Slide AKT202 Chapter 23

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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

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Balanced Scorecard Flow

_{Firms assume that improvements in learning}

and growth will lead to improvements in internal business processes

_{Improvements in the internal business}

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Accounting-Based Performance

Measures

 _{Requires a six-step design process:}

1. Choose Performance Measures that align with top

management’s financial goals

2. Choose the time horizon of each Performance

Measure

3. Choose a definition of the components in each

Performance Measure

4. Choose a measurement alternative for each

Performance Measure

5. Choose a target level of performance

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Step 1: Choosing Among Different

Performance Measures

 _{Four common measures of economic} performance:

1. Return on Investment

2. Residual Income

3. Economic Value Added

4. Return on Sales

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Return on Investment (ROI)

ROI is an accounting measure of income divided by an accounting measure of

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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}

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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}

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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,

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Economic Value Added (EVA)

_{EVA is a specific type of residual income}

calculation that has recently gained popularity

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Return on Sales (ROS)

_{Return on Sales is simply income divided by}

sales

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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}

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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

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Step 4: Choosing Measurement

Alternatives for Performance

Measures

 _{Possible alternative definitions of cost:}

1. Current Cost

2. Gross Value of Fixed Assets

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Step 5: Choosing Target

Levels of Performance

_{Historically driven targets used to set target}

goals

_{Goal may include a Continuous Improvement}

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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

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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

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Distinction Between Managers and

Organization Units

_{The performance evaluation of a manager}

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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

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Moral Hazard

_{Moral Hazard describes situations in which an}

employee prefers to exert less effort (0r report distorted information) compared with the

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Intensity of Incentives

_{Intensity of Incentives – how large the}

incentive component of a manager’s

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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

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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

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Compensation for Multiple Tasks

_{If the employer wants an employee to focus}

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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}

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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

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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

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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

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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

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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,

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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}

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