Slide AKT202 Chapter 23
Performance Measurement,
Compensation,
and Multinational Considerations
© 2009 Pearson Prentice Hall. All rights reserved.
Financial and Nonfinancial
Measures
Firms are increasingly presenting financial
and nonfinancial performance measures for
their subunits in a Balanced Scorecard, and
it’s four perspectives:
1. Financial
2. Customer
3. Internal Business Process
4. Learning and Growth
© 2009 Pearson Prentice Hall. All rights reserved.
Balanced Scorecard Flow
Firms assume that improvements in learning
and growth will lead to improvements in
internal business processes
Improvements in the internal business
processes will lead to improvements in the
customer and financial perspectives
© 2009 Pearson Prentice Hall. All rights reserved.
Accounting-Based Performance
Measures
Requires a six-step design process:
1.
2.
3.
4.
5.
6.
Choose Performance Measures that align with top
management’s financial goals
Choose the time horizon of each Performance
Measure
Choose a definition of the components in each
Performance Measure
Choose a measurement alternative for each
Performance Measure
Choose a target level of performance
Choose the timing of feedback
© 2009 Pearson Prentice Hall. All rights reserved.
Step 1: Choosing Among Different
Performance Measures
Four common measures of economic
performance:
Return on Investment
2. Residual Income
3. Economic Value Added
4. Return on Sales
1.
Selecting Subunit Operating Income as a
metric is inappropriate since it obviously
differs simply on the differing size of the
subunits
© 2009 Pearson Prentice Hall. All rights reserved.
Return on Investment (ROI)
ROI is an accounting measure of income
divided by an accounting measure of
investment
(c) 2009 Pearson Prentice Hall. All rights reserved.
ROI
Most popular metric for two reasons:
1. Blends all the ingredients of profitability
(revenues, costs, and investment) into a
single percentage
2. May be compared to other ROI’s both inside
and outside the firm
Also called the Accounting Rate of Return
(ARR) or the Accrual Accounting Rate of
Return (AARR)
© 2009 Pearson Prentice Hall. All rights reserved.
ROI
ROI may be decomposed into its two
components as follows:
ROI = Return on Sales X Investment Turnover
This is known as the DuPont Method of
Profitability Analysis
© 2009 Pearson Prentice Hall. All rights reserved.
Residual Income
Residual Income (RI) is an accounting measure
of income minus a dollar amount for required
return on an accounting measure of investment
RI = Income – (RRR X Investment)
RRR = Required Rate of Return
Required Rate of Return times the Investment is
the imputed cost of the investment
Imputed costs are cost recognized in some situations,
but not in the financial accounting records
© 2009 Pearson Prentice Hall. All rights reserved.
Economic Value Added (EVA)
EVA is a specific type of residual income
calculation that has recently gained popularity
Weighted average cost of capital equals the
after-tax average cost of all long-term funds in
use
(c) 2009 Pearson Prentice Hall. All rights reserved.
Return on Sales (ROS)
Return on Sales is simply income divided by
sales
Simple to compute, and widely understood
© 2009 Pearson Prentice Hall. All rights reserved.
Step 2: Choosing the Time Horizon
of the Performance Measures
Multiple periods of evaluation are sometimes
appropriate
ROI, RI, EVA and ROS all basically evaluate
one period of time
ROI, RI, EVA and ROS may all be adapted to
evaluate multiple periods of time
© 2009 Pearson Prentice Hall. All rights reserved.
Step 3: Choosing Alternative
Definitions for Performance
Measures
Four possible alternative definitions of
investment:
1. Total Assets Available
2. Total Assets Employed
3. Total Assets Employed minus Current
Liabilities
4. Stockholder’s Equity
© 2009 Pearson Prentice Hall. All rights reserved.
Step 4: Choosing Measurement
Alternatives for Performance
Measures
Possible alternative definitions of cost:
1. Current Cost
2. Gross Value of Fixed Assets
3. Net Book Value of Fixed Assets
© 2009 Pearson Prentice Hall. All rights reserved.
Step 5: Choosing Target
Levels of Performance
Historically driven targets used to set target
goals
Goal may include a Continuous Improvement
component
© 2009 Pearson Prentice Hall. All rights reserved.
Step 6: Choosing the
Timing of the Feedback
Timing of feedback depends on:
How critical the information is for the success of
the organization
The specific level of management receiving the
feedback
The sophistication of the organization’s
information technology
© 2009 Pearson Prentice Hall. All rights reserved.
