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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems

Chapter 9
Behavioral and Organizational Issues in Management Accounting and Control Systems
QUESTIONS 9-1 In the context of a management accounting and control system, control refers to the set of procedures, tools, performance measures, systems and incentives that organizations use to guide and motivate all employees to achieve organizational objectives. The four stages that are needed to keep the organization in control are: 1. Plan: develop an organizations objectives, choose activities to accomplish the objectives, and select measures to determine how well the objectives were met; 2. Do: implement the plan; 3. Check: monitor by measuring and evaluating the systems current level of performance; compare feedback about the systems current level of performance to the planned level in order to identify discrepancies and prescribe corrective action; 4. Act: take appropriate actions to return the system to an in-control state. 9-3 The two broad technical considerations that designers of management accounting and control systems must address are the relevance of the information generated and the scope of the system. When addressing the relevance of a MACS, designers should develop a system that provides information that is timely and accurate enough to be relevant and useful for decision making. The system should provide a consistent framework for the organization, in the sense that the language used and the methods of producing management accounting information do not conflict within various parts of the organization. Finally, employees should be able to use the systems available
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information in a flexible manner so that it can be customized for the decisions at hand. 9-5 The four major behavioral considerations in MACS design are: (1) embedding the organizations ethical code of conduct into MACS design, (2) using a mix of short- and long-term qualitative and quantitative performance measures (or the balanced scorecard approach), (3) empowering employees to be involved in decision making and MACS design, and (4) developing an appropriate incentive system to reward performance. The scientific management view of motivation is that most people find work objectionable, money is the key to inducing performance, and people have little desire to be creative on the job or make good decisions. In this view, management must tightly monitor and control employee behavior and break down tasks so employees need only focus on production, not decision making. The human relations movement view of motivation is that people have needs that go well beyond performing simple repetitive tasks and that money is only one aspect of what people desire. In this view, employees desire respect, a feeling that they contributed something valuable to the organization, and discretion at their jobs. Managements task is to develop a better working environment for people with the goal of improving employee morale, job satisfaction, and performance. The human resources model of motivation view is that people do not find work objectionable. Instead, they want to participate in decision making and have specific goals that they are trying to achieve. Individuals have information and knowledge that they can contribute to the organization; further they are creative, responsible, and wish to improve the organization. The task for management is to create a working environment that will allow creativity to blossom.

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There are a number of choices that individuals can make when ethical conflicts arise. These include: point out a discrepancy or problem to a superior and refuse to act unethically, point out a discrepancy to a superior and act unethically, go to an ombudsperson or mediator, work with respected leaders in the organization to change the discrepancy, go outside the organization publicly, go outside the organization anonymously, resign and go public, resign and remain silent, and do nothing and hope that the problem will dissolve. 9-10 An ethical control system is a system that promotes ethical decision making in an organization. Key elements include the following:

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A statement of the organizations values and code of ethics. A clear statement of the employees ethical responsibilities for every job description and a specific review of the employees ethical performance as part of every performance review. Adequate training to help employees identify ethical dilemmas in practice and learn how to deal with the dilemmas. Compelling evidence that senior management expects organization members to adhere to its code of ethics. This means that management must provide a statement of the consequences of violating the organizations code of ethics, establish a means to deal with violations of the code of ethics, provide visible support of ethical decision making, and provide a private line of communication from employees directly to the chief executive officer, chief operating officer, head of human resource management or board of directors. Evidence that employees can make ethical decisions or report violations of the organizations stated ethics without fear of reprisals from superiors, subordinates, or peers in the organization. An ongoing internal audit of the efficacy of the organizations ethical control system.

9-11 The three key dimensions of motivation are: direction, the tasks on which an employee focuses attention at work; intensity, the level of effort expended by the employee; and persistence, the amount of time an employee will stay with a task. 9-12 Goal congruence occurs when individuals are able to align their goals at work with those of the organization. 9-13 Managers use diagnostic control systems to monitor organizational outcomes and correct deviations from predetermined performance standards. A diagnostic control system tends to run in a routine way, without regular monitoring by a manager. Interactive control systems, in contrast, rely heavily on dialogue among managers and subordinates about data generated by the system and steps to take based on the data. In interactive control systems, managers must spend more time monitoring the decisions and actions of their subordinates. 9-14 Task control is the process of finding ways to control human behavior so a job is completed in a prespecified manner. Results control focuses on measuring and comparing employee performance against stated objectives. Task control is most appropriate when there are legal or safety requirements, when employees handle liquid or precious assets, or when the organization can control the
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environment sufficiently to eliminate the need for judgment. Results control is most effective when organization members understand the organizations objectives, and have the knowledge and skill to respond to changing situations with sound decisions and actions. In addition, the performance measurement system should be designed to assess individual contributions, to provide suitable motivation. 9-15 The two categories in task control are preventive control and monitoring. In preventive control, discretion in performing a task may be minimized because of the precision required or the nature of the materials involved. Monitoring involves inspecting the work or observing the behavior of employees while they are performing a task. 9-16 Quantitative financial measures of performance in a manufacturing organization include:

cost per unit profit per unit return on investment

9-17 Quantitative financial measures in a service organization include:


cost of service profitability of service service revenue

9-18 Quantitative nonfinancial measures of performance in a manufacturing organization include:


yield rate quality schedule adherence number of process problems defective rate on-time delivery percentage

9-19 Quantitative nonfinancial measures of performance in a service organization include:


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number of customer complaints (in a restaurant) number of errors in processing claims (in an insurance organization, for instance). number of repeat customers (for all service organizations) percent of flights with on-time arrival (in the airline industry)

9-20 Qualitative measures of performance include:


image of a product reputation of a product measures of customer satisfaction.

9-21 Gaming a performance indicator occurs when an individual alters his or her actions in an attempt to manipulate a performance indicator through job-related acts. 9-22 Data falsification occurs when an individual falsifies information in favor of himself/herself. It is considered illegal. 9-23 The single most important factor in making major changes to an organization is having top management support, often at the level of the CEO and other senior managers. The change process often relies on a champion who is charged with spearheading the process. 9-24 Earnings management occurs when managers knowingly manipulate reported income.
Smoothing, which is the acceleration or delay of a preplanned flow of data without changing the organizations activities, is an example of earnings management. For example, a manager who wants to meet a net income target may defer expenses to the next period or book future revenues in the current period.

