JUCPA Volume 12 Number 8 August 2015 Ser

Jour na l of U S-China

Public Adm inist rat ion

Volume 12, Number 8, August 2015 (Serial Number 118)

Contents

Management Issues and Practice

The Resistance to Change as a Specific Risk for the Organization Transformation

593 Costel Loloiu, Toma Ple şanu, Dumitru Cătălin Bursuc

Performance Target Setting System and MoU Experience in India

603 Ram Kumar Mishra, Geeta Potaraju

Economical Issues and Innovation

Impacts of Intellectual Capital on Profitability: An Analysis on Sector Variations in Hong Kong 614 Michael C. S. Wong, Stephen C. Y. Li, Anthony C. T. Ku

Models for Transforming Businesses Toward Sustainability

627 Julia Dobreva

Political Studies and and Social Governance

ASEAN’s Role and Potential in East Asian Integration: Theoretical Approaches Revisited

635 Nguyen Huu Quyet

Fiscal Sustainability: Responsiveness in Times of Crisis: A Review of Sub-National Governments in Mexico

651 Alain Dimitrius Izquierdo Reyes, Juan Diego Omar Martínez Delgado

Journal of US-China Public Administration, August 2015, Vol. 12, No. 8, 593-602

doi: 10.17265/1548-6591/2015.08.001

DAVID PUBLISHING

The Resistance to Change as a Specific Risk for the

Organization Transformation

Costel Loloiu, Toma Ple şanu, Dumitru Cătălin Bursuc “Carol I” National Defence University, Bucharest, Romania

The theoretical approaches and also the practice in organizational change show us that there is no such thing as a pre-defined solution, that we cannot say about an organization perspective if it is good or bad, but we can say about it that it is appropriate, in accordance with the organization objectives, that it answers to the national specific and also to the economic and social context. The pre-established solutions do not have an absolute value, they represent only recommendations for establishing the actions regarding the organization management, the applying of the performance management instruments, the developing of the transformation abilities, the change implementation. In this situation, a question arises: Why does a useful and necessary transformation needed to accomplish the organization objectives face a resistance? Besides the personal interests and attitudes, the resistance explanations should be sought in the lack of correlation between the institutional objectives and individual ones, an area which is not enough regulated by the organizational culture, but more often at a high level of inadequacy between the structure and the categories of objectives mentioned above. We appreciate as being essential the learning capacity proved by the organization; the innovative side must face the human nature which preserves its comfort created by the routine, developing the tendency of denial for every change.

Keywords: resistance to change, organizational transformation, risk management

The organization responds to the environmental modifications by adapting specific changes which only aim to the planned outputs limit or may represent the reorganization of structures or processes. The manager equally thinks about the present and the future, the change orientation refers to the given chance and also to the subsequent events threat (Druker, 2010, p. 124).

The nowadays situation of public companies, with new and dynamic risks toward their functionality, makes the managers effort at the strategical and tactical level to aim mainly to designing and implementing the change. Besides the required qualities and abilities for managing the public organizations, it is mandatory the

∗ This work was possible with the financial support of the Sectoral Operational Programme for Human Resources Development 2007-2013, co-financed by the European Social Fund, under the project number POSDRU/159/1.5/S/138822 with the title

“Transnational Network of Integrated Management of Intelligent Doctoral and Postdoctoral Research in the Fields of Military Science, Security and Intelligence, Public Order and National Security—Continuous Formation Programme for Elite Researchers”—“SmartSPODAS”.

Costel Loloiu, Ph.D. candidate in military science and information, “Carol I” National Defence University, Bucharest, Romania; research field: public administration. E-mail: loloiucostel@gmail.com. Toma Ple şanu, Ph.D., Colonel Professor Eng., Dean of the Security and Defence Faculty, “Carol I” National Defence University, Bucharest, Romania; research fields: project management and knowledge management. E-mail: tomaplesanu@yahoo.com.uk. Corresponding author: Dumitru C ătălin Bursuc, Ph.D., Comander (Navy) Eng. Senior Instructor, Director of Postgraduate School in Military Management and Teaching Staff Training Department, “Carol I” National Defence University, Bucharest, Romania; research fields: modelation and simulation, military education, and career training. E-mail: catalin258@yahoo.com.

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION leading personnel recognize the moment when the change is needed or unavoidable and they must require the

others to be part of the initiative. The specialized literature adds the transformational leader to the classical leader types. This type of leader convinces the inferiors about the importance of achieving the new objectives and the rightness of the methods through which they are achieved, increasing the level of implication, the responsibility and the common goal adhesion. In this case, the personnel is encouraged to modify its thinking regarding the way they approach the problems, the subordinates are encouraged to have a new vision and a new attitude toward the problems, according to the personal and the organization objectives (Ispas, 2012, p. 25). The personnel focusing on the activities circumscribed to a successful project could develop a high inertia level which, in the case of running a new project represents a good premise for the organization transformation (Ruckes & Ronde, 2015, pp. 475-497).