Performance Measurement in
Multinational Companies
Additional Difficulties faced by Multinational
Companies:
The economic, legal, political, social, and cultural
environments differ significantly across countries
Governments in some countries may impose
controls and limit selling prices of a company’s
products
Availability of materials and skilled labor, as well as
costs of materials, labor, and infrastructure may
differ across countries
Divisions operating in different countries account for
their performance in different currencies
© 2009 Pearson Prentice Hall. All rights reserved.
Distinction Between Managers and
Organization Units
The performance evaluation of a manager
should be distinguished from the performance
evaluation of that manager’s subunit, such as
a division of the company
© 2009 Pearson Prentice Hall. All rights reserved.
The Trade-Off: Creating Incentives
vs. Imposing Risk
An inherent trade-off exists between creating
incentives and imposing risk
An incentive should be some reward for
performance
An incentive may create an environment in
which suboptimal behavior may occur: the
goals of the firm are sacrificed in order to meet
a manager’s personal goals
© 2009 Pearson Prentice Hall. All rights reserved.
Moral Hazard
Moral Hazard describes situations in which an
employee prefers to exert less effort (0r report
distorted information) compared with the
effort (or accurate information) desired by the
owner because the employee’s effort (or the
validity of the reported information) cannot be
accurately monitored and enforced
© 2009 Pearson Prentice Hall. All rights reserved.
Intensity of Incentives
Intensity of Incentives – how large the
incentive component of a manager’s
compensation be relative to their salary
component
© 2009 Pearson Prentice Hall. All rights reserved.
Preferred Performance
Measures
Preferred Performance Measures are those
that are sensitive to or change significantly
with the manager’s performance.
They do not change much with changes in
factors that are beyond the manager’s
control
They motivate the manager as well as limit
the manger’s exposure to risk, reducing the
cost of providing incentives
May include Benchmarking
© 2009 Pearson Prentice Hall. All rights reserved.
Performance Measures at the
Individual Activity Level
Two issues when evaluating performance at
the individual activity level:
1. Designing performance measures for
activities that require multiple tasks
2. Designing performance measures for
activities done in teams
© 2009 Pearson Prentice Hall. All rights reserved.
Compensation for Multiple Tasks
If the employer wants an employee to focus
on multiple tasks of a job, then the employer
must measure and compensate performance
on each of those tasks
© 2009 Pearson Prentice Hall. All rights reserved.
Team-Based Compensation
Companies use teams extensively for problem
solving
Teams achieve better results than individual
employees acting alone
Companies must reward individuals on a team
based on team performance
© 2009 Pearson Prentice Hall. All rights reserved.
Executive Compensation
Plans
Based on both financial and nonfinancial
performance measures, and include a mix of:
Base Salary
Annual Incentives, such as cash bonuses
Long-Run Incentives, such as stock options
Well-designed plans use a compensation mix
that balances risk (the effect of uncontrollable
factors on the performance measure, and
hence compensation) with short-run and longrun incentives to achieve the firm’s goals
© 2009 Pearson Prentice Hall. All rights reserved.
Strategy and Levers of
Control
Levers of Control:
Diagnostic Control Systems
Boundary Systems
Belief Systems
Interactive Control Systems
Each lever is important and needs to be
monitored
Levers should be interdependent and
collectively represent a living system of
business conduct
© 2009 Pearson Prentice Hall. All rights reserved.
Diagnostic Control Systems
Diagnostic Control Systems evaluate
whether a firm is performing to expectations
by monitoring and evaluating critical
performance metrics, including:
ROI, RI, EVA
Customer Satisfaction
Employee Satisfaction
MUST be balanced by the other lever of
control
© 2009 Pearson Prentice Hall. All rights reserved.
Boundary Systems
Boundary Systems describe standards of
behavior and codes of conduct expected of all
employees
Highlights actions that are “off-limits”
A code of conduct describe appropriate and
inappropriate individual behaviors
© 2009 Pearson Prentice Hall. All rights reserved.
Belief Systems
Belief Systems articulate the mission,
purpose, and core values of a company
They describe the accepted norms and
patterns of behavior expected of all managers
and employees with respect to each other,
shareholders, customers, and communities
© 2009 Pearson Prentice Hall. All rights reserved.
Interactive Control Systems
Interactive Control Systems are formal
information systems that managers use to
focus organizational attention and learning on
key strategic issues
Tracks strategic uncertainties that businesses
face
© 2009 Pearson Prentice Hall. All rights reserved.
