Measuring up: baseball statistics are far superior to those commonly used to manage or evaluate corporations.

In both baseball and business, we are inundated by statistics. Baseball aficionados can routinely rank players by their batting average, on-base percentage and slugging percentage, to mention only a few. Investors can rank corporations by their return on equity, earnings per share, price-earnings ratio and numerous other measures. What's clear, though, is that baseball statistics are far superior to those commonly used to manage or evaluate corporations.

Every baseball fan knows that it makes little sense to compare players by the number of base hits that they have made during a season or by the number of times that they reached base via a hit, walk or hit-by-pitch. To compare base hits, one needs to "know the number of times each player was officially at-bat. So the statistic that really matters is not base hits, but batting average, which is base hits divided by official at-bats.

The problem with batting average, though, is that the denominator, official at-bats, excludes walks, hit-by-pitch situations and sacrifice hits. So a superior measure of a player's performance is his on-base percentage, which consists of the number of times he reaches base via a hit, walk or hit-by-pitch, all divided by his number of at-bats plus his walks, hit-by-pitch instances and sacrifice flies. On-base percentage is therefore the number of times a player reached base divided by the number of times he had an opportunity to do so.

In the corporate world, performance measures are far less informative. We eagerly rank corporations by their financial performance, but we seldom incorporate the appropriate denominator--the risk firms take to achieve that performance. Here is a brief guide to some risk measures (and their acronyms) that we could use to keep score:

V (variance of returns): V is defined as--are you ready for this?--the average of the squared deviations from the average return for a series of time periods--days, months, or years. A related measure is standard deviation, or SD, which is the square root of V. Both were used by Harry Markowitz in his 1959 book Portfolio Selection, which won him a Nobel Prize and caused these measures to be enshrined in MBA textbooks. Despite their credentials, these measures are not intuitively understandable and make no distinction between positive and negative returns.

SV (semi-variance of returns): Markowitz--no dummy--realized the problem with V and SD and so proposed SV as well. SV is similar to V, except that it looks only at downward return deviations and not at upward ones.

PL (probability of loss): PL is the likelihood of a loss on a deal, a line of business or the business as a whole. But PL is flawed because it says nothing about loss severity.

VaR (Value at Risk, also known as PML, Probable Maximum Loss): VaR measures how much a line of business or company could lose during a specified period--a day, month or year--with a specified probability. VaR is typically used to estimate the capital a firm needs to survive extreme possible losses.

TVaR (Tail Value at Risk): This measure is like VaR except that it measures the average amount of losses that exceed VaR--that is, if we are going bust, how big is the mess likely to be? TVaR is most likely to interest regulators and owners of corporate bonds.

During the past decade VaR has become widely used in banking, in part due to regulatory pressure. But in most of the corporate world we stubbornly cling to measures of performance that totally fail to recognize differences in the risks taken to achieve them. Now most corporate executives will strenuously object to this statement, claiming that they do carefully weigh risk as well as return in managing their businesses. But here are a few simple questions--behavioral indicators--that will quickly identify firms that do indeed take risk seriously:

* How many meetings, memos, reports, e-mails, and computer models do you see that pertain to measuring or forecasting earnings?

* How many do you see that pertain to measuring or forecasting risk?

* Does your firm ever measure or reward performance relative to the risk taken to achieve it?

If, in baseball, we need to divide performance measures by the number of opportunities, then in the corporate domain we likewise need to divide commonly-used performance measures by a suitable measure of the risk taken to achieve that performance. Making this happen is one of the principal challenges facing post-Enron corporate managers.

William H. Panning, a Best's Review a columnist, is executive vice president and managing director at Willis Re Inc. He can be reached at [e-mail].