9-25 Empowering employees in MACS design requires two essential elements allowing employees to participate in decision making and ensuring employees understand the information they are using and generating. 9-26 The two interrelated behavioral issues are (1) designing the budget process, which includes how budgets should be determined, who should be involved in the budgeting process, and the level of budget difficulty, and (2) influencing the budget process, which includes how people try to influence or manipulate the budget to their own ends.
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9-27 The three most common methods of setting a budget are: (1) authoritative budgeting in which a superior tells subordinates what their budget will be without requesting input from the subordinates, (2) participative budgeting in which the setting of the budget is done jointly between a superior and subordinates and (3) consultative budgeting in which a superior asks subordinates for their ideas about the budget but then determines the final budget alone. 9-28 Research has shown that the most motivating type of budget is one that is tightthose with targets that are perceived as ambitious, but attainable. 9-29 A stretch target is one that exceeds a previous target by a significant amount and usually requires an enormous increase in effort to achieve. 9-30 Budget slack occurs when subordinates (a) ask for excess resources (more than needed to accomplish budget objectives) and (b) distort information by claiming they are not as efficient or effective at what they do, thus lowering managements performance expectations of them. 9-31 An intrinsic reward is a benefit that a person experiences, without the intervention of anyone else, as a result of doing a job. 9-32 An extrinsic reward is a reward that one person provides to another person in recognition of job performance. 9-33 Incentive compensation is a monetary reward that is based on measured performance. 9-34 The six attributes of effective performance measurement systems are: (1) the person must understand the job and the reward system, and believe that the system measures what employees can control or contribute to the organization, (2) the performance measurement system must reflect careful choices about whether it measures employees inputs or outputs, (3) the jobs performance measures should reflect the organizations critical success factors, (4) the performance measurement system should set clear performance standards or targets that are acceptable to employees, (5) the performance measurement system should accurately assess performance, and (6) the reward system should focus on individual or group rewards depending on the nature of the job. 9-35 Organizations where employees have been given the responsibility to make decisions are best suited for incentive compensation systems because these
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organizations create the environment where the individuals decision making can affect the organizations outcomes. 9-36 A cash bonus is a cash reward tied to measured performance. 9-37 Profit sharing is a cash bonus incentive compensation plan where the total of all cash bonuses paid to all employees is determined by a formula involving the organizations, or an organization units, reported profit. 9-38 Gain sharing is a cash bonus incentive compensation plan where the total of all cash bonuses paid to all employees is determined by a formula involving performance relative to some target. 9-39 In a stock option plan, employees deemed to be able to affect the value of an organizations shares are given the option to purchase those shares at a specified price that is usually higher than the share price at the time the option is issued. EXERCISES 9-40 The mission statement becomes a basis for the organizations accountability to those stakeholders. The notion companys value is ambiguousperhaps deliberately. It may be ambiguous because it is not expected to be taken seriously, or it may be ambiguous so that if it is taken seriously it makes no real commitment. The following interpretations might be made of companys value: by customersservice, quality, and cost; by employeescompetitive wages, good working conditions, and security; by shareholdersa competitive rate of return on investment; and by society conformance to laws and progressive social activities, such as affirmative action. 9-41 When addressing the relevancy of a management accounting and control system, designers should develop a system that provides information that is timely and accurate enough to be relevant and useful for decision making. Information that is insufficiently accurate will lead to errors in evaluating profitability of cost objects and may lead to poor decisions. Timely information is important because the most accurate information that appears after evaluations or decisions are made is irrelevant with respect to those evaluations or decisions. The system should provide a consistent framework for the organization, in the sense that the language used and the methods of producing management accounting information do not conflict within various parts of the organization. For example, having two divisions with different costing systems makes it more difficult to understand and compare results across divisions. If one division of an organization uses activity-based costing principles and another division, especially one that is very similar in goals and function to the first, uses volumebased overhead allocation methods, the information system does not meet the
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consistency criterion. Finally, employees should be able to use the systems available information in a flexible manner so that it can be customized for the decisions at hand. If the management accounting and control system cannot accommodate the specialized needs of each major user, users may develop ad hoc local systems, which can lead to poor decisions or confusion in communications between the users and the rest of the organization. 9-42 The scientific management view of motivation sees employees as the vehicles by which managements goals can be accomplished. People are thought of as simply means to an end, and management treats them almost like machines by timing their actions and trying to make them work more and more efficiently. The underlying philosophy is that most people find work objectionable, dislike decision making or creativity, and find money to be the driving motivator. The human relations school understands that employees want much more from work, including respect, autonomy, and satisfaction; financial compensation is just one of the things workers desire. Management attempts to create a better work environment to increase employees satisfaction and performance. The human resources view goes even further than the human relations school in that employees are seen as key suppliers of ideas and information about how their jobs and the work environment can be improved. This view holds that employees find work enjoyable and desire to make decisions, develop objectives, and attain goals. Individuals are motivated by financial and nonfinancial compensation. Individuals are assumed to have considerable knowledge about their jobs, and to be highly creative, ethical, responsible, and supportive of change in their organizations. The task for management is to create a working environment in which employees can use their information to its fullest ability and in which creativity can flourish. 9-43 The hierarchy of ethical considerations are (1) legal rulesactions prohibited by law, (2) societal normsactions that society has deemed unacceptable, (3) professional membershipsactions that professional memberships discourage, (4) organizational or group normsactions that are unacceptable to an organization or group, and (5) personal normsactions that each individual deems unacceptable. The hierarchy is listed in descending order of authority. 9-44 If the organizations code of ethics is stronger than the individuals, then the employee can either resign or adhere to the organizations rules. In some cases, the organization will strongly enforce its code, and if the individual complies, there may be no problem. If the individuals code of ethics is stronger than the organizations, the individual can quit, do nothing and try to live with the situation, or try to work with the organization to change its code or norms of
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behavior. Employees faced with ethical conflicts should document the events and discussions and list the parties involved. 9-45 First, the individual must make sure that the facts are correct and that there is clearly a conflict. The individual should speak to superiors and determine whether the conflict is institutional or reflects the actions and beliefs of a few individuals. If there is a true conflict, the individual can (1) point out the problem to superiors and refuse to act unethically, (2) point out the problem to superiors and act unethically, (3) talk to an ombudsperson (mediator in the organization), (4) work with organizational leaders to resolve the problem, (5) go outside the organization to publicly resolve the issue, (6) go outside the organization anonymously to resolve the issue, (7) resign and go public, (8) resign and remain silent, and (9) do nothing, and hope the problem will go away. Most experts recommend alternative (4) but any of the alternatives may be appropriate depending on the circumstances. The organizations stated values may conflict with practiced values if individuals see unethical or illegal behavior practiced by co-workers or the organizations leaders, and infer that such behavior is accepted and sanctioned. Organizational leadership therefore plays a critical role in fostering a culture of high ethical standards. 9-46 Any control situation is useful here. The exercise is intended to provide an opportunity to discuss the appropriate matching of the approach to control with a situation. For example, some governments are now advocating that people who have been convicted of drunk driving have their vehicles equipped with a device that prevents the vehicle from being started unless the driver can accomplish a series of dexterity tests on a keypad. This is an example of preventive control. 9-47 Many aspects of work require a variety of actions and decisions, and using only one measure of performance will not capture the complexity of the employees job. The advantage of having multiple measures is that employees will not focus on a single measure and only perform those acts that maximize performance on that measure. The performance measurement system conveys what the organization values, how the individual contributes to what the organization values, and what the employee should do to earn personal rewards and satisfaction. Therefore, if the performance measurement system does not measure some facet of performance, the system not only provides no direct motivation to the employee, who receives no personal benefit in pursuing unmeasured performance goals, but also implies to the employee that the particular facet of performance is irrelevant. An example is a grocery store clerk. If the clerk has been told that accuracy and speed are
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critical, the clerk may infer that answering customer questions and making simple remarks to the customer reflecting common courtesy are unimportant. 9-48 What performance is measured, how it is measured, and what rewards follow from measured performance define the causal link between performance and rewards. Without a clear link, employees do not understand how their effort results in increased rewards and personal satisfaction. 9-49 If the performance measurement system includes factors beyond the employees control, motivation likely will decrease. However, one might argue that many people held responsible for nominally uncontrollable performance factors will develop means to control these factors. 9-50 The president, who controls overall policy and sets the organizations direction, should be evaluated and rewarded based on the trend of key success factors such as profitability, customer satisfaction, employee satisfaction, relations with suppliers, and image in the community. The middle manager, who designs and puts in place systems, should be rewarded based on the overall contribution of the system to the organizations key success factors. These measures might include: the time between when an order is taken and when it is filled, the cost of filling an order, overall system accuracy, and the performance of this system relative to competitors systems. The employee who fills orders operates within the existing system. This person should be evaluated based on the speed and accuracy of work done relative to the potential of the existing systems and the suggestions made that are used to improve the system. In general, the performance measurement systems are similar in their focus on the same broad factorsthe organizations critical success factors. However, they differ in focusing on what each manager controls. 9-51 Some management thinkers believe that the best type of organizational culture is one in which pay for performance is unnecessary. In this view, people will perform well if the owners pay the people a good salary. Other management thinkers believe that tying rewards to performance in the form of bonuses or other incentives is highly motivating because people will exert extra effort if they know they will receive a bonus for good performance. This may lead to greater goal congruence between individuals and the organization, although the empirical evidence is mixed regarding this claim. 9-52 The key difference is that gaming does not involve any falsification of data or information, only the altering of ones actions to do better on a performance indicator.
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9-53 Budget slack can be created by budgeting excess resources that are not really needed to attain the goals of the budget. Slack also can be created by employees who understate their performance capabilities and choose a lower level standard or budget than they know they can attain. Creating slack is a gaming activity designed to facilitate achieving high performance evaluations. 9-54 Workers may believe gaming behavior is an appropriate response (to survive in an organization) if the organization has set up a performance measure that is impossible for employees to attain. For example, in an assembly line, if the average worker can make 10 units of output an hour, but management raises the standard to 16 per hour, workers may take a number of actions that they normally would not take if the standard were reasonable. Such actions would include lowering the quality of output to meet the standard, cutting deals with high producing coworkers to supply them with output, etc. In this situation, workers may simply be trying to keep their jobs. Such behavior will continue until management employs a reasonable standard. Managers may believe it is appropriate (necessary) to game the budgeting process by building in budget slack when they know through experience that upper management automatically reduces the submitted budget. If managers submit budgets reflecting an accurate estimate of their need to accomplish the companys stated goals, they are unlikely to achieve the goals with a reduced budget. 9-55 The employee who participates in decision making will generally be more committed to the decisions made (such as attaining the participatively set budget) and often will experience greater job satisfaction and higher morale as a result. The result can be enhanced productivity, which benefits the organization. In addition, workers may have critical information that can greatly benefit management. For example, workers still perform the major portion of work in non-automated industries, so they have superior knowledge regarding how to improve products and processes. 9-56 Participation in the budgeting process involves a subordinate setting the budget with a superior jointly. In other words, the superior and the subordinate meet and negotiate the budget directly. Consultation, on the other hand, involves the superior seeking the subordinates input on the subordinates budget, but no joint decision-making occurs. Once the superior has the subordinates input, the superior makes the final budget decision. 9-57 From the employees (subordinates) perspective, the benefits from building in slack are twofold. First, the employee may be able to obtain excess resources to
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achieve desired goals. This may take a lot of pressure off the employee and reduce job anxiety. Second, senior management may lower their work expectations of the employee. This may also lead to lower pressure on the employee to perform. Both of these types of slack building are designed to reduce job stress for the employee. However, if incentives are graduated in such a way that achieving higher and higher goals provides the employee with more and more compensation in the form of bonuses, then the employee may lose income by selecting lower goals. From senior managements point of view, employees who build in slack are either using unnecessary resources to achieve a goal that should have been achievable with fewer resources, or they are understating their performance capabilities. Thus, the organization is either not running as efficiently as it can, or is losing potential productivity from employees who are not working as hard as they can. In some cases, senior management may believe that employees build in slack to relieve job pressure. If burnout of employees has been occurring in the organization then perhaps senior management may be more forgiving and view some slack building as necessary to keep their employees from quitting. 9-58 Budgeting games occur when managers or other employees attempt to manipulate information and targets to achieve their specific goals, such as achieving the assigned objectives with the allotted funding, or attaining as high a bonus (given that there is a bonus tied to budget attainment) as possible. One well-known way that employees engage in budgeting games is through the participation process. For instance, employees might ask for resources above and beyond what they need to accomplish their budget objectives. This results in a misallocation of resources for the organization as a whole. Employees may also distort information by underrating their efficiency or effectiveness, thereby attempting to lower managements expectations of their performance. If employees succeed in this type of negotiation, they will find it easy to meet or exceed their budgeted objectives. Again the organization suffers, because it is not obtaining the most accurate information available to assess and improve its operations. Both requiring excess resources and distorting performance information fall under the heading of creating budget slack. 9-59 This question distinguishes between people who are driven exclusively by extrinsic rewards, most often monetary, and people who receive satisfaction by intrinsic rewards as well. This is a matter of individual preference but provides the opportunity for people who do not value intrinsic rewards to understand why some people value them.