The discussion on change must not exclude the continuity elements in the organization activity or structure. The continuity plans existence is legitimated by the fact that, the change must, in the first phase, identify the operations of maximum importance, so that the organization could achieve the main prerogatives the way they are defined in the strategical plans or the normative provisions. The recommendation referring to the continuity plans is that these should be developed starting from the most pessimistic scenario, taking into account the fact that the measures which must be taken should be at a smaller scale, in order to be adapted to the real situation which determined the necessity of change (ASIS Commission on Standards and Guidelines, 2005).

The difficulty of making the change is directly proportional with its depth and the structure dimension which is referring to. The change amplitude goes from individual to group level and to the organizational one. The project management has the most evident dynamics at the project team level, which from one phase to another or from one project to another reorganizes itself inside a matrix structure made up of specialists from different fields of activity.

For public organizations, the modality of change implementation is, generally speaking, from top to bottom due to the set hierarchical structure and the way the authority is centered. The authors consider the restructuring and the functional reorganization as being part of the generally term. They admit that it might exist a situation when change is not responding to a macrosocial situation modification, and this fact leads to other transformations, which are inevitably more subtle. In this case, the change is internally planned by a group with formal authority or informal influence that takes to functioning changes or structure modifications.

We should note that the change reaches the macrosocial level and sometimes has a nature which is inevitably commanded by global evolution. Figure 1 shows the change levels and the relation between the necessary time for the change correlated to its difficulty.

The accelerated dynamics means a quite recent approach of the situations characterized by uncertainty and their consequences and it is considered to be the integrated management risk in organization. This pattern of integrated risk analysis (Sammer, 2002) is justified by the changes rhythm which is commanded by globalisation, by the multitude of regulations belonging to the different domains, by the continuously growing expectations of the interest holders, by the new information and communication technologies, etc. Conducting activities in different countries or multinational environments implies the existence of diverse managerial and organizational culture, with different regulations and application environments. The changes in the integrator macrosystem may induce dysfunction in the objectives achievement. The deficiency may be removed or reduced by the existence of one structure that can manage transformation and observe the organization risks, at national and multinational level.

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION

Organizational Group

Change duration schimb ării

Short

Long

Figure 1. Difficulty and change duration correlation depending on the change level.

Change Resistance and Its Characteristics in Public Organizations

The issue of risks in public organizations cannot be analyzed separate from the realities which accompany the contemporary realities. An integrated model of activities analysis and planning at any level is needed so that the prevention may become an essential component of activity at any level. Organization must respond by structural modifications and by adapting their specific tasks to the new realities and to the way they influence the administrative structures and their missions. It is necessary for the specific regulation basis which ensures the risk’s integrated management in administration companies to be evaluated and reconsidered, in order to observe the organization necessity to adapt itself.

The change formal goals are: increasing the performance in objectives achievement, maintaining the internal organization balance, adapting and functional optimization together with the flexibility of the environment dynamics.

The environment changes and the organization internal evolution represent the change potential of the organization structure, of culture, policies and their processes. In reality, an important resistance is shown when the authors try to implement the modifications in the organization. They adapt a Leavitt diagram (see Figure 2) in order to illustrate the interdependent change characteristics and the mutual influence between technology and organization. Thus, the technological changes are turned from the right direction and cancelled by processes and organizational compounds, structures or persons. The Leavitt pattern of organization evolution shows off that the efficient way to induce the change is represented by a simultaneous change of technologies, tasks, structures, and persons.

It is necessary for the organization to be prepared before a change insertion in one of the components; then it comes the rapid implementation followed by a change institutionalization. The organization determinants which must be taken into consideration are shown below (see Table 1).

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION

Tasks

Structures Persons

Technology

Figure 2. Levitt diagram.

Table 1 The Organization Determinants Which Play a Role in Transformation Process

Structure conditioning

Psychosocial conditioning

Functional conditioning

External conditioning

Tasks, decisions, and processes

Organization type and structure Organizational culture

designated to sustain the

Environmental limitations

change

Organization dimension

Management change adhesion Other organizations interactions The hierachical level in the

Leadership nature and style

Main affected interest group,

Modifications implementation

organization

The normative framework Change amplitude and factors intensity

the personnel attitude

procedures

In order to get benefits deriving from change, the alining of individual and collective interests must be designed at the same level and with the same intensity as the changes imposed by the implementation of the technologic factor. For example, if we choose technology because of the informatics and communication technology evolution acceleration, the modification will require changes of the organization culture elements and the norms, values and procedures.

