ACCT 3420

Intermediate Managerial Accounting

Chapter 23

Multinational Performance
Measurement and Compensation

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Learning Objectives (1 of 2)
1. Analyze and evaluate alternative measures of
financial performance.
2. Evaluate current-cost and historical-cost asset
measurement methods.
3. Analyze the technical difficulties that arise when
comparing the performance of divisions operating
in different countries.

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Learning Objectives (2 of 2)
4. Evaluate the behavioural effects of salaries and
incentives in compensation arrangements.
5. Apply strategic concepts to analyze the four
levers of control and evaluate their usefulness.

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Financial and Nonfinancial Measures
• Firms present financial and nonfinancial
performance measures for subunits in a balanced
scorecard and it’s 4 perspectives:
– Financial, Customer, Internal business process,
Learning and growth
• Firms assume that improvements in learning and
growth will lead to improvements in internal
business processes which will lead to
improvements in the customer and financial
perspectives.
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Governance and Compensation
• Corporate governance and compensation
decisions have come under increasing scrutiny
• Sarbanes-Oxley Act, Bill 198, accounting and
control standards, stock exchange requirements
and rules for public issuers of shares
• disclose how compensation policy and practice
balances risk and return
• scrutiny of performance measures and
compensation policies
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Constraints on Performance Measurement
Decisions

Exhibit 23-1 Constraints on Board of Directors’ (BOD) Performance Measurement Decisions

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Choosing Among Different Performance
Measures
• Four common measures of financial performance
of organization’s subunits:
1. Return on investment
2. Residual income
3. Economic value added
4. Return on sales

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Return on Investment (ROI) (1 of 2)
• ROI is a performance measure that uses readily
available financial accounting information
Income
ROI =
Investment

• ROI can be broken into two components:

Income Income Revenues
= 
Investment Revenues Investment

ROI = Return on Sales  Investment Turnover

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Return on Investment (ROI) (2 of 2)
• Most popular approach as it blends all major
ingredients of profitability into a single number.
• Also called accounting rate of return or accrual
accounting rate of return.
• Be careful when comparing ROI across
companies as figures can be on different bases
(year-end, averages, beginning of year).
• DuPont method shows how changes in specific
components (income, revenue or investments)
can help firm reach target ROI.
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Residual Income (RI)
• Residual income (RI) is an accounting measures of
income minus a dollar amount for required return an
accounting measure of investment.
RI = Income – ( Required rate of return  Investment )

• Required rate of return (ROR) is the company’s

weighted-average cost of capital (WACC)
– The after-tax average cost of all long-term funding
• Required rate of return times the investment is the
imputed cost of the investment.
– Imputed costs are cost recognized in some situations, but
not in the financial accounting records.
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Problems with RI and ROI
• RI promotes a focus on maximizing an absolute
dollar amount, inducing goal congruence
• Maximizing ROI may result in suboptimal
performance
– Managers earning high ROI % may reject projects that
earn more than the company’s required rate of return
– Managers earning low ROI % may accept projects that
earn less than the company’s required rate of return

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Economic Value Added (EVA®)
• EVA is a specific type of residual income
calculation that has recently gained popularity
– Does not use a reported ASPE/IFRS accrual in the
numerator

After-tax  Weighted-Average  Total Current  

EVA = −    − 
Operating Income Cost of Capital  Assets Liabilities 

– Key calculation is the Weighted Average Cost of

Capital (WACC)

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Return on Sales (ROS)
• Return on Sales is simply income divided by sales
• Simple to compute, and widely understood

Return on Sales = Income  Sales

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Selecting the Time Horizon
• Multiple periods of evaluation are sometimes
appropriate.
• ROI, RI, EVA, and ROS all basically evaluate one
period of time.
• However, they may be adapted to evaluate multiple
periods of time
– Prevents actions that cause short-run increases in these
measures but conflict with long-run interests of the
organization
– Benefits of actions taken in current year may take several
years to be measured
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Defining “Investment”
• Four possible alternative definitions of investment:
1. Total assets available
2. Total assets employed
3. Working capital (current assets minus current
liabilities)
4. Shareholder’s equity

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Choosing Measurement Alternatives for
Performance Measures
• Possible alternative definitions of cost:
1. Current cost
2. Gross value of fixed assets
3. Net book value of fixed assets

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Current Cost
• The cost of purchasing an identical asset today to
the one currently held
• The cost of purchasing the services provided by
that asset if an identical asset cannot be currently
purchased
• ROIs calculated using current costs will differ from
those calculated using historical costs