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Extrinsic rewards are rewards provided to the individual by someone else. Examples are bonuses, promotion, and recognition. Monetary rewards such as cash, trips, and stock options convey a direct value. Nonmonetary rewards, such as recognition in the company newsletter, convey value to people who take pride in having their accomplishments recognized by others. An intrinsic reward is a benefit that a person experiences, without the intervention of anyone else, as a result of doing a job. It reflects satisfaction from doing a job well, satisfaction from growth opportunities, or pleasure from helping others learn or grow. 9-60 The choice of the mix of performance measures and the decision about whether those measures are input-based, output-based, or a combination of measures make up one of the most difficult tasks in the design of performance measurement and compensation systems. In general, the greatest alignment between employees and the organizations interests is provided when the performance measurement system monitors and rewards outcomes or employee outputs that contribute to the organizations success. Rewarding a person based on outputs such as good units, or outcomes such as customer satisfaction, forces the person and the organization to direct attention and behavior toward understanding and doing what promotes organization success. However, outcomes and outputs may reflect circumstances and conditions that are beyond the employees control, and when they do, the weaker link between individuals efforts and measured results decreases the motivation provided by the reward system. In addition, it may be impossible to measure outcomes consistently and outcomes may be too expensive to measure. Under circumstances where outcome measurement is problematic, organizations often choose to monitor and reward inputs (such as employee learning, demonstrated skill, and time worked). Knowledge-based pay remunerates based on an employees training and job qualifications, which can be upgraded by training. The employees compensation is based on time input and an hourly rate or salary reflecting the deemed level of skill input, and salary increments can result from new knowledge rather than a promotion or a job change. For example, in some manufacturing organizations, employees can take on-site classes at night to increase their skills. Once these classes are completed, and the new skills mastered, the employees are moved to a higher wage level. Governments often use knowledge-based pay to motivate public servants to improve their skills. For example, a social worker might be given a 10% salary increase, within the same job, for acquiring a diploma in social work. 9-61 This is a deep issue that has been the subject of many articles. The purpose of the question is to identify the issues rather than to reach any definitive conclusion. There are two clear requirements to this questioncomparing the
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pay of this executive to other executives (the relative level) and the absolute pay of executives in general (the absolute level). Business Week and Fortune magazines, among others, have published many articles that compare the compensation of executives with the compensation of other executives. These articles define various measures of success, such as growth in the value of the firms share price, and look at the correlation between executive compensation and these success measures. Then the articles rank the executives based on how closely the change in compensation is related to the change in the success measure. This approach hinges on the ability to define and measure appropriate success measures. This comparison focuses on whether the pay was appropriate given the level of the organizations performance relative to other organizations. However, the issues in compensation are deeper and require a consideration of the purpose, effect, and scope of motivation. Do these people really need to be paid the amounts that they command to do the work that they do? A competitive issue concerns what we have to pay, given the market opportunity for this executive, to keep this person. However, a related issue, which cannot be solved in the short run, is whether these people are worth the compensation they are receivingperhaps they are worth more or less. An obvious, and related, issue is the level of compensation paid to professional athletes. Approaches might be to compare the compensation of the president with the salary of a managing partner in a comparably sized public accounting or consulting firm, or to the salary of a senior partner in a law firm. 9-62 Incentive compensation plans are suitable when employees have the skill and authority to react to conditions and make decisions, and in organizations subject to changing conditions. A cash bonus is often related to activities oriented to short-run performance that should be rewarded immediately to provide a reinforcement effect. Cash bonuses are best tied to measures of achieved operating performance such as quality improvement, sales increases, and success at short-run cost control. These bonuses can be paid to individuals or groups. 9-63 Incentive compensation plans are suitable when employees have the skill and authority to react to conditions and make decisions, and in organizations subject to changing conditions. Profit sharing is used to focus organization members engaged in team activities to improve the organizations short-term performance. 9-64 Incentive compensation plans are suitable when employees have the skill and authority to react to conditions and make decisions, and in organizations subject
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to changing conditions. Gain sharing is best used when there is a visible and agreed performance standard, and the employees can work as a group to improve performance relative to that standard. 9-65 Incentive compensation plans are suitable when employees have the skill and authority to react to conditions and make decisions, and in organizations subject to changing conditions. Stock options are best used to focus attention of senior people, who can affect the organizations long-run performance by their decisions. 9-66 The car design group is deliberately created to design a car. There is no place for individual stars in this groupthe key is to develop a successful product. Therefore, the individuals in that group should be evaluated based on their ability to work as a group to achieve their assigned goals, which should contribute to the group goal of designing a car. However, the safety researchers job is more individualistic. The more individualistic the effort and the more that individual talent can affect the outcome of the group, the greater the potential for individual, rather than group, rewards. PROBLEMS 9-67 This question is designed to get students to reflect on the idea that a MACS reports the results of human action and decision making, and therefore motivates behavior. If MACS designers do not understand basic elements of motivation, then the MACS design will be faulty and incomplete. A brief discussion of the scientific management school of motivation and the human relations movement is important to set the stage for the human resources approach. Students should focus their answers on (a) that most (but not all) people desire to work, (b) that people are now working in complex informationfilled environments, and (c) that people desire to be creative and to solve problems. If MACS designers focus on out-of-date assumptions about human motivation and behavior, then the system will be designed inappropriately in todays environment. In addition, the major role of control systems is to motivate behavior congruent with the objectives of an organization. System designers need to consider the behavioral implications and consequences of MACS. 9-68 The four major behavioral considerations in MACS design are (1) embedding the organizations ethical code of conduct into MACS design, (2) using a mix of short- and long-term qualitative and quantitative performance measures (or the balanced scorecard approach), (3) empowering employees to be involved in
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decision making and MACS design, and (4) developing an appropriate incentive system to reward performance. (1) The MACS design should incorporate the principles of an organizations code of ethical conduct to guide and influence behavior and decision making as people face ethical dilemmas on the job. Often managers are subject to intense pressures from their job circumstances and from other influential organizational members to suspend their ethical judgment in certain situations. The ethical framework embedded in system design is extremely important because it will influence the behavior of all users. The ways in which organizations and individuals measure performance sends signals to all employees and stakeholders about what the organization considers its priorities. If organizations choose performance measures without careful consideration, then behavior incongruent with the organizations goals can occur. The Balanced Scorecard integrates an appropriate mix of short- and long-term financial and non-financial performance measures used across the organization, and helps organizations grapple with their intangible or intellectual assets. The Balanced Scorecard is a systematic approach to performance measurement that translates an organizations strategy into clear objectives, measures, and targets. Empowering employees in MACS design requires two essential elements allowing employees to participate in decision making and ensuring employees understand the information they are using and generating. Encouraging participation has a two-fold benefit for organizations. First, research has suggested that employees who participate in decision making evince greater feelings of morale and job satisfaction, as well as commitment to the decision. In many instances, these heightened feelings translate into increased productivity as employees begin to feel that they have some ownership and control over what they do at work. Second, the organization is able to gather information about improving jobs and processes from the individuals who are closest to those jobs and processes. The second critical element of empowering employees is ensuring that they understand the information they use and on which they are evaluated. If employees at all levels understand the organizations performance measures and the way they are computed, the employees can take actions that lead to superior performance.

(2)

(3)

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(4)

MACS design involves choosing the most appropriate reward systems to motivate desired behavior. Although intrinsic rewards are sufficient to motivate some people to choose behavior consistent with the organizations goals, a system of extrinsic rewards often provides additional motivation for desirable behavior.