Recent study (Righi & Saurin, 2015, pp. 19-30) shows that changes targeting the technological modifications have a pretty reduced framework to make them operational. Rules of change implementation are set and they follow the system complexity and environmental limitations which may have four directions which trace the dynamics interactions and also the unexpected evolutions with direct or mediated effects.

The forces-field action which governs the organizational transformation compares the change forces and the forces which oppose the change (Card, 2013, pp. 87-92). Forces against change can be of individual or group type and they refer to the following elements (Kotter & Schlesinger, 2008):

(1) Personal interest not connected to the organization interest; (2) Errors in understanding the implications of organizational change; (3) Different situation assessment especially between the management and the workers;

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION

(4) Low tolerance to change generated by the distrust to the capacity to adapt. The recommended action is, in this case of deficiencies, reducing the forces which are opposing the

organizational change. If correctly and in time identified, these forces may be reduced until cancelling their unwanted consequences using efficient management measures, a good communication inside the organization and a harmonization in the informal plan of the organization structure. The optimal solution is to transform them in forces that are positive to change.

When they are not controlled, the analyzed forces are uncertainty elements for the decisions, the management must make and in that situation, it is obvious that the person will try to reduce the problem to familiar situations using simplification.

Taking into consideration the pressures induced by changes on decisional personnel in the public organization, the authors admit the absolutely natural situation when these persons need certainty about the taken decisions. Adequate for this phase of organization transformation, the risk integrated management provides a warranty and control progressive framework that contributes to the transformation success.

Change Resistance in Public Organization Seen as a Risk Factor

The present and the processes and phenomena evolution at global level are characterized by a permanent state of change. Assessing the risks for the organizations must be related to this dynamic and to turn it into specific instruments that should ensure an optimum for functioning in managerial planning. Actions that in the past were blamed and were low disseminated, nowadays are widely diffused. For example, in the 75% of actual

conflicts, the children are used as soldiers or in the suicide attacks 1 .

Modifying realities at macrosocial level means a raised dynamic of the organizational change. At public organization level, changes in risks and threats situation referring to fundamental goals and their evolution raise very much the organizational changes rate. The risks’ management must develop a character which should eliminate the reactivity in order to respond to these transformation situations.

The social practice and also the elementary logic validate that risks cannot be identified and evaluated in their integrity. Opposite this situation, the authors find the tendency to deny the risks, an attitude type underlying the idea that an unknown danger does not affect you (Bursuc, 2014, p. 232). In the managerial practice, nowadays, there is a mutation from the situation of confronting the risks and assuming them, to an analysis and systematic risk measurement phase and also design of the ways to manage them.

The current legislation allows overcoming the reactivity management and enforcement of a proactive conduct in the management exercise. So, at the organizational level, the risk management is included in the internal control management, thus providing systematic tools for diagnosing, monitoring, and managing the risks associated to organizational activity.

The Institute of Internal Auditors (IIA) determines a mutation on the way risks are seen at the organizational level 2 . This perception will allow us to take into consideration the organizational change mechanisms. The risk management becomes an integrated part of the internal audit, the process being characterized by decentralization, accountability, and expanding of the best practices. By specific norms, a system of risk

1 UNHCR. 2008 global refugee trend: Statistic overview of population or refugees. Internally displaced persons and other persons in concern to UNHCR. Retrieved from http://www.unhcr.org.

2 In 2002, IIA modified fundamentally the internal audit process and the way risks are dealt inside this process.

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION management is set even where it does not exist. Risk is seen as any factor which can have an impact on the

organization capacity of reaching its goals. In this situation, we can include the unfavorable personnel action generated by the distrust on management, misunderstanding of the change objectives, or lack of adhesion. The situation of the forces involved in change requires an assessment of the forces for and against transformation. The analysis allows highlighting the forces pro-change and their share, a situation that is usually in balance and which is naturally against change. The conceptual integration of the mentioned elements converges to describing organizational pathologies characterized by lack of flexibility and adaptation at all levels, a reactive attitude and constant response post-factum to changes in the environment.

Thus, the risk management provides a methodology that ensures a global risk management, which allows the organization to get the best cost under a programmed change. The estimated risk factors are any deficiencies, non-conformities, environmental or organization irregularities in the context of occurrence of events and they will cause adverse consequences for the entity. The regulatory framework well set must be doubled in practice by structures and responsibles at organization level, which from decision positions to plan and implement the right measures for the optimization of the process (Books, 2011, p. 17).

