1. CHAPTER 11 Performance Measurement, Compensation,
and Multinational Considerations

2. Financial and Nonfinancial Measures
Firms are increasingly presenting financial and nonfinancial performance measures for their subunits in a Balanced Scorecard, and its four perspectives:
Financial
Customer
Internal Business Process
Learning and Growth

3. 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

4. Accounting-Based Performance Measures
Requires a six-step design process:
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

5. Step 1: Choosing among Different Performance Measures
Four common measures of economic performance:
Return on Investment
Residual Income
Economic Value Added
Return on Sales
Selecting Subunit Operating Income as a metric is inappropriate since it obviously differs simply on the differing size of the subunits

6. Return on Investment (ROI)
ROI is an accounting measure of income divided by an accounting measure of investment

7. ROI Most popular metric for two reasons:
Blends all the ingredients of profitability (revenues, costs, and investment) into a single percentage
May be compared to other ROIs both inside and outside the firm
Also called the Accounting Rate of Return (ARR) or the Accrual Accounting Rate of Return (AARR)

8. 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

9. 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 costs recognized in some situations, but not in the financial accounting records

10. 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

11. Return on Sales (ROS)
Return on Sales is simply income divided by sales
Return on Sales = Income
Revenues
Simple to compute, and widely understood

12. 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
may be adapted to evaluate multiple periods of time

13. Step 3: Choosing Alternative Definitions for Performance Measures
Alternative definitions of investment:
Total Assets Available
Total Assets Employed
Total Assets Employed minus Current Liabilities
Stockholders’ Equity

14. Step 4: Choosing Measurement Alternatives for Performance Measures
Possible alternative definitions of cost:
Current Cost
Gross Value of Fixed Assets
Net Book Value of Fixed Assets

15. Step 5: Choosing Target Levels of Performance
Historically driven targets used to set target goals
Goal may include a Continuous Improvement component

16. 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

17. 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

18. 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

19. 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

20. Moral Hazard Moral Hazard
situations in which an employee prefers to exert less effort (or 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

21. Intensity of Incentives
how large the incentive component of a manager’s compensation is relative to their salary component

22. 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 manager’s exposure to risk, reducing the cost of providing incentives
May include benchmarking

23. Performance Measures at the Individual Activity Level
Two issues when evaluating performance at the individual activity level:
Designing performance measures for activities that require multiple tasks
Designing performance measures for activities done in teams

24. 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

25. 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

26. 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 long-run incentives to achieve the firm’s goals

27. Strategy and 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

28. 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 levers of control

29. Boundary Systems Boundary Systems
standards of behavior and codes of conduct expected of all employees
Highlights actions that are “off-limits”
A code of conduct describes appropriate and inappropriate individual behaviors

30. 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

31. Interactive Control Systems
formal information systems that managers use to focus organizational attention and learning on key strategic issues
Track strategic uncertainties that businesses face