9-69 Reasons individuals may feel justified in cheating at golf include the following: Its only a game. My competitors are doing it. Everyone does it. It does not hurt anyone. The ends justify the means. They dont see anything wrong with it. There is certainly concern that individuals who cheat at golf are also likely to cheat in business, as stated by Jeff Harp in the In Practice materials on cheating at golf. Also in the In Practice materials, behavioral economist Dan Ariely expressed concern that cheating at golf reveals attitudes about bending the rules in other arenas. He further expressed concern that cheating at small things could lead to cheating at larger things and become an accepted practice in business. 9-70 This question is based on a situation described in an article by Andrew W. Singer, Can a Company Be Too Ethical? Across the Board (April 1993), 17 22 (copyright by The Conference Board). One option is to report nothing about the packet and revise your bid lower than your competitors, with the expectation that you will have spared jobs and provided a better return to shareholders. Singer reports the companys alternative response: The CEO informed its competitor and the U.S. Government about the packet, and let its original bid stand. The competitor won the contract. The CEO believed he made the appropriate decision (that is, not too ethical), despite the fulfilled predictions of lost jobs and reduced profits. The CEO reasoned that his companys reputation for ethical behavior would enhance the companys long-run prospects. 9-71 This type of situation is probably not uncommon. You can confront her again and ask that she resubmit the report, and encourage her to discuss the companys policies on flexible scheduling to accommodate the family responsibilities she
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described. If she refuses then, you can tell her that for her sake and the good of the organization, you will have to tell your boss. Chances are she will rectify the report. 9-72 This is a thornier situation than that portrayed in some of the earlier questions. In this situation there is a threat that you, the employee, will lose your job if you dont comply. A possible course of action is to not comply and go to your immediate superior, who in this case is the controller, and ask his/her advice. The controller may be able to talk to the executive in an indirect manner and have him back off. In this case the executive may disavow any knowledge of the incident; however, this still leaves you at risk. Another alternative is to have your superior go to other more senior management in the firm to describe the situation. Because you and the executive were the only ones to have the conversation this becomes a difficult situation. However, once senior management is alerted to the problem they may be able to monitor the executive and begin a file of his activities. 9-73 (a) Preventive control: Preventive control is usually used in situations where there is the possibility for the employees actions to deliberately or accidentally cause damage, risk, or loss either to the employee or to the organization. In preventive control, discretion in performing a task may be minimized because of the precision required or the nature of the materials involved. The examples chosen should indicate why preventive control is appropriate and should clearly illustrate an approach where the organization is designing the job to try to prevent some undesired employee behavior. Monitoring: Monitoring involves inspecting the work or observing the behavior of employees while they are performing a task. Monitoring is most useful in settings similar to those indicating preventive control. While preventive control focuses on designing the job or the process to prevent the undesired activity from happening, monitoring relies on random observation to enforce the operating rules. Therefore, unlike the preventive control situation, there is no attempt to design the job to avoid the undesired behavior. The examples chosen should reflect an appropriate setting for monitoring and should demonstrate an understanding of the differences between preventive control and monitoring. Results control: Results control is most useful in situations where employees understand the organizations objectives and their contribution to those objectives, and employees deliver a high component of skill,
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knowledge, or commitment to their jobs. For results control to be effective, the organization must clearly define its objectives, communicate them to appropriate members, and design performance measures consistent with the objectives. This method does not directly monitor or control the tasks to be performed, often because it is difficult to measure the components of what the employee delivers to the job. The disadvantage of results control is that results can be affected by circumstances beyond the employees control. Therefore, results control is often conditioned by assessing performance relative to a standard that reflects the circumstances the employee faced. The examples chosen should reflect situations where the employee contributes skill, knowledge, or motivation to the job that cannot be directly assessed. 9-74 The discussion should focus on examples showing that most employees in complex work environments perform a variety of tasks. Clearly, not all performance on all tasks is monitored, but as soon as one begins to consider that more qualitative measures such as quality and customer satisfaction are important, it becomes evident that a mix of measures is appropriate. It may be useful to come up with examples from different work contexts. You might consider how to measure the performance of people in the following jobs:

a used car salesperson a nurse in a hospital an auto mechanic a university professor (this is pretty close to home, however!) a fund raiser an insurance underwriter

The discussion can then be focused to what happens at the workgroup level. With teams or workgroups, performance evaluation becomes more difficult, but there are qualitative variables such as group morale and satisfaction that should also be assessed. Issues related to group output measures such as quality and timeliness are also measurable. Qualitative divisional measures are harder to determine, but again, the overall quality and reputation of a product reflects on a division. Customer satisfaction at this level can also be a sound qualitative measure.

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9-75 The competitive characteristics are low price, conformance to specifications, short cycle times, high quality, good service and on-time delivery. These objectives are consistent with just-in-time manufacturing systems. Important performance measures would include: cycle times (including the time taken to fill a customer order from start to finish, and production time), first-pass yield (proportion of good items to total items produced at the final inspection station), number of production system failures, conformance to schedule, cost per unit, customer satisfaction scores, number of customer complaints and material yield. 9-76 Both participation in decision making and education to understand information received in organizations contribute to employee empowerment in MACS design. The reason is that the MACS is the central information system in most organizations. Like all information systems, its benefits are a direct function of the quality of the information contained in it, and whether employees find it useful for decision making. Asking for input about system design and the kinds of information that should be generated from the system from those employees who work with a MACS on a routine basis (and in some cases even for those who only use the system on a limited basis) has several effects. First, the system is updated with information that comes from employees who are closest to their jobs and hence know what information they need. Second, through participation employees will feel that they are having a direct effect on their work environment and this could increase their motivation and morale. Third, the organization as a whole benefits because it is able to obtain the most up-to-date information and at the same time potentially increase motivation for its employees to perform. The situation that organizations want to avoid is one in which uninformed people design the information system without really understanding the information needs of employees. When this occurs, employees believe that the system is useless and begin to develop their own private information systems to get their work done and gauge their performance. Clearly, if many employees are developing their own systems, there is little coordination throughout the organization regarding information, and a formal system is largely ineffective. In order for a MACS to function well, employees must be constantly re-educated as the system and its performance measures change. If employees understand the organizations current performance measures and the way they are computed, the employees can take actions, resulting in superior performance measurements that lead to intrinsic and extrinsic rewards for employees, and achievement of the organizations goals.

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9-77 (a) This form of budgeting is called consultative. (b) The pros of consultative budgeting are that the organization can gather information from subordinate managers about their local operations. Local managers have more insight and experience than those far from the operation. Some organizations hope that allowing subordinates input in the budgeting process will increase their motivation to achieve the budget. Other advantages are that it is quicker than participative budgeting and participative budgeting may be impractical. On the con side, the superior has the final say on the level at which the budget is set. In some situations, the final budget may be far from where the subordinate manager thought it should be. In this case, employees morale and commitment will decline. In the worst case, the superior has no intention of using the subordinates input. This form of consultation is called pseudoparticipation and can have very negative effects on the subordinates morale if he or she finds out the entire procedure was a charade. 9-78 In participative budgeting, budgets are set jointly between superior and subordinate managers. This means that both parties negotiate the budget and once both parties leave the negotiating table, what has been decided will stand. Participative budgeting has many advantages, such as allowing superiors to obtain the subordinate managers information about local conditions, and increasing the subordinate managers commitment and motivation to achieve the budget. In some very large firms with many managers and many budgets, participation of this kind may be impractical given the time and energy involved in meeting with each manager. Setting budgets authoritatively is very efficient. Senior management can simply determine by fiat what each subordinate managers budget will be. This may be the most appropriate method if subordinate managers are not very knowledgeable about the budgetary process or if the organization is simply trying to save time and the resources involved with the other two types of budget-setting methods. The disadvantage of setting budgets in an authoritarian manner is that subordinate managers have very little ownership of the budget, since they were not involved in any way with setting the budget. This lack of ownership could lead to decreased motivation to achieve the budget. Further, managers never really learn about the budgeting process and will always be left in the dark. Finally, the organization misses out on the insight and information about local operations that subordinate managers may have. When budgets are set via consultation, the organization is attempting to gather information from subordinate managers about their local operations. The idea is that local managers have more insight and experience than those not close to the
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operation. The organization is also hoping that allowing subordinates input will increase their motivation to achieve the budget. The concern with consultation is that the superior has the final say on the level at which the budget is set. In many cases the final budget may not be close to where the subordinate manager thought it should be. In the worst case, the superior has no intention of using the subordinates input. This form of consultation is called pseudo participation and can have very negative effects on the subordinates morale if he or she finds out the entire procedure was a charade.

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9-79 (a) The motivation of the sales group is to understate their sales estimates in order to increase their expected sales commission. (b) The organizations budgets will understate sales. If capacity is planned based on understated sales, then capacity will be too low and the organization will continuously be using overtime to meet demand. (c) The need is to develop a scheme that eliminates the motivation of the sales force to understate their sales expectations. The idea would be to decouple the sales estimates and the sales targets. One approach would be to eliminate the sales commissionhowever, this is likely not a choice that would be considered seriously. Another possibility is to base sales estimates on historical trends. The organization might undertake to link industry sales to demographic or economic indicators in order to end the reliance on sales force forecasts. Another approach would be to reward the sales person for two things: (1) the accuracy of the estimate and (2) the level of sales. 9-80 Woody is engaging in the process of building slack into his budget. Many believe that this is a rational thing for Woody to do to protect himself from any kinds of uncertainties in the environment that he might face. For example, if his key source of raw materials dries up and Woody has to find an alternative source which, on short notice, will cost him three times his usual costs, extra money in the budget will allow him to purchase the materials. Having those excess resources may also allow him to achieve his production goals without exceeding his budget. Of course, if everyone in Woodys organization pads his or her budget, the organization will be run very inefficiently and ineffectively. One way for the organization to reduce slack building is to modify the way that it evaluates Woody and his fellow managers performance. If, in the past, harsh penalties have been levied on those who did not achieve their budgets, then slack building behavior will be encouraged. Instead, the organization may determine performance schemes that reduce the pressure to meet the budget, by providing a 5% or 10% confidence interval around the actual level of the budget. If a manager falls in this range, then he or she is not penalized. Or, a system can be set up that is based on multi-year performance in which a manager is not evaluated just on one year, but over several years. Thus, if a manager does not meet the budget in one year, but does well in the others, he or she is not penalized. Either of these approaches may reduce the amount of slack that Woody would be inclined to build into his budget.

