List of Contents

Q&A Session ............................................................................................................................................................2

Session 2 – Introduction to Management Control, Management Control Problems, and Management

Control Systems .......................................................................................................................................................2

Session 3 – The Design of Control Systems and the Costs and Benefits of Delegation ...................................14

Session 4 – Responsibility Accounting .................................................................................................................24

Session 5 – Planning, Budgeting, and Target Setting .........................................................................................33

Session 6 – Financial Performance Measures .....................................................................................................40

Session 7 – Non-Financial Performance Measures ............................................................................................51

Session 8 – Statistical Testing of Non-Financial Measures ................................................................................59

Session 10 – Discussion of the Hand-in Case ......................................................................................................63

Session 12 – Subjective Performance Evaluation ...............................................................................................67

Session 13 – Relative Performance Evaluation ..................................................................................................74

Session 14 – Management Control through Self-Selection ................................................................................81

Glossary ..................................................................................................................................................................88
 Q&A Session
Session 4: details on results controls; transfer pricing!
Session 6: Balachandran: where are you coming form?; myopia
Session 7: overcoming myopia; intangibles included ! more holistic picture; BSC: how to
measure!!!
Session 9: mediation analysis
Session 10: why would one refrain from statistical testing?
Session 12: subjective judgement ! link to non- nancial meausres; effects for employees and
supervisors; not everything is measurable objectively
Session 13: leniency & compression; relative evaluation; forced ratings; overcome biases in
subjective evalution; control of uncontrollable through relative performance
Session 14: Cultural control; banker (fav paper of Christoph); selection effect ! incentives
attracting different types of employees; Campbell ! hiring and decision rights

Session 2 – Introduction to Management Control, Management Control Problems,

and Management Control Systems

BuzzWords: Results Controls, Action Controls, Personnel Controls, Cultural Controls,

Management Control Problems (Lack if direction/ motivation; personal limitations)

Guiding Questions

a) What are management control systems (MCS) and why do we need them?

b) Where can we nd management control systems and who designs them?

c) What are the control problems that exist?

d) Which management control mechanisms do managers have available?

e) How do different management control mechanisms address the control problems?

Merchant & Van der Stede (2017) – Chapter 1: Management and Control

• Prevent the rm from nancial and reputation losses, and possibly even failure
• In contrast MCS might sti e creativity and initiative or foster short term orientation
• Measures that “measure the temperature” (performance) and compares it with desired
standards, gives feedback and takes corrective action if necessary, involving a single
feedback loop
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 ! this is a rather old view, MCS should be proactive this implies they should prevent the
rm from suffering adverse effects on performance
• MCS encourage, enable, and sometimes force the employees to act in the organization’s
best interest ! how can be ensured that all employees carry out their responsibilities?
• MC = all the devices or systems that managers use to ensure that employees are consistent
with the organizational objectives and strategies
o Proactive: controls designed to prevent problems before the organization suffers
any adverse effects on performance
o There are detective and preventive types of controls
• What is management? Organizing resources and directing activities in order to achieve
organizational objectives
• MCS should be future oriented and objectives-driven
• MCS prevent rms from impairment of assets, de cient revenues, excessive costs,…and
ultimately failure
• Function: in uence employee behaviors in desirable ways
• Bene t: increased probability that the organization’s objectives will be achieved
• Objective setting is a prerequisite for the design of any MCS ! in any organization
people have to have a basic understanding of what the organization is trying to accomplish
• Questions to be answered when designing MCS
o Do our employees understand what we expect from them?
o Will they work consistently hard and try to do what is expected of them? Will they
pursue the organizations objectives and strategies?
o Are they capable of doing a good job?
! to solve MC problems: re ect on how to in uence, direct, or align employees’ behaviors
• Behavioral emphasis: Managers taking steps to help ensure that employees do what is
best for the organization

Back to Gloassary

Causes of Management Control Problems

• Lack of direction: employees perform inadequately because they do not know that the
organization wants from them
! Function of MC: Inform employees about how they can direct their contributions to the
ful llment of organizational objectives
• Motivational problems: employees do not perform as the organization expects, although
they know what is expected
o Common because individual and organizational objectives do not coincide
naturally
o Employees act in their own personal interest at the expense of their organization’s
interest
o Self-interested behavior and effort aversion
o Wasting, mismanaging, and misappropriating organizational resources, are
prevalent in most organizations (e.g. serving the Internet while at work)
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 o Whenever possible motivation should be the primary focus on effective MCSs while
also providing any necessary behavioral constraints and/ or mitigating any
behavioral displacements through a well-designed combination of controls
• Personal limitations: employees know what to do and are motivated, but are not able to do
so
o Might be of a personal nature: lack of aptitude, training, experience, task-speci c
knowledge
o Can occur when jobs are poorly designed: even skilled employees get stressed
which leads to on-the-job accidents and decision errors
o All employees usually face limitations to perceive new problems, remember
important facts, process information properly ! training can be used to mitigate
those limitations

