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Organisational Behaviourand Effective Reward

SystemsLecture 9

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Learning Objectives

Define the use of performancemeasurement systems withinorganisations

Identify deficiencies in conventionalperformance measurement and lookat contemporary efforts

Identify characteristics of goodperformance measurement systems

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Performance MeasurementSystems

Measure performance of areas of thebusiness and individuals by comparingperformance with a target

Essential part of the planning andcontrol process

Go beyond the measurement offinancial performance

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Purposes of PerformanceMeasurement

To communicate the strategy and plansof the business and align employeesgoals

To track performance against targets

To identify problem areas

To evaluate emplyees performance and

as a basis for rewards

To guide managers in developing futurestrategies and operations

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Conventional PerformanceMeasurement

CorporateDivisions

DivisionsPlants

DepartmentsProductions processes

Work teams

Responsibility Centre

Investment Centre

Profit Centre

Revenue CentreCost Centre

Performance Measure

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Return on Investment (ROI)

ROI is a financial measure of the performanceof an investment centre

Considers both the profit and the capital

invested Measure of how effectively each investment

centre used its invested capital (averageoperating assets) to earn a profit

ROI = profit .

avg op. assets

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Return on Investment

Improving ROI

Increase either or both components of ROI

Increase return on sales by increasing

selling price or sales revenue, or decreasingexpenses

Increase investment turnover by increasingsales revenue or reducing invested capital

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Advantages of ROI

Encourages managers to focus on both profitand the capital invested to earn that profit

Can be used to evaluate the relativeperformance of investment centres

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Limitations of ROI

Can encourage managers to focus on short-term financial performance, at the expense ofthe long-term

Can encourage managers to defer assetreplacement

May discourage managers from investing inprojects which are acceptable from theorganisations point of view, but decrease the

investment centres ROI

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Residual Income

RI is the amount of profit remaining aftersubtracting the imputed interest charge

Promotes goal congruence

Takes account of the organisationsrequired rate of return in measuringperformance

Encourages investment in projects whichyield a positive residual income

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Limitations of Residual Income

RI is a dollar measure and thus cannot beused to assess relative performance ofdifferent-sized businesses

Can encourage short-term orientation

The measure for profit and invested capital(asset base) chosen may affect behaviour

Need to be clearly defined and consistent across anorganisation

Use the profit margin attributable to theinvestment centre (to evaluate the viability of thecentre)

Consider responsibility and controllability ofmanager when determining the asset base

(average assets)

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Measures of Shareholder Value

Improving the worth of thebusiness from the shareholdersperspective

Value-based management - usingshareholder value analysis tomanage a business

Need to understand the value drivers(activities or actions that createvalue)

Need to consider strategy, finance

and corporate governance

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Measures of Shareholder Value

Several measures can be used

Economic Value Added (EVA)

EVA = NOPAT (avg. op. assets x WACC)

Market Value Added (MVA)

MVA = MV of company BV of company

Shareholder Value Added (SVA)

SVA = Corporate value MV of debt

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Conventional PerformanceMeasurement

Measures focus on profit and itscomponents (revenue and costs)

Profit important for owners,financial markets, and creditorsand therefore important tomanagers

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Problems with ConventionalPerformance Measures

They are not actionable Describe consequences, not causes

Emphasise only one perspective of

performance Do not allow assessment of performance

across all strategically important areas

Provide limited guidance for future

actions Report only on the immediate financial

outcomes of actions and decisions

May encourage actions that decreaseboth customer and shareholder value

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Contemporary PerformanceMeasurement Systems

Non-financial and financial measures

Non-financial measures have not alwaysbeen part of the formal performance

measurement system. Strategic orientation

Selected to directly measure areas thatprovide a competitive advantage andincrease value.

External benchmarks

Continuous improvement

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Advantages ofNon-Financial Measures

Examples

Reflect the drivers of future financial

performanceMore actionable

More understandable, easier to relateto

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Problems withNon-Financial Measures

Wide choice of non-financial measuresavailable

Development can be ad-hoc and

undirected

Trade-offs must be made

May lack integrity

May not easily translate into financialoutcomes

W i Si f I d t

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Warning Signs of an InadequatePerformance Measurement

System Performance is acceptable on alldimensions, except profit

Customers do not buy, even when prices

are competitive No one notices when performance reports

are not supplied

Significant time is spent debating themeanings of measures

The measures have not changed for sometime

The business strategy has changed

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Characteristics of GoodPerformance Measurement Systems

Link to strategy and goals of theorganisation

Be simple

Recognise controllability

Emphasise the positive

Be timely

Include benchmarking Embrace participation and empowerment

Include only a few performance measures

Link to rewards

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Designing Measures forContinuous Improvement

Selecting relevant performancemeasures

Performance measures should be changed

to reflect changes in the businessDefining and redefining the measure

Development of new measures

Making the performance target morechallenging

Increase difficulty over time

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Behavioural Implications ofChanging Performance Measures

Performance measurement undertakento encourage goal-congruent behaviour

Resistance to change

Rewards linked to achievable targets

Support across the entire organisation

Bottom-up approach used to identify

measures

Treated as part of a comprehensivesystem, not an add-on

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Behaviour Implications

Main objectives of a reward systeminclude:

To attract qualified employees

To motivate employees to achieve highlevel of performance

To create an enjoyable workplace that

will ensure employees return

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Intrinsic and Extrinsic Rewards

Intrinsic Extrinsic

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Reward Preferences

Below are a list of rewards:

Pay, bonuses and other pay incentives, Time off,Flexible working hours, Advancement and promotionopportunities, Recognition from supervisor, peers, etc,Ownership or profit-sharing, Autonomy, Personal

challenge and growth, Enjoyment at work, Socialsupport and friends, Job security, Interesting andchallenging work

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References

Ivancevich, J.M., Konopaske, R.,Matteson, M.T. (2011). Evaluation,Feedback and Rewards.

Organisational Behaviour andManagement (9 ed.)

Langfield-Smith, Thorne & Hilton.

(2010). Management Accounting:Information for Creating andManaging Value. Australia: McGrawHill.