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9-81 Tying pay to performance has taken hold of U.S. business. Some believe that paying a good, fair salary should be motivating enough, and that using pay-forperformance sends the wrong signal to employees. That is, such incentive schemes signal that employees will only do their best work if they get a bonus. Others believe that it is psychologically more motivating to link pay to performance. Some organizations that use pay-for-performance compensation pay employees a lower flat wage than other non-pay-for-performance firms and then add a bonus that brings up the total compensation package to be approximately equal to the non-pay-for-performance firm. A possible disadvantage of tying pay to performance is that employees may focus only on the item(s) used to determine the bonus, leading to dysfunctional behavior as employees lose sight of what is best for the organization. Furthermore, employees may give little attention to qualitative factors and they may focus only on short-term goals. 9-82 Organization Unit Symphony orchestra Government welfare office Airline complaint desk Control room in a nuclear-generating facility Basketball team What Behavior Should What Is an Appropriate Be Rewarded? Incentive System? Number of tickets sold, Market wage plus profit-share Group-oriented performance Number of cases processed, Market wage plus Success in helping clients performance-related bonus Customer Market wage plus satisfaction performance-related bonus Operating equipment Market wage as required Individual performance for some players plus team success Wage plus performancerelated bonus

9-83 This is a practical question designed to put the student in a situation of managing a business where employees cannot be supervised directly and have a strong impact on repeat sales. The dilemma is that the jobs are relatively low skilled (although the job is manual and quickly learned, there are important skills relating to dealing with customers) and the economics of the competition do not allow this organization to use higher wages to attract and keep motivated employees. Most responses will suggest some type of profit sharing system where the employees are paid a market wage to attract them to the organization and then a profit share to motivate them to do their work conscientiously and to develop
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their people skills. Note that it is the customer, not the company, that absorbs the unfavorable labor efficiency variance under the current pricing scheme since the customer pays for hours worked. This may have an unfavorable effect on the organization by causing higher prices and losing customers. The company might consider moving to a charge that is based on work done rather than time worked. This would provide the opportunity of shielding the customer from unfavorable labor efficiency variances and allow the use of a gain sharing type of plan that pays workers bonuses based on their ability to beat time targets for the individual jobs. However, if this approach was used it would be critical to use customer satisfaction surveys to ensure that quality is not being sacrificed to beat the time targets. The company might offer a bonus after a given number of days of employment to increase the retention of good employees. The company might also offer a bonus for very satisfied customers identified through surveys. 9-84 (a) This is a deep issue that plagues all research and development activities in profit seeking organizations. The question is how to draw the line between letting people do research that is so basic that it may never result in profitable patents but, if it does, may represent a profound competitive advantage, and other research that is totally oriented to developing profitable products. The key is that the organization must develop a policy which states that no more than a certain proportion of the research and development activity can be devoted to basic research (that is research that is not devoted to developing any product in particular but may pay off in some unspecified way). The key is to debate and establish that proportion. There does appear to be a problem at the moment. If we define research and development productivity as the rate of new product introduction divided by the expenditures on research and development, this organization is not doing well. In the long-term, competitive pressures will not allow this organization to continue in this way. (b) The focus will be on identifying market opportunities and directing the attention of the research staff toward meeting these opportunities. A share of the income provided by a new product could be paid to people who develop that product. The compensation plan needs to be changed. Currently, scientists are rewarded based on their level of education and the number of research papers published in scientific journals. The number of research papers published should be dropped as a performance metric. Compensation should be tied to the number of new prototypes developed,
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the number of new products developed, or the number of patentable inventions. 9-85 (a) Some obvious positive points: this plan is very specific, it focuses on profit performance, it rewards group performance, and it can be adjusted for good or bad conditions that the organization members cannot control. Some obvious concerns: profit performance is a short-run performance measure and there is no discussion of how the pool proceeds are distributed to individual employees. Like all group incentives, this plan suffers from the problem of people who do not do a good job pulling down those that do. The upper limit will encourage people to pull back their effort if they believe the organization performance is approaching the upper limit. Also, employees may have somewhat limited ability to control earnings from operations if external economic factors play a large role in earnings. 4% + 3%
332 320 390 320

(b)

(c)

= 4.51428%

Profit-sharing pool = 4.51428% $332,000,000 = $14,987,410 (rounded) (d) Tightening standards every period reduces the motivational effects of this system. This is because process improvements provide benefits for fewer periods than if standards remain the same. Perhaps the plan should only tighten the standards every 3 years. Profit sharing pool = lower of [45,000,000 (100,000,000 18%)] 40% or 7,000,000 = lower of (45,000,000 18,000,000) 40% or 7,000,000 = lower of 27,000,000 40% or 7,000,000 = lower of 10,800,000 or 7,000,000 Profit sharing pool = $7,000,000 (b) 68,000 25,000,000 Marg Watsons bonus = 7,000,000 0.00272 Marg Watsons bonus = $19,040 Marg Watsons bonus = 7,000,000

9-86 (a)

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(c)

This profit sharing plan is specific and has justifiable economic properties. The target profit level probably is intended to provide the required return to shareholders and is desirable. The plan pays nothing unless a certain level is achieved. This may be unfair when times are bad. That is, with severely depressed economic conditions, the employees may do a good job and earn no bonuses. It is not good enough to say that if the owners do not do well the employees should not do well. It is not the role of employees to bear this type of risk. Their job is to do the best they can under the conditions that they find. This is an undesirable feature of all profit-sharing plans. The choice of 18% should reflect the return available to shareholders for comparable investmentsthe shareholders required rate of return. The required rate of return is likely to be lower; therefore the 18% is too high and should be adjusted downward. Basing the profit share on salary rather than performance assumes that the employees contribution is proportional to salary. While this makes the plan easy to administer, it does not tie the reward to the performance level. A more appropriate approach would set performance targets for the individual and base the individuals share of the total bonus pool on achievement of the performance targets. The upper limit of $7,000,000 is desirable from the perspective of the shareholders but dampens motivation from the perspective of the employees. That is, when performance reaches the level where the bonus pool is $7,000,000 the employees may slack off. The 40% profit share seems a bit low. Some plans are as high as 50%. It is difficult to say but the lower proportion may dampen the motivational effect of the plan. Furthermore, the individuals considered may have limited ability to control earnings.

(d)

9-87 (a)

Target hours = (0.2 200,000) + (0.15 220,000) + (0.25 130,000) + (0.1 240,000) = 129,500 hours Savings = (target hours actual hours) wage rate Savings = (129,500 110,000) $16 = $312,000 Gain share = $312,000 50% = $156,000

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(b) (c)

It is clear and it is based on something that the employees can control directly. A gain share of 50% of the savings seems reasonable. It is not clear whether this amount is substantial enough to have any motivational effect on the employees. If the bonus is shared equally among the workers, the bonus amounts to about 8.9% ($156,000 [110,000 $16]) of wages paid. The employees may or may not find this a strong motivator. The Scanlon plan base ratio would be determined as follows payroll costs 3,000,000 Base ratio = = = 0.06 value of production 50,000,000 The quarterly amounts accumulated in the plan are shown in the following table.
Quarter 1 Ratio Plan Change Cumulative 2,475,000 = 0.055 45,000,000 (0.060 0.055) = $225,000 $225,000 45,000,000 3,480,000 = 0.058 60,000,000 (0.060 0.058) = $120,000 $345,000 60,000,000 = 0.065 55,000,000 (0.060 0.065) = ($275,000) 55,000,000 2,832,000 48,000,000 = 0.059 48,000,000 (0.060 0.059) = $48,000 3,575,000 $70,000

9-88 (a)

$118,000

Therefore the amount available to be distributed to the employees at the end of the year would be 35% of $118,000 or $41,300. (b) The Scanlon plan assumes that the payroll costs are highly variable. This was likely true in the 1930s when the plan was originally proposed. However, in todays conditions many labor costs are essentially fixed and may be very difficult to change in response to short-term fluctuations in demand. The plan also assumes labor costs decrease over time if labor efficiency increases, which may not be true in a highly unionized setting. The plan also assumes that declines in labor costs are due to labor efficiencies, which may not be true. The company may be experiencing layoffs or production downturns.
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(c)

The Scanlon plan assumes employee participation and group effort. Therefore, a reasonable proposal is to divide the distribution equally among the employees covered by the plan. An alternative in a small group, where all the employees know each other, would be to have the employees vote on the distribution in a private ballot by ranking each members contribution. Under this approach, the base ratio for the following year would be 0.055, the ratio experienced in quarter 1. This is called the ratchet effect. Its result is to quickly tax away any innovations that the employees develop so that they experience no long-term benefit from their innovations. This quickly dampens enthusiasm for, and the motivational effect of, the plan. To avoid this, the base ratio should hold over a longer period of time, perhaps three years, unless there is a system change, such as new equipment, that creates a new standard for the base ratio. Speeding up production was supposed to increase productivity and lower coststhereby making the company more cost competitive. Speeding up production also allowed workers to meet shipping schedules. Middle managers sacrificed quality for conformance to the directive to speed things up. Many motorcycles were shipped with known defects that the production people expected the dealers to repair. The result was that the quality of the motorcycles declined and customers began to move away from this company. The system was modified by instructing the employees that the organization was committed to quality and that no motorcycle was to be shipped with any known defect. Front-line employees were given the authority to stop the production line whenever they saw a quality problem. This got the message to all employees and customers that HarleyDavidson had changed; both quality and efficiency were now important.