Back to Gloassary

Characteristics of good Management Control

• “out of control”: describe situations where there is a high probability of poor performance
• This can even occur when good MC is in place ! there is not perfect control system; MC is
also costly; therefore, it is rarely cost effective to implement perfect or even enough control
• Cost of not having a perfect MCS: control loss
• Optimal control: can be said to have been achieved if the control losses are expected to be
smaller than the cost of implementing more control
• Good controls must be…
o Future oriented: goal is to have no unpleasant surprise in the future; past is only
relevant for experience and lessons learned
o Objectives-driven: objectives represent what the organizations seeks to attain

Control Problem Avoidance

• Implementing MCS in not always the best way to achieve good control ! control problems
can be avoided
• Activity Elimination: turning over potential risks (and associated problems) to a third party
through subcontracting, licensing, divestment
o Economic based literature: can speci c activities be controlled more effectively
through markets (external) or through organizational hierarchies (internal !
transaction cost economics)
• Automation: usage of computers, robots, expert systems, and other means of automation
to reduce exposure to control problems
o Avoid the human problems of inaccuracy, inconsistency, and lack of motivation
o Facilitated through technological advancements
o Limitations: feasibility ! humans are usually better in making complex, intuitive
judgements; regulatory constraints; costs
• Centralization: decision-making happens at the top-management level ! avoid lower-
level employees making poor judgements
o Usually, the following decisions are centralized: major acquisitions, divestments,
capital expenditures, organization changes, hiring of key personnel
o However, not all decisions can be centralized; decentralization calls for results
controls
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• Risk sharing: with outside entities; bound losses that could be incurred by inappropriate
employee behaviors
o Buying insurance
o Joint venture agreements
Back to Gloassary
 Merchant & Van der Stede (2017) – Chapter 2: Results Controls

• Results controls: reward employees for generating good results ! what are good results?!;
e.g. pay-for-performance
• Results controls create meritocracies (rewards are given to the most talented and hard-
working employees); further ingredient: operational ef ciency
• Combinations of rewards linked to results inform employees as to what result areas are
important and motivate them to produce the results the organization rewards
• In uence actions and decisions: cause employees to be concerned about the
consequences of their actions and decisions
o Organizations do not dictate to employees what actions or decision they should
take
o Employees are empowered to take actions/ decisions they believe will best
produce the desired results
o Help to discover talents and get placed into jobs, in which they can perform well

Prevalence (Verbreitung) of Results Controls

• Typically means of controlling the behaviors of professional employees with decision
making authorities
• Results controls are necessary for the implementation of decentralized organizations with
autonomous responsibility centers
• Instill a performance culture: responsible manager has to make the trade-off between
operating discipline (ef ciency) and greater responsiveness to local business needs
( exibility)
• Create a “entrepreneurial model” within large corporations: give decision authority to
managers, then hold them accountable for the results they produce ! promise to award
the risk
• Results controls can also be used at lower levels
• Critical design choices: degree of delegation of decision rights; design of incentive
systems to motivate managers to achieve the desired results
• Drawbacks of decentralization:
o In ghting
o Loss of economies of scale: increase overlap

Results controls and the control problems

• Preventive-type bene ts: alleviate lack of direction/ motivational problems/ personal
limitations
• Detective-type bene ts: information about how strategies, organizational entities, or
employees are performing

Elements of results controls

• De ning the dimensions on which results are desired
o Performance measures need to be congruent/ aligned with the chosen
performance dimension ! what you measure is what you get
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 o Measurement of the desired performance dimensions must be aligned with what is
desired ! unintended consequences
• Measuring performance in the chosen dimensions
o Objective nancial and non- nancial measures
o Subjective judgements
o managers must translate nancial goals into operational goals
o Weightings of each measure must be assigned ! evaluation of overall
performance: explicit and implicit weightings can be equally valuable; complement
each other
• Setting performance targets
o Improve motivation by providing clear goals to strive for
o Allow employees to assess their own performance
• Providing rewards for target attainment
o Incentives: salary increases, bonuses, promotions, job security, training
opportunities, freedom, recognition, …
o Punishments
o Link rewards to results that employees can in uence
o Extrinsic rewards: cash, stock, decision authority
o Intrinsic rewards: sense of accomplishment/ achievement
o Reward preferences vary for different employees ! best case: tailored rewards