© 2009 Pearson Prentice Hall. All rights reserved.
Compensation,
and Multinational Considerations
© 2009 Pearson Prentice Hall. All rights reserved.
Financial and Nonfinancial
Measures
Firms are increasingly presenting financial
and nonfinancial performance measures for
their subunits in a Balanced Scorecard, and
it’s four perspectives:
1. Financial
2. Customer
3. Internal Business Process
4. Learning and Growth
© 2009 Pearson Prentice Hall. All rights reserved.
Balanced Scorecard Flow
Firms assume that improvements in learning
and growth will lead to improvements in
internal business processes
Improvements in the internal business
processes will lead to improvements in the
customer and financial perspectives
© 2009 Pearson Prentice Hall. All rights reserved.
Accounting-Based Performance
Measures
Requires a six-step design process:
1.
2.
3.
4.
5.
6.
Choose Performance Measures that align with top
management’s financial goals
Choose the time horizon of each Performance
Measure
Choose a definition of the components in each
Performance Measure
Choose a measurement alternative for each
Performance Measure
Choose a target level of performance
Choose the timing of feedback
© 2009 Pearson Prentice Hall. All rights reserved.
Step 1: Choosing Among Different
Performance Measures
Four common measures of economic
performance:
Return on Investment
2. Residual Income
3. Economic Value Added
4. Return on Sales
1.
Selecting Subunit Operating Income as a
metric is inappropriate since it obviously
differs simply on the differing size of the
subunits
© 2009 Pearson Prentice Hall. All rights reserved.
Return on Investment (ROI)
ROI is an accounting measure of income
divided by an accounting measure of
investment
(c) 2009 Pearson Prentice Hall. All rights reserved.
ROI
Most popular metric for two reasons:
1. Blends all the ingredients of profitability
(revenues, costs, and investment) into a
single percentage
2. May be compared to other ROI’s both inside
and outside the firm
Also called the Accounting Rate of Return
(ARR) or the Accrual Accounting Rate of
Return (AARR)
© 2009 Pearson Prentice Hall. All rights reserved.
ROI
ROI may be decomposed into its two
components as follows:
ROI = Return on Sales X Investment Turnover
This is known as the DuPont Method of
Profitability Analysis
© 2009 Pearson Prentice Hall. All rights reserved.
Residual Income
Residual Income (RI) is an accounting measure
of income minus a dollar amount for required
return on an accounting measure of investment
RI = Income – (RRR X Investment)
RRR = Required Rate of Return
Required Rate of Return times the Investment is
the imputed cost of the investment
Imputed costs are cost recognized in some situations,
but not in the financial accounting records
© 2009 Pearson Prentice Hall. All rights reserved.
Economic Value Added (EVA)
EVA is a specific type of residual income
calculation that has recently gained popularity
Weighted average cost of capital equals the
after-tax average cost of all long-term funds in
use
(c) 2009 Pearson Prentice Hall. All rights reserved.
Return on Sales (ROS)
Return on Sales is simply income divided by
sales
Simple to compute, and widely understood
© 2009 Pearson Prentice Hall. All rights reserved.
Step 2: Choosing the Time Horizon
of the Performance Measures
Multiple periods of evaluation are sometimes
appropriate
ROI, RI, EVA and ROS all basically evaluate
one period of time
ROI, RI, EVA and ROS may all be adapted to
evaluate multiple periods of time
© 2009 Pearson Prentice Hall. All rights reserved.
Step 3: Choosing Alternative
Definitions for Performance
Measures
Four possible alternative definitions of
investment:
1. Total Assets Available
2. Total Assets Employed
3. Total Assets Employed minus Current
Liabilities
4. Stockholder’s Equity
© 2009 Pearson Prentice Hall. All rights reserved.
Step 4: Choosing Measurement
Alternatives for Performance
Measures
Possible alternative definitions of cost:
1. Current Cost
2. Gross Value of Fixed Assets
3. Net Book Value of Fixed Assets
© 2009 Pearson Prentice Hall. All rights reserved.
Step 5: Choosing Target
Levels of Performance
Historically driven targets used to set target
goals
Goal may include a Continuous Improvement
component
© 2009 Pearson Prentice Hall. All rights reserved.
Step 6: Choosing the
Timing of the Feedback
Timing of feedback depends on:
How critical the information is for the success of
the organization
The specific level of management receiving the
feedback
The sophistication of the organization’s
information technology
© 2009 Pearson Prentice Hall. All rights reserved.