(d)

9-89 (a)

(b)

(c) (d)

9-90 Denver Jacks approach does not allow for participation on the part of employees. Thus, he is losing many good ideas and probably stifling the motivation of his employees. Further, Denver Jack is not getting the employee buy-in from which he would benefit. On the other hand, some believe that a topdown approach to decision making is efficient and does not tie up scarce human resources. Each kind of organization must decide what approach or combination of approaches is the most appropriate for its purposes.
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9-91 This incentive compensation plan seems to meet the most important characteristics of effective incentive compensation plans. It clearly distinguishes between wages and incentive compensation and does not attempt to replace wages with incentive compensation. The plan is precise in terms of what it rewards on the two elements of performanceshorter-term performance measures that are subject to cash bonuses (presumably these performance measures would relate to the organizations key success factors) and longer-term measures of performance determined by share prices. The stock price component of the plan has a time frame that is long enough to promote a longer-term decision-making perspective, but short enough to support the reinforcement effect of rewards. In order to distinguish between market and executive effects on share prices, the longer-term plan could be adjusted to eliminate market-wide effects by basing rewards on performance relative to a peer group. A key characteristic of the plan is that it relies heavily on decisions made by independent outsiders. This improves the ethics associated with the administration and operation of this plan. 9-92 (a) This change is inconsistent with the idea that compensation should have a fixed and a variable component and that the fixed component should reflect the market opportunity. The employees would likely complain about the risk imposed on them by the new system. The employees would also now be unwilling to undertake any activities that do not relate directly to earning a commission. Given the approach of all compensation being commission based taken, an argument can be made that it is reasonable to set the commission so that the wage bill would have been the same under the previous and new systems. This approach seems to leave the workers equally well off under the two systems. However, economic theory supports a position that riskaverse workers must be compensated for bearing more risk under the new system if they are to be equally well off in expected utility. Thus, a different and better approach might to maintain a wage and to provide motivation through a much lower rate of commission than the new system uses.
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(d)

The top employees will likely stay since their income will increase. The weaker sales people will likely leave to find jobs where the income is not so risky. In general, this system will tend to attract high-pressure sales people who are sales-oriented and who will be unwilling to do anything not directly related to earning commissions. The company will have to decide if this is what it wants. The system rewards only one aspect of employees behavior, which could be detrimental to the company. In addition, employees may resort to data falsification and gaming in order to increase their income. This incentive scheme, which is traditional in government, is inappropriate. It promotes building up staff without regard to the true need for staff dictated by legislative initiatives and legitimate client needs. It also promotes inefficiency among her subordinates; the longer they work (perhaps due to inefficiencies), the more she gets paid. The performance measurement scheme should reward the ability to achieve outcome targets defined by client requirements that the government is committed to meeting. Labor efficiency measures should be put in place. Examples include number of claims processed by each employee per day, client wait time for in-office visits, and number of claims denied by each employee per day. Possible qualitative measures include client satisfaction and number of client complaints per day. Based on salaryeasy to administer, likely to be considered fair and, to the extent that salary reflects the relative ability to contribute to results, is based on contribution; based on equal shareeasy to administer, likely to be considered fair and reflects how people often divide up rewards when left to their own devices; based on positionsame as based on salary; based on individual performanceties reward most closely to performance and likely to have the highest motivational impact. Based on salarymay convince lower level employees that they have little to contribute, does not necessarily reflect contributions; based on equal sharemay have little motivational effect, may lead to feelings of inequity if some people contribute nothing; based on positionsame as based on salary; based on individual performancemay be difficult and costly to administer, may lead to arguments about interpreting the performance measure. The choice should be reasoned. The response should identify the objective of compensation (to support the achievement of organization goals) and the individuals understanding of how rewards motivate people. Any
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response is acceptable as long as it clearly reflects that the goal is to promote achievement of organization performance and that the reward design must reflect the belief of how rewards motivate individual behavior. CASES 9-95 Anne Wu should proceed carefully. (a) Anne Wu should approach this issue with Judy Choy by stressing that the fast pace of work that is currently underway is contributing to the 10% error rate. As errors increase, the cost of correcting them increases. There are probably other reasons for the 10% error rate and these reasons need to be investigated before a faster pace of work is demanded. The organization seems to be stressing quantitative information (volume of claims processed) and not really focusing on quality (error-free work) and customer satisfactionboth extremely important qualitative factors. The organization should use a mixture of quantitative and qualitative measures. Output per claims examiner is an important indicator, but so is the error rate per examiner. The organization should also assess the number of refiled claims per examiner as a way to help build quality into the examiners work.

(b)

(c)

9-96 This response describes what is reported about Sherron Watkinss experiences at Enron. Numbers in square brackets refer to the references listed at the end of the responses for this case. (a) Watkins discovered problems in the summer of 2001, while working on an assignment for Andrew Fastow, who was then Enrons chief financial officer. Watkins was tasked with estimating the economic effect of potential sales of some of Enrons assets. In conjunction with this task, Watkins evaluated each assets estimated book value and market value. She stated the following [2]: A number of assets were hedged with an entity called Raptor. Any asset that was hedged should, for the most part, have a locked-in sales value for Enron, meaning that despite current market prices, Enron should realize the hedged price of the Raptor.

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It was my understanding that the Raptor special-purpose entities were owned by LJM, a partnership run by Mr. Fastow. In completing my work, certain Enron business units provided me with analyses that showed certain of the hedged losses that had been incurred by Raptor were actually coming back to Enron. the Raptor hedge had declined in value such that Raptor would have a shortfall and would be unable to fully cover the hedge price that it owed Enron. I was highly alarmed by the information I was receiving. My understanding as an accountant is that a company could never use its own stock to generate a gain or avoid a loss on its income statement. I continued to ask questions and seek answers, primarily from former co-workers in the global finance group or in the business units that had hedged assets with Raptor. I never heard reassuring explanations. Watkinss response is summarized in [4]. According to [5], Coopers trail of discovery began when an executive told her that corporate accounting had taken $400 million out of his reserve account and used it to boost WorldComs income. Despite reassurances from audit firm Arthur Andersen and CFO Scott Sullivan, as well as hostility from Sullivan, Cooper led her internal audit team to eventually discover that the firm had capitalized billions of dollars of expenditures that should have been expensed. (b) Watkins appears to have considered or attempted to implement options 1 or 4. Option 1 is to point out the discrepancy to a superior and refuse to act unethically, understanding that this may lead to dismissal. When Watkins became aware of the accounting problems at Enron, she did not want to challenge Fastow or then-CEO Jeffrey Skilling about the problems until she had another job lined up, because it would have been a jobterminating move [2]. She interviewed for a position at Reliant Energy and planned to sign a new job contract and confront Skilling on her last day at Enron [4]. When Skilling suddenly resigned on August 14, 2001, the new CEO, Kenneth Lay, invited all employees to submit questions for an August 16 meeting at which Lay would talk about Skillings resignation. Watkins submitted to Lay an anonymous letter with the statement, I am incredibly nervous that we will implode in a wave of accounting scandals [4]. On August 16, Watkins discussed her memo with Cindy Olson, then vice president for human resources. Upon Olsons
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advice Watkins arranged to meet with Lay personally, on August 22. Watkins prepared a memo detailing her concerns. She included the following quote from a manager-level employee: I wish we would get caught. We are such a crooked company [2, 6 (p. 367)]. Watkins hoped that after the first memo, the company would act on her suggestions, come clean, and avert disaster [6, p. 321]. After Watkins met with Lay, he promised follow up on Watkinss concerns. Watkins asked to be transferred from Fastows group. Thus, after Skillings resignation, Watkins appears to have been following option 4: Work with respected leaders in the organization to change the discrepancy between practiced and stated ethics. Watkinss memos became public because her memos were part of the many, many documents subpoenaed by the House Committee on Energy and Commerce. Watkins and her memos became national news [6, pp. 345-347]. Reference [3] states that a congressional subcommittee investigating Enrons collapse released Watkins letter to chairman Kenneth Lay warning him that the companys methods of accounting were improper. Cooper also attempted to implement options 1 and 4. She approached the companys audit firm, Arthur Andersen, and CFO Scott Sullivan about the troublesome accounting issue. Reference [5] reports that Cooper received assurances from Arthur Andersen; she was so concerned about Sullivans angry response that she felt her job was at risk. After weeks of investigation, Cooper s team confirmed that the firm had capitalized billions of dollars of expenditures that should have been expensed. At Sullivans request, Cooper explained what her team had found. Cooper then conveyed her findings to the head of the audit committee, and to the companys controller, David Myers. (c) As stated in part (b), Watkins certainly felt pressured not to challenge Fastow and Skilling, regardless of the issue. Her information raised serious concerns about extremely serious accounting improprieties, and conflicts of interest for Fastow. If Watkins dropped her concerns, Enrons executives and employees would benefit in the short term until it became impossible to hide the wrongdoings. Similarly, Cooper felt great pressure not to challenge CFO Sullivan. Her information raised serious concerns about accounting improprieties that the CFO and the companys controller were aware of. And, similar to Watkinss situation, many felt that if Cooper dropped her concerns,
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WorldComs executives and employees in Enron would benefit in the short term, and some felt that the company might eventually turn itself around financially. (d) Enrons 2000 on-line annual report lists four key values: communication, respect, integrity, and excellence [7]. Enron distributed illustrated booklets listing these four values [6, p. 103], and Skilling and Lay narrated a video discussing the four values. The video was given to all employees [6, p. 104]. Nevertheless, top management did not consistently demonstrate the stated values. When Watkins, Cooper, and Rowley were asked why others did not do what these three did, they agreed that it was the value system at the top [1]. For example, Lay demonstrated lack of ethical leadership by insisting that Enron employees use his sisters travel agency [6, p. 36]. A job satisfaction survey at Enron in the mid-1990s revealed that many people felt uneasy about expressing their opinions at Enron. Lay and Skilling promised corrective action. Consistent with this, the company distributed stick-note pads with this quote from Martin Luther King, Jr.: Our lives begin to end the day we become silent about things that matter [4]. In contrast to managements official position encouraging people to speak up about important matters, Watkins discovered that very shortly after she met with Lay to discuss her concerns, Enrons lawyers provided information to management about legal issues related to firing whistleblowers [4]. Watkins discovered this in February 2002. She commented, Theres nothing in there to remind them to remember the code of conduct, the vision and values [4]. According to [8], WorldCom CEO Bernie Ebbers and CFO Scott Sullivan were celebrated leaders Sullivan had a reputation of impeccable integrity. Their reputations apparently provided reassurance to most employees when Ebbers and Sullivan made it clear that employees should not question WorldCom practices. Also according to [8], loyalty by employees and the Board of Directors was well compensated, so that neither group had incentives to confront the leaders on questionable practices. (e) The Time interviewers described the three persons of the year as follows [3]: none of them are rebels in the usual sense. The truest of true believers is more like it, ever faithful to the idea that where they
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worked was a place that served the wider world in some important way. Cooper explicitly mentioned values and ethics that you learn through your life [1] and Rowley and Watkins appear to agree. In other interview statements, Watkins refers to Johnson & Johnson doing the right thing in response to the Tylenol scare [1]. After her meeting with Lay to discuss the problems she had uncovered, Watkins felt that she had done the hardest thing in my life, but I had carried the torch and dropped it off [4]. Reference [4] describes Watkins as independent and known for openly stating her opinions and being able to support them. (f) As mentioned in (d), Watkins discovered that very shortly after she met with Lay to discuss her concerns, Enrons lawyers explored the ramifications of firing her in relation to whistle blowing [4]. Her hard drive was seized, she was forced to move from her executive suite to a plain office, and given work of little substance [4]. She feared for her safety [4]. At WorldCom, employees were expected not to question the companys practices (see part (d)), and Cooper personally felt Sullivans hostility (see part (a)). Cooper suffered great stress. Following the resulting shakeup at WorldCom, Cooper suffered ostracism from some employees and no senior executive at WorldCom thanked her for uncovering the accounting impropriety [8]. (g) This question is designed to challenge students to think about and discuss how they will make ethical decisions, especially in the face of severe personal consequences. In addition, students may propose other courses of action that Watkins could have taken. For example, some former Enron employees think Watkins should have informed the Securities and Exchange Commission [4]. Watkins said that in retrospect, she would have gone to the board [1]. [1] Anonymous. The Interview, http://www.time.com/time/personoftheyear/2002/poyqa.html, posted December 22, 2002; 4:31 A.M. EST. Print version: New York:Time. December 30, 2002-January 6, 2003, Vol. 160, Iss. 27; p. 58. Anonymous. Enrons Many Strands; Lone Voice: Excerpts from the Testimony of Executive Who Challenged Enron, The New York Times (February 15, 2002), Late EditionFinal, Section C, Page 7, Column 1, Business/Financial Desk.
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[3] [4]