Conditions determining the effectiveness of results controls

• Results controls work best if all of those conditions hold
• If those conditions are not ful lled results controls might even be impotent or reduce
dysfunctional side effects

a) Organizations can determine what results are desired in the areas being controlled
• Results desirability
• Organizations must know what is important and communicate the desired results
effectively to the employees
• Congruency needs to be ensured

b) The employees have signi cant in uence on the results for which they are being held
accountable (controllability)
• Controllability principle: if results area is totally uncontrollable, the measures reveal nothing
about what actions or decision were taken
• Noise in the measures: true cause is obscured

c) Results can be measured effectively

• Can the results measure evoke the desired behavior? Congruency!
• Measuring needs to be done effectively, therefore measures need to be precise, objective,
timely, understandable, and cost ef cient
• Precision: degree to which repeated measurements under similar conditions show the
same results ! then the measurement is reliable; reduction of random error
o Without precision much of the information value is lost
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 • Accuracy: degree of closeness of measurements of a quantity to its actual (true) value !
reduction of systematic error (bias) leads to more accuracy
• Objectivity: not in uenced by personal feelings, mental states, emotions, tastes, or
interpretations ! measures should be unbiased
o Objectivity is particularly low when performance is self-reported or when evaluates
are allowed considerable discretion in the choice of measurement methods
o likely to induce systematic error due to selectivity, leniency, or self-criticalness
• Timeliness: refers to the lag between the employee’s performance and the measurement
of results
o Motivational aspect: employees need repeated performance pressure to perform
at their best
o Increases the value of interventions that might be necessary
• Understandability
o Employees must understand what they are held accountable for ! communication
o Employees must understand what to do to in uence the measure
• Cost ef ciency: cost vs bene ts

Back to Gloassary
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 Merchant & Van der Stede (2017) – Chapter 3: Action, Personnel, and Cultural
Controls

Action controls
• Actions themselves are the focus of control
• Action controls take four basic forms: behavioral constraints, pre-action reviews, action
accountability, and redundancy
• Behavioral constraints: negative form of action controls; make it impossible or more
dif cult for employees to perform actions they should not
o Physical constraints: locks, passwords, access rights, …
o Data protection and privacy concerns faced by actually all organizations ! e.g
penetration test
o Segregation of information: keep sensitive information decentralized
o Administrative constraints: place limits on the employee’s ability to perform speci c
tasks; e.g. restriction of decision-making authority ! underlying assumption:
higher level managers can be trusted and have a better knowledge about the
issues (evidence suggests that checkers also require checking)
o Separation of duties: breaking up the tasks necessary to accomplish certain
sensitive duties
o Poka-yoke: Combination of administrative and physical constraints ! step built into
a process to prevent deviation from the correct order of steps; a certain cation must
be completed before the next step can be performed
• Pre-action reviews: scrutiny of action plans ! approval by a reviewer is required; e.g.
budgeting and planning processes
• Action accountability: holding employees accountable for actions they take
o De ned actions ! communicate ! observe ! reward/ punish actions
o Usually implemented with negative reinforcements ! punishments
o E.g codes of conduct
o Sometimes the actions require judgement: the desired actions cannot be
described in detail in advance
o Actions can be tracked in several ways: direct monitoring/ supervision; mystery
shoppers; activity reports/ expense documentation
• Redundancy: assigning more employees or equipment to a task than necessary !
increases the probability that a task will be completed reliably

Action controls and control problems

• Action controls address one or more control problems
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 Prevention vs Detection
• Prevention controls: undesirable behaviors are prevented from occurring ! most powerful
form of control because the costs and harm stemming from the undesirable behaviors will
be avoided
• Detection controls: applied after the occurrence of the behavior
o Effective when behaviors are detected in a timely manner and corrective actions
can be taken
o Discourages individuals form purposefully engaging in such behaviors

Conditions determining the effectiveness of action controls

• In order to be effective action controls need to ful ll the following conditions

a) Organizations can determine what actions are (un)desirable

• This knowledge is often dif cult to obtain
• De nitions of preferred actions in highly complex and uncertain task environments are
often incomplete and imprecise
• Can be achieved by analyzing action pattern
• It is important that the actions for which employees are held accountable for actually are
those leading to the accomplishment of organizational goals with the highest probability

b) Organizations are able to ensure that (un)desirable actions (do not) occur
• Organizations must have some ability to ensure or observe that the desired actions are
taken
• E.g. the effectiveness of behavioral constraints and pre-action reviews varies directly with
the reliability of the physical devices or administrative procedures in place
• Management override: many cases could be prevented if managers did a suf cient job of
reviewing transactions accounts, and processes
• Action tracking can be also challenging
• Again, ensure precision, objectivity, timeliness, understandability, and cost ef ciency
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Back to Glossary