All these elements are found in the practice of public organizations but, because of their specificity, the elements take particular ways of expression. As an open system, a public organization has only a direct internal control with limited possibilities to adjust effectiveness. This refers to the functioning and activities assessment, the act which is the responsibility of members with duties; we include here the super organized structures staff. Other persons outside the organization, through their action only induce influence elements of the external environment. This lack of control and regulation through direct feedback at macro-social level is complemented by internal mechanisms which are legislatively regulated.

The reduced possibility of external control over public institution determines its greater rigidity and at the same time, gives the organization greater stability over time. Compared with other types of organization, the mentioned stability generates a high level of institutional inertia against the change adaptation.

The public organization is characterized by strict normative regulations, the necessity of specific normative regulations in the administrative field is one of the highest, because the organization is extremely complex; the stake of carrying out the tasks is good governance and it should be noted that unlike other organizations, a number of consequences of the activity, as error or failure, have an absolute existential value

condition 3 . The evolution of society in the transition to the economy based on knowledge and less on conventional

raw materials and physical labor occurs in close correlation with changes in the productive and social sector and induces changes in the nature of public administration. This framework requires a new understanding of relations between the administration and a rapidly changing society (Toffler, 1995, p. 89), including a new understanding of how to adapt the organization to the changing process of global society.

Usually, the change means to give up stability, the conditions, and the action context which used to be; this fact, associated with the impossibility of controlling future announced by the change, provokes insecurity justified by the risk factors and direct or derived consequences.

The conclusions of studies from the last two decades highlight the importance of the way people perceive and relate to change, identifying some factors appreciated as risk factors, factors which provoke the resistance

3 The government failure provokes dramatic consequences from country bankruptcy till major crimes against humanity.

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION

to change and they refer to: (1) The lack of information regarding the goals and the change sense having as a result the lack of motivation; (2) Information concerning the acceptance of change is effective when there is homogeneity of organization members, which is only possible for small organizations. The change management act represents a strategic activity for the management, for a leader who must identify and know the organizational characteristics, understand the specific of every phase in functioning the institution general mechanism which allow him/her the intervention in order to raise the actions’ efficiency and efficacity. The bureaucratic institution notion implies change rigidity generated by the fundamental characteristics of this type of organization:

(1) Exclusive vertical subordination; (2) Correlating authority with responsibility during activities; (3) Increasing the role of discipline and order in organizational cohesion; (4) Specialization of roles and statuses; (5) Jobs, functions, and degrees hierarchy. From this perspective, the public organization does not exist as a result of individual options, but based on

objective criteria that take into consideration the personnel capacities, abilities, and disponibilities to fulfill tasks.

The internal hierarchy is distinguished from others because it generates social group layers. The social distance between the positions taken by different personnel categories shapes intraorganizational phenomena which must be taken into consideration. These phenomena if not well-directed might block or slow down the organizational transformation process.

The understanding of the effects of social stratification from public organization involves a complex and interdisciplinary approach and requires ethics and consistency from the management side. Every public organization acts for goals achievement next to the governmental apparatus components that way the organizational transformation will affect and is affected by elements interdependency from that macrosystem.

Processual Nature Solutions to Analyzed Problem

Internationally, there are some directions meant to determine the theoretical apparatus and instruments designated for integrated risk management, which will have direct implications on organizational performance. The works in the field (Burciu, 2008, p. 541) group the trends which are seen as organizational resistance overtaking elements using the following directions:

(1) Reporting to the stakeholders and the certification that the risks have been identified, but acknowledges that the need for transformation exists and is functional;

(2) Evaluating and promoting the benefits resulting from change in organization effective management; (3) Continuous improvement of methods and strategies of institutional risk management. The practice in the fields establishes that organizations manage risk by identifying and analyzing it,

subsequently assess if the activity should be modified by risk treatment, in order to meet risk criteria 4 . In

4 ISO 31000:2009, Risk management—Principals and guidelines. Retrieved from http://www.consultantacertificare.ro/stiri/ standardul-pentru-managementul-riscului-iso-31000.html.

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION conducting the process, organizations make public information and consult with the stakeholders, monitor and

check the risk level and the means that can provide control. These means can modify the consequences in order to ensure that it does not exist a recurrence for risk treatment. International Standardization Organization (ISO) 31000 represents the international standard which thoroughly, systematically, and logically describes this process and can be used by any organization, it is not particular to a special social or economical field and can

be applied to any type of risk. For organizations of any type and dimension, it is necessary a reaction to a variety of risks which are considered to have an impact on the planned goals. The risk evaluation is part of the management that identifies the way the goals may be affected and analyzes the risk consequences and their probability of occurrence. The analysis phases precede decision and determine if a treatment is needed. As a solution, the SR EN 31010/2010 standard—risk management. Risks’ assessment technique is in the ISO 31000 standard support and ensures regulations regarding the selection and the way the systematic techniques for the risk assessment are applied.