Lacayo, R. and A. Ripley. Persons of the Year, New York: Time. December 30, 2002January 6, 2003, Vol. 160, Iss. 27; p. 32. Morse, J. and A. Bower. The Party Crasher, http://www.time.com/time/magazine/article/0,9171,1003992,00.htm l, accessed February 5, 2011. Formerly at http://www.time.com/time/personoftheyear/2002/poywatkins.html, posted December 22, 2002; 4:31 A.M. EST. Print version: New York: Time. December 30, 2002-January 6, 2003, Vol. 160, Iss. 27; p. 53. Ripley, A. The Night Detective, http://www.time.com/time/magazine/article/0,9171,1003990,00.htm l, accessed February 5, 2011. Formerly at http://www.time.com/time/personoftheyear/2002/poycooper.html, posted December 22, 2002; 4:31 A.M. EST. Print version: New York: Time. December 30, 2002-January 6, 2003, Vol. 160, Iss. 27. Swartz, M. and S. Watkins. Power Failure: The Inside Story of the Collapse of ENRON. New York:Doubleday, 2003. http://www.enron.com/corp/investors/annuals/2000/ourvalues.html, viewed February 15, 2003. Zekany, K., L. Braun, and Z. Warder. 2004. Behind Closed Doors at WorldCom, Issues in Accounting Education, 19, 101-117.

[5]

[6] [7] [8]

9-97 See the solutions for Case 2-48. 9-98 Citibank Performance Evaluation, Harvard Business School Case (HBS Case No. 9-198-048, teaching note No. 1). In the solutions here, notes are first provided for the textbook case questions, followed by the published HBS teaching note. Textbook case questions:
Copyright 1999 by the President and Fellows of Harvard College. Harvard Business School. This note was prepared by Professor Robert Simons and Professor Antonio Dvila at IESE for the sole purpose of aiding classroom instructors in the use of Citibank: Performance Evaluation, HBS No. 198-048. It provides analysis and questions that are intended to present alternative approaches to deepening students comprehension of business issues and energizing classroom discussion. Reprinted by permission of Harvard Business School. 83
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(a) Why has Citibank introduced its Performance Scorecard? What benefits does Citibank expect the Performance Scorecard to provide? As stated at the end of the first paragraph in the case, last year, the California Division of Citibank had introduced a new performance scorecard to highlight the importance of a diverse set of measures in achieving the strategic goals of the division. Also see the first three paragraphs of the section titled New Performance Scorecard. (b) What cause-and-effect linkages are implied in the Performance Scorecard? See TN-4 and the related teaching note discussion. (c) What characteristics are desirable for measures used to evaluate and reward performance? Discuss the Performance Scorecards measures in relation to the characteristics you identified. See TN-5 and the related teaching note discussion of characteristics such as alignment with strategy, measurability, objectivity, completeness, and linkage to value. (d) Assume that you are Lisa Johnson. Complete Exhibit 1 to evaluate Jamess performance and explain your rationale for your rating on each of the six dimensions and the overall evaluation. See the teaching note discussion, beginning with the section titled Performance evaluation. Harvard Business School Teaching Note Teaching Objectives This case presents the costs and benefits of using multiple performance measures to evaluate performance. The issues presented in the case include: Introducing a performance scorecard as a diagnostic system to implement intended strategy. Evaluating the pros and cons of using a performance scorecard to evaluate and reward performance. Identifying the characteristics of a good measure.
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Discussing the benefits and costs of using a subjective performance evaluation. Case Synopsis The top management team of Citibank California is meeting to review the performance of the banks branch managers and decide their bonuses. James McGaran is next in the review process. The committee and students must decide whether to give him an above par rating (with a bonus of 30% of his salary), a par rating (with a 15% bonus) or a below par rating (with no bonus). James McGaran is the manager of the most important and toughest branch in the Los Angeles area. His financial performance has been impressive since he took charge of the branch in 1992. In 1996, his financial performance was, again, outstanding, well above the targets defined by top management. But in 1996 Citibank introduced a performance scorecard including financial as well as nonfinancial measures. Customer satisfaction was among the non-financial measures used as leading indicators of future financial performance. Unfortunately, James branch scored below par in customer satisfaction and, according to established policies, he should receive, at most, an overall par rating. However, Lisa Johnson, his supervisor, is not convinced that a par rating would fairly reward James effort. Some of the services measured in customer satisfaction are not under James control including phone banking and ATM services. Moreover, James would perceive a par rating as unfair because of the difficulty in managing his branch, the excellent financials, and the limitations that he perceived in the customer satisfaction measure. On the other hand, this decision will be closely watched by the rest of the division as a test of the new performance evaluation system. Assignment Questions 1. Why has Citibank introduced a Performance Scorecard? 2. Assume that you are Lisa Johnson. Complete Exhibit 9-2 to evaluate James performance. Case Theory and Background For background reading that describes the concepts and theory illustrated in this case, see Robert Simons, Performance Measurement & Control Systems for Implementing Strategy, Prentice Hall (2000), Chapters 9 and 10. The case can be used to address several theoretical issues. James performance in terms of customer satisfaction is a good setting to discuss the characteristics of
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a measure. The discussion naturally evolves around the issues of controllability and information content of a measure, reliability of a measure, and the advantages and limitations of objective and subjective measures. Citibanks performance scorecard provides an excellent setting to evaluate the advantages and disadvantages of using financial as well as non-financial measures to communicate strategy and evaluate performance. The implicit assumption when using non-financial indicators is the existence of a business model that relates these non-financial measures to value creation. Through the discussion, students can be asked to visualize the model used by top managers at Citibank and assess its adequacy to implement the intended strategy. Finally, the case presents a rich setting to explore issues around performance evaluation and economic incentives. The evaluation process at Citibank includes a target setting process, the use of financial, non-financial, subjective, and objective measures, and objective and subjective performance evaluation criteria. Each of these issues are useful to present concepts related to profit planning and budgeting, measurement theory, performance evaluation, and design of economic incentive systems. Pedagogy This case illustrates the tensions that emerge when the performance measurement system is expanded to include measures beyond financial results. Non-financial measures communicate the organizations strategy but, at the same time, remove autonomy from the people in contact with the customer who have to work with the additional constraints imposed by the new non-financial goals. Strategy and structure Before discussing James performance, it is a good idea to describe the strategy and structure of Citibank California to have the important actors and their objectives in the blackboard. Citibanks strategy can be described as: build a profitable franchise by providing relationship banking combined with a high level of service to its customers. Whereby high level of service, management means: *0 *1 Careful personal attention and A broad selection of financial products. Exhibit TN-1 presents the relevant organizational structure.

