic Management and International Business Simulation