The mentioned standard goal is to reflect the good practice usually applied in selection and the way risk assessment evaluation techniques are applied; it does not refer to new or emerging concepts that did not reach a good level of professional consensus 5 . A procedural approach meant to treat resistance to change as a risk for the public organization is presented in Figure 3.

1. Establish the needs for change in the organization 6. Supervision and review

5. Applying plans and supervising the results in the

2. Design and apply the measures integrated risk management

for organizational change

Public organization determined to change

4. Validation measures and conform the organizational change

3. Identify the risk analysis and concept

the risk treatment

Figure 3. Resistance to change processual treatment as risk in the public organization.

For synthesizing the stages of exemplified treatment, the authors will briefly resume the components of the organizational change process: (1) Defrost—reducing the forces that maintain organization in the present state; (2) Change—transforming the organization to a new and desirable level;

5 http://www.consultanta-certificare.ro/stiti/iso-31010.html.

RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION

(3) Refreezing—stabilizing organization at a new balance state and fixing it. We should mention that the change process must be implemented following the phases order, every phase

is a consequence of the preceding functionality; in the first phase, it is essential to have information that do not acknowledge or do not follow the habits or practices from the old organization and to correlate the new information with important personal goals in order to induce a tension level that justifies the change opportunity.

Final Discussions

In case of continuous growth of environment influence on the organization, it is necessary that risk assessment is undertaken with full respect for the phases and procedures, and control and self-control activities, with their fixation on the flow stages that require permanent adaptation and updating. Only in this way, it can

provide increased activities efficiency correlated with evolving risks 6 .

For public organization, it is necessary that in designing risk management programs, valuable action proportional to the risk intensity should be provided, and they should be prioritized and targeted on two axes: the highest risks dangerousness or the most difficult to control. The resistance to change of the organization is not reported as a risk for organizations and it is not regarded as a specific case for the administrative institutions. An overhaul is needed and then, through planning, it is necessary to develop consistent measures, applying the same methods for similar situations being generalized in this way a positive experience and success for the organization activity. The situations of regional or global instability, which are characteristics for the periods of crisis require the more concrete measures and appropriate analysis and risk management in any organization. The organization must respond by structural changes and adapt to new realities, to specific tasks and how they influence their administration structures and missions. As well, the normative specific base which ensures the risk integrated management in public organizations must be evaluated and reconsidered.

References

ASIS Commission on Standards and Guidelines. (2005). Business continuity guideline: A practical approach for emergency preparedness, crisis management and disaster recovery . ASIS International. Retrieved from https://www.uschamber.com/ sites/default/files/legacy/issues/defense/files/guidelinesbc.pdf

Books, D. (2011). Security risk management: A psychometric map of expert knowledge structure. Risk Management, 13(1-2), 17-41. Burciu, A. (2008). Management introduction (pp. 263-520). Bucharest: Economica Publishing. Bursuc, D. C. (2014). Analysis of resistance to change as a specific risk of military organization. Proceedings of the International

Scientific Conference Strategies 21 12th Edition—The Complex and Dynamic Nature of the Security Environment . November 25-26, “Carol I” National Defence University Centre for Defence and Security Strategic Studies, Bucharest, Romania.

Card, A. J. (2013). A new tool for hazard analysis and force-field analysis: The Lovebug diagram. Clinical Risk, 19(4-5), 87-92. Druker, P. F. (2010). The essential Druker. Peter F. Druker management works selection. Bucharest: Meteor Press Publishing. ISO 31000:2009, Risk management—Principles and guidelines . (2009). Multiple. Distributed through American National

Standards Institute (ANSI). Ispas, A. (2012). Comparative analysis—Servant leadership and transformational leadership. Intercultural Management, 14(1), 25.

6 In annex B. 2 of SR ISO IWA 2 standard—Quality management systems—Applying ISO 9001/2000 guidelines, exist measures together with a grid which sets the minimum accepted value which can provide an operational instruments set for determine the

performance indicators.

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RESISTANCE TO CHANGE AS RISK FOR THE ORGANIZATION TRANSFORMATION

Kotter, J. P., & Schlesinger, L. A. (2008). Choosing strategies for change. Harvard Business Review. Harvard Business School Publishing Corporation. Retrieved from https://hbr.org/2008/07/choosing-strategies-for-change/ar/1 Righi, A. W., & Saurin, T. A. (2015). Complex socio-technical systems: Characterization and management guidelines. Applied Ergonomics, 50 , 19-30. Ruckes, M., & Ronde, T. (2015). Dynamic incentives in organizations: Success and inertia. Manchester School, 83(4), 475-497. Sammer, J. (2002). Combating risk. Business Finance Magazine. Retrieved from http://www.businessfinancemag.com/

magazine/archives/ article.html?articleID=13858&pg=1 Toffler, A. (1995). Power shift (pp. 87-102). Bucharest: Ed. Antet.

