incentives and bsc managerial accounting david fender
TRANSCRIPT
Incentives and BSC
Managerial Accounting
David Fender
Today
What?
We will look at incentives – pros and cons
You will learn about the Balanced Scorecard
Why?
Because money makes the world go round
US humor
US humor
Let’s think about incentives
What kind of incentives do you know? What is your experience?
Forms and types of compensation
Measurement of performance versus compensation
Bonuses Based a contract Subjective bonuses
Non-monetary compensation
Promotion/ Title bump Salary increase
What is the primary
objective of a firm’s
compensation system?
“What you measure gets done!”
What is the primary
objective of a firm’s
compensation system? To attract talented people to a company (self-
selection)
To provide incentives to make people exert and appropriately allocate effort in a manner consistent with the firms goals (i.e., to achieve goal congruence). flat salary won’t work must tie compensation to performance
Induce communication
Direct attention
What are potentially constraining factors (other factors) that you should consider when setting compensation?
Factors when determining
compensation
Potentially constraining factors: Cost Risk to employee and employer Fairness
Equitable compensation (equity principle)
Transparency – comparability Accountability
Factors when determining
compensation
Fire
Financial performance measures have a lag
timeWhat are you likely to see earlier?
Parts not fitting of a car coming down production line
Warranty claims
Example 1: CEO Motorola
CEO changed agenda of meetings – non-financial performance measures where covered first – he left when the hardcore money numbers where covered
Why? – he wanted to set a signal that when quality is achieved the financials will follow and that employees should focus on other numbers instead of money
Example 2: VW
Gap between car parts is a measure for quality of production – the less the better
VW had quality problems in 80s – CEO wanted to emphasize quality and measured gaps between car parts when cars rolled of the line
Non-financial performance measure
Nonfinancial performance metrics (NFP): Variables not denominated in $$ but
associated with value creation Reliability may be low (e.g. customer
satisfaction) NFP should SUPPLEMENT, not replace
financial measures
Are often leading indicators of financial performance(relevance is high)
Are often more actionable
What do I mean by more actionable?
What’s the difference between CEO compensation
and compensation for a production line supervisor?
Why aren’t high-level financial metrics good
performance measures to evaluate and reward the
production line supervisor?
“Sensitive”
What we need are performance measures
that are
“sensitive”
to individual managerial actions.
Additional advantage of NFP
As a manager you need to connect to people
Other people might not speak “cost accounting”. Engineers speak a different language.
Balanced Score Card
Balanced Score Card (BSC)
The Balanced Scorecard
The balanced scorecard translates an organization’s mission and strategy into a set of performance measures that provides the framework for implementing its strategy
It is called the balanced scorecard because it balances the use of financial and nonfinancial performance measures to evaluate performance
FinancialGoals Measures
InternalGoals Measures
InnovationGoals Measures
CustomerGoals Measures
Customer Perspective:How should we look to our customers?
Innovation & Learning Perspective:How can we continue to improve and create value?
Internal Business Perspective:What must we excel at?
Financial Perspective:How should we look to our shareholders?
Balanced Scorecard (BSC)
Bob KaplanHarvard Business School
No single measure can guide and motivate the actions to drive future performance.
Need to balance short-term performance with long-term growth opportunities. BSC combines measures with short term
and long term orientationAND
With short term and long term feedback
Balanced Scorecard (BSC)
The Financial Perspective
Evaluates the profitability of the strategy
Uses the most objective measures in the scorecard
The other three perspectives eventually feed back into this dimension
The Customer Perspective
Identifies targeted customer and market segments and measures the company’s success in these segments
The Internal Business Prospective
Focuses on internal operations that create value for customers that, in turn, furthers the financial perspective by increasing shareholder value
Includes three sub processes:1. Innovation2. Operations3. Post-sales service
The Learning & Growth Perspective
Identifies the capabilities the organization must excel at to achieve superior internal processes that create value for customers and shareholders
Why useful?
It tells the story of a company’s strategy by articulating a sequence of cause-and-effect relationships. It helps identify trade-offs
It assists in communicating the strategy to all members of the organization by translating the strategy into a coherent and linked set of measurable operational targets.
The scorecard limits the number of measures used by identifying only the most critical ones (reduces complexity).
BSC and Strategy
We proudly announce:
Performance measures
Strategy
Why?
Measuring success requires a well defined strategy Why?
Defining a strategy gets easier with a balanced scorecard! Why?
The balanced scorecard lays out concrete actions to attain desired
outcomes.
A balanced scorecard should have measuresthat are linked together on a cause-and-effect
basis.
If we improveone performance
measure . . .
Another desiredperformance measure
will improve.
Then
How does BSC connect to strategy?
Identify and define what your business is
Identify measures of success by with different lag times
Transform this into financial success measures
SM and KPI
Strategy map:
A strategy map is a diagram that is used to document the primary strategic goals being pursued by an organization or management team.
KPI:
Key Performance Indicators are quantifiable measurements, agreed to beforehand, that reflect the critical success factors of an organization.
Theory The choice of measures should be a function of
the organization’s strategy and its corresponding value drivers the measure’s informativeness about the achievement of
organizational objectives (and/or about managers’ actions… more on this next time)
In reality, the choice of measures is poorly linked to strategy in many companies*
69% attempted to link measures to strategy However, only 22% attempted to rigorously make this link
Source: C. Ittner, 2003 AIMA Conference*Gates, “Aligning Strategic Performance Measures and Results”
BSC and strategy in practice
Employee skills in installing options
Number ofoptions
available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
Profit
Learningand Growth
Internal Business Processes
Customer
Financial
The Balanced Scorecard ─ Jaguar
Employee skills in installing options
Number ofoptions
available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
Profit
Increase Options Time
Decreases
Strategies
Satisfaction
Increases
Increase
Skills
Results
Employee skills in installing options
Number ofoptions
available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
Profit
Satisfaction
Increases
ResultsCars sold
Increase
The Balanced Scorecard ─ Jaguar
Employee skills in installing options
Number ofoptions
available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
ProfitResult
s
TimeDecrease
s
Contribution
Increases
Satisfaction
Increases
The Balanced Scorecard ─ Jaguar
Employee skills in installing options
Number ofoptions
available
Time toinstall option
Customer satisfactionwith options
Number of cars sold
Contribution per car
ProfitResult
s
Contribution
Increases
ProfitsIncreas
eIf numberof cars sold
and contributionper car increase,
profits increase.
Cars Sold Increases
The Balanced Scorecard ─ Jaguar
Human pitfalls
Common measures bias Managers default to financial numbers
Categorization We think of people as either good or
bad Non-negativity bias
We do not want to give negative feedback
Fundamental attribution error We just hate to be wrong
Citibank
Introduced BSC with subjective performance measures in the US
Few years later abandoned subjective measures and replaced them by objective measures Measures created perception
of unfairness among employees
Conclusion
“I had hoped to be able to document the incidence and value of innovative accounting and control systems …”
“I found that changes in accounting lag far behind changes in the real production phenomena they are supposed to represent.”“Effective managerial accounting systems must reflect the value-creating activities of
companies: in operations, in marketing and sales, and in product and process
development…” (Kaplan, 1985)
Take-Away
Why use incentives?
Balanced Scorecard
Group incentives