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Management Accounting (Fach) / Performance Evaluation & Incentives (Lektion)

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  • Goals of Performance Measurement & Incentive Contracting Managerial Autonomy (i.e., decentralization) Economic Appraisal of managerial performance Goal congruence between principals and agents (reduce ‘agency problems’)
  • Choices in Performance Measurement & Incentive Contracting Measurement choices, i.e. Single-Aggregated, Integrated,... financial vs. non-financial Relative performance weightings Payout Structure
  • Incentive Effects of Performance Measures “Expectancy” = =      effect of                              effort --> measured outcomes “Instrumentality” = = effect of      measures outcomes --> rewards “Valence” = =            effect of                        rewards --->  motivation Effort -> Measures Outcomes -> Rewards -> Motivation
  • Pros&Cons of Single-Aggregated Measure Pros: Focus Optimization towards an achievement Cons: Opportunism Management Myopia
  • Pros&Cons of Non-financial Measures Pros: Includes Leading indicators Focus on Long-term results Cons: Performance measurement costs Reporting & Validity checks costs Proper Balance of measures Information overload Opportunities for disputes
  • The Balanced-Scorecard - Translates an organization’s mission into a comprehensive set of measures- Feedback on how well the organization is implementing its strategic goals. - An increasing number of medium- to large-size firms have implemented a BSC in the last 15 years (Mercer Consulting) -> Why? The Source of Value Has Shifted From Tangible to Intangible Assets e.g., % of market value related to…(S&P500) Four Measurement Areas (with the need to plot causal links) Financial Measures [improve shareholder value, EBIT] Customer Measures [Market Share, Survey, NPS, Complaints] Internal Processes Measures [Cycle Time, Defects, Activity Costs] Learning-Growth Measures [Training TIme, Turnover, Staff Satisfaction Score]
  • Pros and Cons of the Balanced-Scorecard Pros: Integratation of financial and non-financial parameters. Translates mission into comprehensive set of measures Cons: Often more weight on financial measures No solid evidence about optimal weightings No solid evidence about assumed causal linkages between measures Interaction among measures Non-linear relationships
  • Pros&Cons of Integrated Systems Pros: Limited Opportunism Establish Trade-off management Focus on long-term results Cons:  Difficult to optimize multiple dimensions optimization over time (trade-offs) --> profits vs. customer satisfaction --> margins vs. market share
  • Pros&Cons of Non-linear Payout Structure thresholds, targets, caps.. Pros Allows target-setting Aligned with the budgeting process Cons: May distort incentives Sub-optimal decisions Convec curve, reward bigger sums at above target  Incentive risk taking and volatile results, as iti is higher or lover convex payout and volatility is always bad. 
  • Pros&Cons of Linear Pay-out Structure Pros: Limit Opportunism Cons: Volatility: Rewards independent from targets Induces incentrives (the kinks)  Manager close to min. hurdle -      Pull profits to current period  Manager way below min. hurdle -  Push profits to next period Manager close to max hurdle -       Push profits to next period  
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  • Using aggregated financial vs. disaggregated non-financial measures: Using aggregated financial measures: Widespread use across organizations Linked to long-term organizational goals Aggregate view of organizational performance  Easy to manipulate Using disaggregated non-financial measures: Increase “informativeness” of performance Lead indicators of future firm performance; Better match with strategy-implementation Easy to understand by lower-level employees Cannot be used alone (Balanced scorecard)
  • Why is the issue so controversial? increase in ratio of average CEO compencation to average production worker since 1996 Performance-based incentives are a large portion of Total Compensation  Total Comp: Fixed Salary + Variable Bonus + Variable LTIPs + Restricted Stock + Stock Options  % Variable Pay from 40% in 1992 to 63.5% in 2010 % Variable Cash from 21% in 1992 to 25% in 2010 % Variable Equity from 21% in 1992 to 40% in 2010 [especially strong increase]
  • Changes to Incentives and Performance Evaluation 1 - Stronger Shareholder Activism: More frequent proxy resolutions sponsored by unions and pbulic pensions funds, aimed at monitoring top-executive pay.  2 - Tighter rules: 2A Sarbanes-Oxley Act (2002) New generation of CEOs are personally accountable for their companies financial statements  2B Dodd-Frank Act (2011) Mandatory Say-on-Pay vorint gofr most US public company shareholders allowing them the right to vote on executive compensaion packages (vote not binding) Introduced by Obama  3 - New SEC disclosure Rules (2006)  Companies should disclose not just the amounts paid to executives, but also the criteria upon which the amounts were awarded Companies should also disclose the value of the packages that each executive will receive upon exit in case of a change in control, termination or retirements(severance pays, deferred compensation) 
  • Performance Measures should be Congruent with organizational goals Controllable by the manager  Informative of the manager actions Timely and accurate Understandable and Acceptable  -> There is not perfect measure and we have to mitigate the imbalances 

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