Journal of US-China Public Administration, August 2015, Vol. 12, No. 8, 603-613

doi: 10.17265/1548-6591/2015.08.002

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Performance Target Setting System and MoU Experience in India

Ram Kumar Mishra, Geeta Potaraju Institute of Public Enterprise, Hyderabad, India

In order to make state-owned enterprises (SOEs) more efficient, countries around the globe introduced a system called Performance Contracting System which brought in focus on the results and achievements of a public enterprise and put them on a path of financial profitability. In India, this system was called as the MoU (memorandum of understanding) system and was introduced with an intention to bring in greater focus in the working of the enterprises and in turn maximize benefits for their shareholders. One of the most critical ingredients of the MoU system is identifying the performance criteria and setting performance targets for enterprises adequately benchmarking them with similar enterprises in India and abroad. The paper highlights the issues and challenges in determining the performance targets under the MoU system and some best practices adopted by countries like China, South Korea, and others.

Keywords: performance contracts (PCs), performance target, performance benchmarking, memorandum of understanding (MoU)

Performance contracts (PCs) have been adopted by governments globally as tools to enhance performance of their state-owned enterprises (SOEs). A study conducted by the World Bank shows that more than 32 developing countries adopted the system of PCs and they have been termed differently by different countries like contrat-plan in France, the memorandum of understanding (MoU) in India, signaling system in Pakistan and so on (Shirley, 1995). All these contracts are negotiated and written agreements between governments and their enterprises with mutually agreed targets which the enterprises achieve within a given time frame. The system also defines the mechanisms for evaluating the performance within the specified period within a pre-determined institutional framework.

PCs have been broadly classified under two systems—the French based systems and the signaling system. The French system was followed by France, Africa (Senegal, Benin, and Morocco), and Latin America. Under this system, weights were not allocated to the targets which added a high degree of subjectivity to the evaluation process, while in the signaling system, signals were sent to the managers in order to monitor the results of the contacts. This system originated in Pakistan and Korea and was adopted by many Asian countries (Pakistan, South Korea, and Bangladesh), Africa (Ghana, Nigeria, and Gambia), and Latin America. Initially,

Corresponding author: Ram Kumar Mishra, Ph.D. in public finance, senior professor, director, Institute of Public Enterprise, Hyderabad, India; research fields: public sector policy and management, public finance, corporate governance, public private partnerships, and climate change. E-mail: ramkumarmishra@gmail.com.

Geeta Potaraju, Ph.D. in management, assistant professor, Centre for Governance and Public Policy, Institute of Public Enterprise, Hyderabad, India; research fields: good governance, public enterprise policy, citizen participation and governance tools, and public system studies. E-mail: pgeeta@ipeindia.org.

PERFORMANCE TARGET SETTING SYSTEM AND MOU EXPERIENCE IN INDIA the MoU system adopted in India was based on the line of French system; during its evolution, many features

from the signaling system were adopted. Currently, the MoU signed between the public enterprises and the ministries consists of mission of the enterprise, its objectives, performance criteria, weightages assigned to each criterion and the period of contract and the mode of evaluation. The MoU system is based on the balanced score card approach, wherein all key factors in financial, financial are adequately represented.

The role and importance of these enterprises in a national economic growth changed considerably from being mere tools of fulfilling social objectives to being growth engines and contributing to economic prosperity of a nation. With the onset of the global financial crisis in 2008, for some countries, especially among the resource-rich emerging economies, the SOEs represented their main source of international capital as they accounted for one fifth of international mergers and acquisitions (Mehdi, 1985). The SOEs have emerged as an important source of international investment globally.

While there are some inherent problems that go along with these enterprises—they are usually very large in size with multiple control and accountability points which make them very difficult to govern. Therefore, the system of PCs was introduced at a time when many governments were facing troubles to manage performance of their enterprises. In this paper, the authors will focus on target setting process which is a key component of performance contracting system.

Target Setting Process

As a part of the process of PCs targets are set for both financial and non-financial parameters which are based on what the enterprise can reasonably achieve, given the expected policy environment, market situation, capital expenditures, and the level of delegation of financial powers to the enterprise. For each indicator, a rage of values is set so that performance can be graded, e.g., as excellent, good, fair, poor, or bad. There are some established methods for setting enterprise targets (Performance contracting for public enterprises, 1995).

