Performance Measurement, Compensation, And Multinational Considerations

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Performance Measurement, Compensation, and Multinational Considerations By: Ashwin Chaudhary

Transcript of Performance Measurement, Compensation, And Multinational Considerations

Page 1: Performance Measurement, Compensation, And Multinational Considerations

Performance Measurement,Compensation,and Multinational Considerations

By:

Ashwin Chaudhary

Page 2: Performance Measurement, Compensation, And Multinational Considerations

23-2To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 3: Performance Measurement, Compensation, And Multinational Considerations

23-3To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 4: Performance Measurement, Compensation, And Multinational Considerations

23-4To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.

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

6. Choose the timing of feedback

Page 5: Performance Measurement, Compensation, And Multinational Considerations

23-5To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.

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 Selecting Subunit Operating Income as a metric is

inappropriate since it obviously differs simply on the differing size of the subunits

Page 6: Performance Measurement, Compensation, And Multinational Considerations

23-6To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.

Return on Investment (ROI)

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

IncomeInvestmentROI =

Page 7: Performance Measurement, Compensation, And Multinational Considerations

23-7To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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 ROIs both inside and outside the firm

Also called the Accounting Rate of Return (ARR) or the Accrual Accounting Rate of Return (AARR)

Page 8: Performance Measurement, Compensation, And Multinational Considerations

23-8To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Income Income RevenuesInvestment Revenues InvestmentX=

Page 9: Performance Measurement, Compensation, And Multinational Considerations

23-9To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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 costs recognized in some situations,

but not in the financial accounting records

Page 10: Performance Measurement, Compensation, And Multinational Considerations

23-10To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

After-tax Weighted-Average Total CurrentOperating Income Cost of Capital Assets Liabilities ) }EVA {= X (

Page 11: Performance Measurement, Compensation, And Multinational Considerations

23-11To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.

Return on Sales (ROS)

Return on Sales is simply income divided by sales

Simple to compute, and widely understood

Page 12: Performance Measurement, Compensation, And Multinational Considerations

23-12To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 13: Performance Measurement, Compensation, And Multinational Considerations

23-13To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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. Stockholders’ Equity

Page 14: Performance Measurement, Compensation, And Multinational Considerations

23-14To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 15: Performance Measurement, Compensation, And Multinational Considerations

23-15To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 16: Performance Measurement, Compensation, And Multinational Considerations

23-16To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 17: Performance Measurement, Compensation, And Multinational Considerations

23-17To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 18: Performance Measurement, Compensation, And Multinational Considerations

23-18To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 19: Performance Measurement, Compensation, And Multinational Considerations

23-19To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 20: Performance Measurement, Compensation, And Multinational Considerations

23-20To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.

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 employee’s effort (or the validity of the reported information) cannot be accurately monitored and enforced

Page 21: Performance Measurement, Compensation, And Multinational Considerations

23-21To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.

Intensity of Incentives

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

Page 22: Performance Measurement, Compensation, And Multinational Considerations

23-22To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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 manager’s exposure to risk, reducing the cost of providing incentives

May include Benchmarking

Page 23: Performance Measurement, Compensation, And Multinational Considerations

23-23To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 24: Performance Measurement, Compensation, And Multinational Considerations

23-24To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 25: Performance Measurement, Compensation, And Multinational Considerations

23-25To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 26: Performance Measurement, Compensation, And Multinational Considerations

23-26To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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 long-run incentives to achieve the firm’s goals

Page 27: Performance Measurement, Compensation, And Multinational Considerations

23-27To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 28: Performance Measurement, Compensation, And Multinational Considerations

23-28To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 29: Performance Measurement, Compensation, And Multinational Considerations

23-29To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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 describes appropriate and

inappropriate individual behaviors

Page 30: Performance Measurement, Compensation, And Multinational Considerations

23-30To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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

Page 31: Performance Measurement, Compensation, And Multinational Considerations

23-31To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. 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