Performance Measurement in
Multinational Companies
Additional Difficulties faced by Multinational
Companies:
The economic, legal, political, social, and cultural
environments differ significantly across countries
Governments in some countries may impose
controls and limit selling prices of a company’s
products
Availability of materials and skilled labor, as well as
costs of materials, labor, and infrastructure may
differ across countries
Divisions operating in different countries account for
their performance in different currencies
© 2009 Pearson Prentice Hall. All rights reserved.
Distinction Between Managers and
Organization Units
The performance evaluation of a manager
should be distinguished from the performance
evaluation of that manager’s subunit, such as
a division of the company
© 2009 Pearson Prentice Hall. All rights reserved.
The Trade-Off: Creating Incentives
vs. Imposing Risk
An inherent trade-off exists between creating
incentives and imposing risk
An incentive should be some reward for
performance
An incentive may create an environment in
which suboptimal behavior may occur: the
goals of the firm are sacrificed in order to meet
a manager’s personal goals
© 2009 Pearson Prentice Hall. All rights reserved.
Moral Hazard
Moral Hazard describes situations in which an
employee prefers to exert less effort (0r report
distorted information) compared with the
effort (or accurate information) desired by the
owner because the employee’s effort (or the
validity of the reported information) cannot be
accurately monitored and enforced
© 2009 Pearson Prentice Hall. All rights reserved.
Intensity of Incentives
Intensity of Incentives – how large the
incentive component of a manager’s
compensation be relative to their salary
component
© 2009 Pearson Prentice Hall. All rights reserved.
Preferred Performance
Measures
Preferred Performance Measures are those
that are sensitive to or change significantly
with the manager’s performance.
They do not change much with changes in
factors that are beyond the manager’s
control
They motivate the manager as well as limit
the manger’s exposure to risk, reducing the
cost of providing incentives
May include Benchmarking
© 2009 Pearson Prentice Hall. All rights reserved.
Performance Measures at the
Individual Activity Level
Two issues when evaluating performance at
the individual activity level:
1. Designing performance measures for
activities that require multiple tasks
2. Designing performance measures for
activities done in teams
© 2009 Pearson Prentice Hall. All rights reserved.
Compensation for Multiple Tasks
If the employer wants an employee to focus
on multiple tasks of a job, then the employer
must measure and compensate performance
on each of those tasks
© 2009 Pearson Prentice Hall. All rights reserved.
Team-Based Compensation
Companies use teams extensively for problem
solving
Teams achieve better results than individual
employees acting alone
Companies must reward individuals on a team
based on team performance
© 2009 Pearson Prentice Hall. All rights reserved.
Executive Compensation
Plans
Based on both financial and nonfinancial
performance measures, and include a mix of:
Base Salary
Annual Incentives, such as cash bonuses
Long-Run Incentives, such as stock options
Well-designed plans use a compensation mix
that balances risk (the effect of uncontrollable
factors on the performance measure, and
hence compensation) with short-run and longrun incentives to achieve the firm’s goals
© 2009 Pearson Prentice Hall. All rights reserved.
Strategy and Levers of
Control
Levers of Control:
Diagnostic Control Systems
Boundary Systems
Belief Systems
Interactive Control Systems
Each lever is important and needs to be
monitored
Levers should be interdependent and
collectively represent a living system of
business conduct
© 2009 Pearson Prentice Hall. All rights reserved.
Diagnostic Control Systems
Diagnostic Control Systems evaluate
whether a firm is performing to expectations
by monitoring and evaluating critical
performance metrics, including:
ROI, RI, EVA
Customer Satisfaction
Employee Satisfaction
MUST be balanced by the other lever of
control
© 2009 Pearson Prentice Hall. All rights reserved.
Boundary Systems
Boundary Systems describe standards of
behavior and codes of conduct expected of all
employees
Highlights actions that are “off-limits”
A code of conduct describe appropriate and
inappropriate individual behaviors
© 2009 Pearson Prentice Hall. All rights reserved.
Belief Systems
Belief Systems articulate the mission,
purpose, and core values of a company
They describe the accepted norms and
patterns of behavior expected of all managers
and employees with respect to each other,
shareholders, customers, and communities
© 2009 Pearson Prentice Hall. All rights reserved.
Interactive Control Systems
Interactive Control Systems are formal
information systems that managers use to
focus organizational attention and learning on
key strategic issues
Tracks strategic uncertainties that businesses
face
© 2009 Pearson Prentice Hall. All rights reserved.
© 2009 Pearson Prentice Hall. All rights reserved.