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Performance evaluation After this brief introduction, the discussion can shift to evaluation of James performance where the tension of the case resides. In particular, students have strong opinions on how Citibank measures customer satisfaction. The discussion can start with the following question: How would you have rated James performance before the Performance Scorecard was used? Undoubtedly, his financials are impressive and it is very likely that he would have gotten an above par rating which includes a 30% bonus and the prestige associated with recognizing his accomplishments in the toughest branch of the California region. Next, the instructor can ask, How do you rate James performance in each of the five perspectives of Citibanks performance scorecard? In answering this question, the instructor should leave customer satisfaction until the other five perspectives have been discussed. Most students will agree that he deserves an above par rating in all of the perspectives (except for customer satisfaction) because he performed above target. James impressive performance can be emphasized by taking a close look at the financial perspective where targets had been increasing throughout the period and James over-performed every time. As a summary of James performance we can say: In the financial perspective he was impressive: 16% over budget [for revenue] in addition to a target that kept on moving up over time. In strategy implementation he was above par in all quarters but one (the first one). This is the only other perspective where some students may argue that the performance was not that good. Usually, these students have decided to give James a par rating and are looking for additional arguments to reinforce their decision. But, the rest of the class will tend to dismiss this assessment. In control he has been rated above par in all rated quarters. In people, where Lisa has discretion to judge performance, James received an above par in every single quarter. Same for standards, were Lisa again showed her appreciation for James work. While students discuss the various measures and dimensions of the performance scorecard, it is helpful to build Exhibit TN-2 on one of the blackboards and ask about the nature of each measure: is this an objective or a subjective measure? While standards and people are subjective measures, control and customer
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satisfaction are less so, and strategy implementation and financial are the most objective (if we accept the objectivity of accounting). Certainly, leaving aside customer satisfaction, James would have gotten an above par rating and full bonus as he did in previous years. But: How did James perform in terms of customer satisfaction? (see Exhibit TN3). His quarterly scores (66, 63, 54, and 72) are below the targets defined for this performance dimension and, therefore, he should receive a below par rating. But not all students agree on the adequacy of this performance measure. The following table illustrates some of the points that students may bring to the discussion. In favor of a Below Par rating *0 Emphasizes Citibank strategy. In favor of a Par rating *1 He became branch manager in 1992 and he is still producing good results => the measure may not be a leading indicator. *3 The measure is not good because only 25 customers per quarter does not represent the population. In addition, there is a selection bias because only customers that visited the branch were eligible for the interview. *5 James segment is more demanding and therefore he should get a lower rating.

*2 Customer satisfaction is a leading indicator of performance and represents the business model. A bad rating will be reflected in financials sooner or later. *4 It focuses his attention and that of the rest of the division on the importance of customer satisfaction to fulfill the intended strategy.

*6 Customers answering the survey are also judging services not controlled by James. *7 Too much emphasis on customer satisfaction may force a wrong asset allocation by James.
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He may overinvest in customer satisfaction. The main arguments against customer satisfaction are: It does not necessarily reflect strategy (i.e., it is not a leading indicator). Few students will notice this underlying assumption. We will come back to this issue later in the discussion. The measure is unreliable because using 25 customers per quarter does not have enough precision or because people answering the survey are a biased sample. It is very unlikely (in terms of probabilities) that he got four bad ratings because of bad luck. However, there is merit in the comment that customers who visit the branch may not be representative of the full customer population especially to the extent that high net worth customers prefer to use banking services by telephone, ATM, or even have banks visit them in their offices or homes. Related to the previous argument, some students may argue that the questionnaire is badly designed. Usually, if questioned, the student means that the measure includes things that James cannot control as described in the following point. But some students may argue that the questionnaire is wrong and then the argument focuses on the reputation and reliability of a professional marketing research firm. The measure includes things that are not controllable by James like ATM and phone banking. Students feel very strongly about this issue as they see it unfair. However, every branch gets the same ATM and phone banking service and it is likely that some offices are above par in customer satisfaction. Blaming ATM and telephone banking is also a handy excuse for James. An additional reason to dismiss this argument is that any measure includes uncontrollables if it is to be complete. Moreover, James can manage the expectations of his customers regarding ATM and phone banking, therefore having certain control upon these uncontrollables. A useful example is to ask students what performance measure they would choose for a CEO: share price or profits. The discussion will illustrate the tension between the controllability principle and the importance of including the results of all types of actions (informativity principle). If students still feel strongly, the instructor can propose (as it was the case) that the customer satisfaction measure included mostly branch-related questions. Finally, the standard for James should be different because his customers are more demanding.
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The conclusion of the above discussion is that customer satisfaction may not be a perfect measure but this argument is valid for any measure that we can think of because the perfect measure does not exist. It is always possible to find a limitation in any measure and we have to work with the tools that are available. It is not possible to ignore a particular measure because we dont like what it says. Target setting The last criticism on customer satisfaction (point 5 above) rises the interesting point of target setting: if James branch is the toughest in the division, maybe a better target setting process would take care of the problems with the customer satisfaction measure. How are targets decided? The process begins when Frits Seegers and area managers negotiate targets for the division as a whole and for each area in particular. Control and customer satisfaction are common to all areas and branches, while financial and strategy implementation goals are specific to each branch. Next, each area manager establishes the financial and strategy implementation goals for each branch making sure that they add up to the area targets. Some students may argue: the customer satisfaction target is common to everybody and it should not be so. Others will counter: Why should James get a lower customer satisfaction target? Every branch manager could give an argument for the uniqueness of his branch and why he should get a lower target. Therefore, it seems that changing targets is not a good idea. The Design of the Performance Scorecard The primary purpose of a performance scorecard is to communicate a particular strategy down the organization and establish a basis for evaluation based on this strategy. Therefore, defining a specific performance scorecard and linking rewards to the accomplishment of the specified measures (diagnostic system) is appropriate when top managers are aware and clear about the strategy they want to pursue and they have the appropriate measures. In contrast, it can have undesirable consequences if the model is incomplete and leaves out significant variables. In this case, organizational effort will be misdirected.

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Building on the previous point, the instructor can go back to Exhibit TN-2 and ask students to draw top managers cause-effect relationships implicit in the design of the performance scorecard (Exhibit TN-4). Linked to this process, there is a shift of decision rights from branch officers to top managers. When the only performance indicators were financial measures, branch managers could achieve financial performance in several different ways. However, when performance includes financial as well as non-financial measures, the branch manager has less alternatives to achieve performance because he has to perform in certain dimensions as specified by top managers. The instructor could reinforce this discussion with the following questions: What would happen if financials were good but non-financial measures (for example standards) were bad?, would James be achieving Citibanks goals? James performance evaluation At this point in the class, the instructor may choose to take a vote. Usually, the class is still strongly divided between students that see par as fair and those that see below par as the appropriate evaluation. What are the pros and cons of giving him either of these two ratings?: Par *0 Rewards James effort. Allows him to receive maximum bonus. *2 It is what James would have received in previous years. Below Par *1 Gives credibility to new system, otherwise it is undermined. *3 Communicates the importance of customer satisfaction to the rest of the organization.

*4 It is easier to communicate. *5 Systems should be flexible to adapt to exceptions. *6 We keep Jamess motivation up. In the worst case, he may resign if he feels that the new system has penalized his best efforts.
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The problem facing Lisa and Frits is typical of a subjective performance evaluation system. These systems have the advantage of being flexible to adapt to special cases like James case and take into account information that objective performance evaluation may not include. But, these systems have limitations. First, they make hard decisions like this one even harder because the decision is not objective: Lisa and Frits have the last word and there is a personal component to it. In addition and to avoid the personal tension linked to a negative evaluation, people using subjective evaluation tend to overstate performance, there is evaluation inflation. Finally, subjective evaluation encourages politics inside the organization in an effort to influence the decision maker. Conclusion The above class outline is more than enough for a 75 minutes discussion and it points out the most interesting learning points in the case. But the case is still richer than what has been described up to now and the instructor can explore two additional questions: How would you communicate the decision to James? Would you roll-out this performance scorecard to other regions at Citibank? Students may want to know what happened: James got a below par rating on customer satisfaction, but Frits chose to override the system and gave him an overall above par rating for the year. To indicate the importance of customer satisfaction, however, he awarded a 25% bonus in lieu of the maximum 30%. But, as in all cases, the relevant issue is the learning points during the class which can be summarized with the overheads in Exhibit TN-5.

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Exhibit TN-1: The Relevant Organizational Structure

Frits FritsSeegers Seegers President President Citibank CitibankCalifornia California

Other Area managers

Lisa LisaJohnson Johnson Area manager Area manager Los LosAngeles AngelesArea Area

Support functions

Other branch managers

James JamesMcGaran McGaran Branch manager Branch manager Financial FinancialDistrict District

Other branch managers

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Exhibit TN-2: The Performance Scorecard


Variables Standards Standards Leadership Ethics / Integrity Customer interaction Community involvement Contribution to overall business Performance Teamwork Training and development Employee satisfaction Audit Legal Regulatory Measures Measured subjectively through Lisas assessment

People People

Measured subjectively through Lisas assessment

Control Control

Measured subjectively by auditors, but using standardized procedures

Customer Customer satisfaction satisfaction Strategy Strategy implementation implementation Households Cross-sell, splits, mergers Retail asset balances Market share Revenue Expense Margin

Measured through a survey by an external company Measured objectively

Financial Financial

Measured objectively

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Exhibit TN-3: James customer satisfaction ratings

Rating

Goal 80 72 66 63 54

First quarter

Second quarter Quarters

Third quarter

Fourth quarter

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Exhibit TN-4: Cause-effect relationships


Standards Standards

People People

Control Control

Customer Customer satisfaction satisfaction

Strategy Strategy implementation implementation

Financial Financial

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Exhibit TN-5: Concluding overheads

Citibank: Performance Evaluation The performance scorecard should be based on a business model with cause-effect relationships. To choose diagnostic measures, managers must evaluate three criteria: Alignment with strategy: Does it tell people what they should be focusing on? Measurability: Can it be measured? Is it objective, complete, and responsive. Linked to value: Are we confident that it creates economic value?

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Citibank: Performance Evaluation The performance scorecard can be used as a diagnostic system to communicate strategy if: There are measures available to communicate strategy. Cause and effect model relating leading and lagging indicators is reliable. If communication is the objective, choose impact over elegance (i.e., keep it simple). Use formula-based incentives when you are confident that measures are correlated with economic value creation.

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