(1) Inter-firm comparison: comparison of different firms in terms of their performance and profitability. Such a type of comparison is possible only when uniform costing is applied by all the firms which form a basis for comparison. The accumulated data regarding costs, prices, profits, etc., of different concerns are put in the form of consolidated statements and are made available to all the member-units so that they can make a comparative assessment of their achievements and weaknesses with those of others. This type of comparison helps in improvement in efficiency wherein each member-unit can try to improve its efficiency when on comparison with other member-firms it comes to know about its weak points. However, one of the key requirements of this method is the need for complete information;

(2) International comparisons of firms are not easy, because differences in market conditions, regulatory environment vary for each country. It is also not possible to comparison firms with other firms for monopoly enterprise, except where they are broken up regionally and the regional bodies can be compared. A combination of methods may be used for assessing public enterprises in each period.

(a) Trend analysis could be a basis for assessing performance improvement. If performance contracting is conceived as an instrument for progressive improvement of performance, then past performance adjusted for exogenous change is a sufficient standard. The Korean PCs make extensive use of regression analyses of past data. Seven-year time series analysis is made for most of the quantitative indicators. Form these, it is possible to project the expected targets for the following years, and also the standard deviation. This method is said to simplify target setting and reduce controversy. However, it rests on the assumption that the future will be a

PERFORMANCE TARGET SETTING SYSTEM AND MOU EXPERIENCE IN INDIA

simple projection of the past; (b) Yardstick competition is applied by a target-setter knowing the unit costs in simi1ar enterprises. In Bangladesh, for example, a detailed system of comparing cotton textile mills is used by the Bangladesh Textile Mills Corporation. The target is set by reference to the average enterprise, or the most efficient enterprise, taking the best performance on each activity. The United Kingdom Audit Commission has a tradition of “inter-firm” comparisons of local authority performance, which indicates that such comparisons may be valid and useful, despite disputes on their interpretation (Geeta, 2000);

(c) Work study and management audit is also used to set up targets, which represent reasonably efficient performance, though this method is slow and costly. The United Kingdom Monopolies and Mergers Commission (MMC) carries out in-depth review of efficiency as required by the Department of Trade and

Industry. The MMC examines the trend of performance indicators, such as unit costs and quality, and management processes for want of valid international or intra-national comparisons of performance indicators, it tends to conform to widely accepted standards of management practices.

Target Setting and Performance Evaluation of SOEs in India

In India, the process of the target setting and evaluation begins with the: (1) Department of Public Enterprises first, releasing MoU guidelines in the month of October/November; (2) based on the guidelines, draft MoUs are prepared by enterprises and submitted to their administrative ministries; (3) examination of draft MoUs is done by the MoU division of the Department of Public Enterprises and documents are handed over to the members of the task force (technical expert group outside government set up to oversee the MoU process); (4) MoU negotiation meetings are scheduled between the enterprise and task force that begin from January/February; (5) negotiation meetings end up with finalization of the MoUs with the task force (January/March) each year; and (6) all MoUs are signed before March 31 of every year (Public Enterprises Survey 2011-12 , 2011-2012).

MoU Guidelines and Evaluation

Every year, MoU guidelines are issued by the MoU division of the government, taking into account the dynamic and complex environment in which the public enterprises operate. Based on the guidelines, the enterprises prepare the draft MoUs and from there, the MoU is negotiated and finally, the MoU is signed. The MoU guidelines form the first step of the MoU cycle. MoU evaluation process is based on the “Balance Score Card” approach and is a combination of “financial” and “non-financial” targets, having equal weightage in the overall scores. In the case of sick and loss making enterprises, the guidelines try to focus more on the non-financial indicators rather than the financial indicators and the slightly alter the ratio of the financial to non-financial weights. A five point grading scale is used to grade the enterprises—“excellent” to “poor”, based on the score they receive in the MoU score.

Financial Targets

Financial targets are specified and defined by the government in its guidelines and all enterprises are expected to adhere to these while choosing the financial targets without any deviation and a self certification is to be filled out by the enterprises to this effect. The guidelines are clear that the financial targets should be realistic, growth oriented, and aspirational. The targets must be, at the same time, consistent with the budget for

PERFORMANCE TARGET SETTING SYSTEM AND MOU EXPERIENCE IN INDIA the respective year and in conformity with those made by the Planning Commission, Ministry of Finance,

Administrative Ministry/Department, and other statutory and regulatory bodies. In instances where the enterprises are found to be under-pitching, the task force or the Department of Public Enterprise will have the liberty to call upon their top management to give explanations for such under-pitching or gross over achievement. The basic targets are to be arrived at based on a combination of the performance of the enterprise over five preceding years and other factors such as: (1) capacity and its expansion; (2) business environment; (3) projects under implementation; (4) government policies; (5) external factors; and (6) company’s growth forecast (MoU guidelines 2015-16, 2015-2016).