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Long-Term Assets
• Cost measured at gross book value (original cost),
OR
• Cost measured at net book value (original cost
less accumulated depreciation)
– Using net book value results in a higher ROI due to the
smaller base (which decreases every year)
– Net book value is consistent with total assets shown on
the balance sheet and with net income (includes
depreciation expense)
– Incentive for retaining old property, plant and
equipment
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Choosing Target Levels of Performance
• Historically driven targets used to set target goals
that may include a continuous improvement
component

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Selecting Performance Goals
• Book value accounting measures:
– often inadequate for evaluating economic returns of old
investments
– sometimes create disincentives for new expansion
• Must ensure that the budget is tailored to a
particular subunit and the particular accounting
data
• Asset valuation and income measurement
problems solved if top management focuses on
what is attainable in the budget period
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Choosing the Timing of the Feedback
• Timing of feedback depends on:
– How critical the information is for the success of the
organization
– The specific level of management receiving the
feedback
– The sophistication of the organization’s information
technology

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Performance Measurement in Multinational
Companies
• Additional difficulties faced by multinational
companies:
– The economic, legal, political, social, and cultural
environments differ significantly across countries
– Governments in some countries impose controls and
limit selling prices of a company’s products
– Availability and costs of materials, skilled labour and
infrastructure differ across countries
– Divisions operating in different countries account for
their performance in different currencies

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Levels of Analysis Differ Between Managers
and Subunits
• The performance evaluation of a manager should
be distinguished from the performance evaluation
of that manager’s subunit, such as a division of
the company.

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The Trade-Off: Creating Incentives vs.
Imposing Risk
• An inherent trade-off exists between creating
incentives and imposing risk.
– An incentive should be some reward for performance.
– An incentive may create an environment in which
suboptimal behaviour may occur: the goals of the firm
are sacrificed in order to meet a manager’s personal
goals.

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Intensity of Incentives
• Intensity of incentives—how large the incentive
component of a manager’s compensation should
be relative to their salary component.

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Moral Hazard
• Moral hazard describes situations in which an
employee prefers to exert less effort (or report
distorted information) compared with the effort (or
accurate information) desired by the owner
because the employee’s effort (or the validity of
the reported information) cannot be accurately
monitored and enforced.
• BSC approach can be used to measure
performance in more than one way.

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Preferred Performance Measures
• Preferred performance measures
– Are sensitive to or change significantly with the
manager’s performance
– Do not change much with changes in factors that are
beyond the manager’s control.
– Motivate the manager as well as limit the manger’s
exposure to risk, reducing the cost of providing
incentives.
– May include benchmarking.

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Performance Measures at the Individual
Activity Level
• Two issues when evaluating performance at the
individual activity level:
1. Designing performance measures for activities that
require multiple tasks.
2. Designing performance measures for activities done
in teams.

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Compensation for Multiple Tasks
• If the employer wants an employee to focus on
multiple tasks of a job, then the employer must
measure and compensate performance on each
of those tasks.

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Team-Based Compensation
• Companies use teams extensively for problem
solving.
– Teams achieve better results than individual employees
acting alone.
– Encourages employees to work together to achieve
common goals.
– Encourages cooperation.
– Balance competition and cooperation by giving incentives to
individuals on the basis of team performance.

• Companies must reward individuals on a team based

on team performance.

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Executive Compensation Plans
• Based on both financial and nonfinancial performance
measures, and include a mix of:
– Base salary
– Annual incentives, such as cash bonuses
– Long-run incentives, such as stock options
– Perquisites, such as life insurance, office with a view

• Well-designed plans use a compensation mix that balances risk

(the effect of uncontrollable factors on the performance
measure, and hence compensation) with short-run and long-run
incentives to achieve the firm’s goals.
• Emphasize achievement of organizational goals, administrative
ease and perceived fairness.

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Strategy and Levers of Control
• Levers of control:
– Diagnostic control systems
– Boundary systems
– Belief systems
– Interactive control systems
• Each lever is important and needs to be
monitored.
• Levers should be interdependent and collectively
represent a living system of business conduct.

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Diagnostic Control Systems
• Diagnostic control systems evaluate whether a
firm is performing to expectations by monitoring
and evaluating critical performance metrics,
including:
– ROI, RI, EVA
– Customer satisfaction
– Employee satisfaction
• Must be balanced by the other levers of control.

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Boundary Systems
• Boundary systems describe standards of
behaviour and codes of conduct expected of all
employees.
– Highlights actions that are “off-limits.”
– A code of conduct describes appropriate and
inappropriate individual behaviours.

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Belief Systems
• Belief systems articulate the mission, purpose,
and core values of a company.
– They describe the accepted norms and patterns of
behaviour expected of all managers and employees
with respect to each other, shareholders, customers,
and communities.

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Interactive Control Systems
• Interactive control systems are formal information
systems that managers use to focus
organizational attention and learning on key
strategic issues.
• Track strategic uncertainties that businesses face.

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