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Performance Measurement,
Compensation,
and Multinational Considerations
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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 its four
perspectives:
1. Financial
2. Customer
3. Internal business process
4. Learning and growth
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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 processes will
lead to improvements in the customer and financial
perspectives.
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Accounting-Based Performance Measures
Requires several steps:
1. Choose performance measures that align with top
managements financial goals.
2. Choose the details of performance measures.
3. Choose a target level of performance and a feedback
mechanism for each performance measure.
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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
Selecting subunit operating income as a metric is
inappropriate because it obviously differs simply
on the differing size of the subunits.
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Return on Investment (ROI)
ROI is an accounting measure of income divided by
an accounting measure of investment.
Income
Investment
ROI =
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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 ROIs both inside and
outside the firm
Also called the accounting rate of return (ARR) or
the accrual accounting rate of return (AARR)
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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 Profitability
Analysis
Income Income Revenues
Investment Revenues Investment
X =
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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, but not
in the financial accounting records.
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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.
After-tax Weighted-Average Total Current
Operating Income Cost of Capital Assets Liabilities
) }
EVA
{ = X (
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Return on Sales (ROS)
Return on sales is simply income divided by sales.
Simple to compute, and widely understood.
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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.
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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. Stockholders equity
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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
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Choosing Target Levels of Performance
Historically driven targets used to set target goals
Goal may include a continuous improvement
component
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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 organizations information
technology
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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 companys 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.
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Distinction Between Managers and
Organization Units
The performance evaluation of a manager should be
distinguished from the performance evaluation of that
managers subunit, such as a division of the company.
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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 goals of the firm are
sacrificed in order to meet a managers personal goals.
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Moral Hazard
Moral hazard describes 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 employees effort (or the validity of the reported
information) cannot be accurately monitored and
enforced.
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Intensity of Incentives
Intensity of incentiveshow large the incentive
component of a managers compensation should be
relative to their salary component
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Preferred Performance Measures
Preferred performance measures are those that are
sensitive to or change significantly with the
managers performance.
They do not change much with changes in factors
that are beyond the managers control.
They motivate the manager as well as limit the
mangers exposure to risk, reducing the cost of
providing incentives.
May include benchmarking.
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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 activities done
in teams
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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.
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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 based
on team performance.
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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 hence compensation)
with short-run and long-run incentives to achieve
the firms goals.
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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.
Levers should be interdependent and collectively
represent a living system of business conduct.
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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
MUST be balanced by the other lever of control
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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 describes appropriate and
inappropriate individual behaviors.
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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 one another, shareholders, customers, and
communities.
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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 face.
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