Another important factor to be considered for the basic financial targets is the national/international benchmarking. In the extant MoU system, the basic targets are generally expected to be an ambitious growth over the performance of the enterprise in the preceding year, however, if the performance of the enterprise is found to be bad in the previous year, then a more realistic target based on the average performance of the previous three years is to be taken into account.

Non-Financial/Dynamic Targets

The non-financial targets are a little more difficult to determine and the guidelines specify that the non-financial targets must be Specific, Measurable, Attainable, Result-oriented, Tangible (SMART). Non-financial targets in the MoU should be in the following categories: (1) Sector specific and enterprise specific targets; (2) Initiatives for growth; (3) Capacity addition; (4) Project management and implementation; (5) CAPEX—capital expenditure; (6) Corporate Social Responsibility (CSR) and sustainability; (7) Research and development; (8) Human resource management; (9) Risk management. Corporate governance is a very important aspect in the existing system of MoU, where there are negative

marks and penalties in scores for any enterprise found to be in non-compliance of the corporate governance norms which were specified by the government and for listed companies the Security and Exchange Board of India (SEBI) guidelines. Similar penalties and negative markings are also applicable to the non-compliance of the CSR guidelines, Department of Public Enterprise (DPE), Government of India guidelines, and other forms of non-compliance.

Grading

The MoU system when first introduced was based on the French Contracting System and it was later changed to the “signaling system” after a year and after 2004-2005, it was further refined to the “Balance Score Card” approach. The performance of the enterprises in the MoU system is scored on a 5 point index which is calculated as the aggregate of all the “actual achievements” as against the targets set in the 5 point scale.

The grading is done based in the MoU “composite score” (see Table 1).

PERFORMANCE TARGET SETTING SYSTEM AND MOU EXPERIENCE IN INDIA

Table 1 MoU Rating Scale

MoU composite score

Less than 87.5-67.5

Very good

Less than 67.5-37.5

Good

Less than 37.5-12.5

Fair

Less than 12.5

Poor

Issues and Challenges in Target Setting

Target setting process is one of the key activities of performance contracting system. A successful enterprise which is on the path of upward movement and aspires to be a leader in industry would adopt mechanisms for identifying realistic targets. Research has found out that SOEs world over have been grappling with this issue of target setting.

Broadly, the issues faced by enterprises can be categorized into the following:

Determining Performance Levels

There is a constant pressure on the management of public enterprises to raise the bar of performance each year. There is a general feeling among the enterprise managers that if they achieve a target in a year, their performance bar is raised in the next year. Therefore, there is a need to set realistic targets which can be achieved under given circumstances which have physical limits, such as capacity utilization, profitability, etc. Due to this reason, there is a tendency for the enterprises to set targets in such a way that it is very much within the reach of the enterprise. While setting targets, the enterprises make sure that their targets are neither too low which are easily achievable without effort nor too high which make them unachievable.

Information Asymmetry

Ideally, PCs must reduce the information advantage that enterprises have over the government and motivate enterprise officials through rewards or penalties (such as to pay bonuses or impose penalties) to achieve the targets (Shirley, 1995). In reality, the asymmetry of information between an enterprise and ministry allows the enterprise to get the targets it wants to set for itself. This asymmetry of information is taken advantage by the enterprise managers who use this information advantage to negotiate targets that were either hard for outsiders to evaluate or easy for them to achieve. In any case, performance is hard to evaluate, for example, when there are many targets or when targets change frequently or when the negotiations dragged on so long that targets were set equal to ex post performance, targets can be set soft.

The information advantage of the enterprise coupled with governments’ failure to give the bureaucrats responsible for negotiating the contracts and evaluating results the power, resources, and status they needed to face enterprise managers at a level playing field leads to poor target setting. Enterprises are therefore able to negotiate targets that they could achieve without making additional efforts to improve productivity. Here is a good example, the Government of Pakistan (Geeta, 2000) provides guidelines for setting targets as mentioned below:

(1) Efficient target setting to carried out in a participatory process. Without this approach, targets tend to take the form of formal directives, which are often overtly accepted and covertly resisted; (2) Targets to be clear-cut;

PERFORMANCE TARGET SETTING SYSTEM AND MOU EXPERIENCE IN INDIA (3) Targets to be neither too low nor high. This would give wrong signals to the managers;

(4) Each enterprise must be looked at in its own unique environment which must be taken into account; (5) The targets must ensure that generation of surplus is significantly more than distribution by way of

bonus; (6) Targets must take into account the social tasks, which are taken up by the enterprises.

Ownership Model