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Video lectures (papers) Management Accounting and Control
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Performance Measures – IntroductionA performance measure is a quantifiable indicator used to assess how well an organization is achieving
its desired objectives. Some example of performance measures or key performance indicators (KPIs) are
the following (ranked from aggregate measures to specific measures):
Stock price (market-based measures)
Return on investment (accounting return measures)
Net profit (aggregate financial measures)
Sales versus last year (disaggregate financial measure)
Customer satisfaction (external nonfinancial measures)
Employee satisfaction or machine downtime (internal nonfinancial measures)
Which qualities of the performance measure do employees find important? That depends on:
Sensitivity; the extent to which (the expected value of) the performance measure changes with
changes in the agent’s effort. An overly sensitive performance measure is one whose percentual
change is bigger than the percentual change in effort. Similarly, there can be performance
measures who do not move 1-to-1 with effort.
Precision; the extent to which (the expected value of) the performance measure is influenced by
factors outside of the control of the manager. Sales, for instance, is not a very precise
performance measure because the sales of a firm can be influenced by actions of the
competitor. Performance measures can be positively or negative influenced.
Verifiability; the extent to which it is ex ante clear how the performance measure is calculated.
Which qualities of the performance measure do CEOs find important? That depends on:
Congruence; the extent to which the performance measure reflects contribution to overall firm
value. The difference between firm-level performance and business unit-level performance
should be as small as possible. For instance, return on invested capital and stock price are
congruent performance measures because they reflect an overall firm value.
Performance measures at the business unit (BU) level are not always highly congruent, as can be
explained by the figure below. You, as a CEO, might want to measure a business unit’s performance
based on the firm’s stock price, but the business unit then argues that this is affected by a lot of things
outside its control, so that would be unfair.
As an employee, you are mainly interested in how your effort is reflected in the business unit
performance measure; so, the focus is on precision and sensitivity. As a CEO, you are mainly interested
in the business unit performance measure and how that is translated into firm value; so, the focus is on
congruence.
,Does the perfect performance measure
exist (the one that keeps congruence
on the one hand and precision &
sensitivity on the other in balance)? No.
If you go for a more congruent
performance measure, then you have
to give up some precision and
sensitivity (and vice versa).
Performance Measure Properties and Delegation (Moers, 2006)
Which actions can the CEO of Nespresso take to increase firm value? We need to try to measure
whether the CEO is doing a good job in these actions, meaning that we need to come up with KPIs.
Action KPI
Improving customer satisfaction Net Promotor Score
Changing prices Price relative to competitors
Making internal processes more efficient Waste from production
Investing in new product development Number of new products per year
Specific performance measures provide information about a subset of actions. Aggregate performance
measures provide information about all actions. This is beneficial because:
Aggregate measures provide incentives to the manager for making trade-offs among the
different actions he/she can take.
Aggregate measures allow the principal to ‘naturally’ constrain the manager’s actions to those
actions that increase firm value. For instance, if you evaluate a manager only on sales, then it
could be that is does actions that increase the sales a lot, but in such a way that overall firm
value decreases. If you evaluate him on total profit, he will not take these actions.
It is very costly to develop and report specific performance measures for every subset of actions.
It is sometimes difficult to know all the actions a manager needs to do to increase firm value.
Aggregated financial performance measures and delegation: Generally, we see that the use of aggregate
performance measures leads to more delegation. This means that if you have a business unit manager
and you evaluate him based on a more aggregate performance measure, then there is a higher
probability that he has more decision rights. The paper argues that this relationship is strengthened if
the quality of the aggregated financial
performance measure is higher in terms
of sensitivity, precision and verifiability.
Stated differently, the effect of
aggregated financial performance
measures on delegation is stronger if
the quality of the aggregated financial
performance measure is higher.
, Research methodology:
Survey among managers of 6 different firms (collected through Hay Management Consultants).
Researcher did a lot of effort to ensure a highly valid survey.
114 fully completed surveys (response rate of 56%).
Large within firm variance with respect to delegation of decision rights and relative use of
aggregate financial performance measures (which is good as one can only explain the effect of X
on Y if there is variation in X and Y).
Delegation: the extent to which respondents have decision-making authority with respect to (1)
new product development, (2) hiring and firing of employees, (3) selection of large investments,
(4) budget allocations, and (5) pricing decisions.
Relative incentive use of financial performance measures: the importance of financial
performance measures for evaluation purposes, monetary compensation and nonmonetary
rewards (relative to nonfinancial performance measures).
Control variables: environmental uncertainty, size, number of hierarchical levels.
The results show indeed that the effect of the use of aggregated financial performance measures on
delegation is only significant when the quality of the financial performance measure is relatively high
compared to the nonfinancial measure.
We see that the increasing the use of
aggregated financial performance
measures has a positive effect on the
decision-making authority that is
delegated if the financial performance
measures are of high quality. The effect is
negative if the aggregated financial
performance measures are of low quality.
Conclusion: the association between the relative incentive use of financial performance measures and
delegation of decision rights is positively affected by the relative quality of the financial performance
measures. The extent to which firms delegate decision rights to business unit managers is (at least
partially) determined by the quality of the financial performance measures.
If we think about the three-legged stool, there is a link between three aspects of the stool: there is a link
between the organization design and performance evaluation, but the extent to which this link is
positive is determined by the quality of the reporting system.
Nonfinancial Performance Measures and Promotion-Based Incentives (Campbell, 2007)
Why do we offer the probability to get promoted to employees?
The probability of a promotion induces employees to work harder (the incentive effect of
promotions).
The firm also wants to promote the most capable employees to a higher hierarchical position
(the matching effect of promotions).
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