Personnel Controls
• Build on employees’ natural tendencies to control or motivate themselves
• Personnel controls serve three purposes
o Ensure that each employee understands what the organization wants
o Help to ensure that each employee is able to do a good job ! have all the
capabilities and resources
o Increase the likelihood that employees will engage in self-monitoring
o Self-monitoring: force that pushes most employees to want to do a good job, to be
naturally committed; employees are able to derive positive feelings of self-respect
and satisfaction when they do a good job; also referred to as intrinsic motivation or
loyalty
• Finding the right people to do a job, train them and giving them a good work environment
and necessary resources increases the likelihood that a job is done properly
• Selection and Placement: possible indicators of success: education, experience, past
successes, personality, and social skills
o Recruiting systems: matching job requirements with job applicants’ skills
o Social media background checks
o Average cost per hire in the US: 4,500$
• Training: increase the likelihood that employees do a good job
o Provide information about what actions/ results are expected and how the
assigned tasks can be best performed
o Increase the sense of professionalism
o Create an atmosphere of learning and collaboration within the organization
• Job design and provision of necessary resources
o Job design: allow motivated and quali ed employees a high probability of success
! ensure that the job is not designed too complex
o Resources: can include items such as information, equipment, supplies, staff
support, decision aids, …

Cultural Controls
• Designed to encourage mutual monitoring; powerful form of group pressure on
individuals who deviate from group norms and values
• Culture is built on shared traditions, norms, beliefs, values, ideologies, attitudes, and ways
of behaving
• Cultural norms are embodied in written and unwritten rules that govern employees’
behaviors
• Strong organizational cultures can prompt employees to work together and be aligned;
however, they can also be a source of inertia/ blind spots
• Cultural controls include codes of conduct, group rewards, intra-organizational transfers,
physical and social arrangements, and tone at the top
• Codes of conduct: formal written documents providing a broad and general statement on
organizational values, commitments to stakeholders, and way in which the management
likes the organization to function
o E.g. codes of ethics, credos, mission, vision, management philosophy
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 o Help employees to understand what behaviors are expected even in absence of a
speci c rule ! principle based; not rule based
o Messages should be conveyed though formal training sessions and informal
discussions or mentoring meetings
o Drawbacks: results are regarded more important than means in practice; lack of
understanding how the standards apply to the job; policies are easy to override/
bypass
• Group rewards: providing rewards/ incentives based on collective achievement
o Bonus, pro t-sharing plans providing compensation based on overall company or
entity performance
o Encouraging broad employee ownership of company stock with effective
communication ! keep employees informed and enthusiastic ! encourage
employees to think like owners
o Create a sense of ownership and engagement
• Other approaches to shape organizational culture
o Intra-organizational transfers: employee rotations ! transmit culture throughout
the company
o physical and social arrangements ! of ce plans, architecture, interior design;
dress codes, habits, vocabulary
o tone at the top: should be consistent with the type of culture they are trying to
create; actions and behaviors should be consistent with their statements; leaders
should act as role models

Personnel/ Cultural controls and the control problems

How can those MC problems be addressed by cultural/ personnel controls?

• Lack of direction
o Providing training
o Assigning new personnel to work groups that will provide good direction
• Motivational problems
o Minimized in organizations with strong culture
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 o Hiring employees with high motivation and the right t with the employees
o Assigning people to work groups that will tend to make them adjust to group
norms
• Personal limitation: selection, training and provision of necessary resources
Effectiveness of personnel/ cultural controls
• Hiring as a crucial process for nding the employees which t the company
• Founder imprinting: best chance for creating a strong culture early in the organizations life;
e.g. Apple
• Cultural controls are usually unobstrusive
• Advantages compared to results/ action controls
o Usable in almost every setting
o Lower cost
o Less harmful side effects
• Also makes economic sense: “pays to be nice to employees” ! lower turnover rates
• Effectiveness can vary signi cantly across individuals, groups, communities, and societies
• When cultures are too strong, but need to change they can become a liability

Back to Gloassary
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 Session 3 – The Design of Control Systems and the Costs and Bene ts of
Delegation

BuzzWords: Indirect Costs, Direct costs, Control Tightness, MCS Design, Delegation

Guiding Questions

a) What are the costs and bene ts of the various control mechanisms?

b) What is delegation of decision rights and what are its costs and bene ts?

c) How to design an appropriate management control system (when to focus on action,

results, personnel, and cultural controls)?

Merchant & Van der Stede (2017) – Chapter 5: Control System Costs

Direct Costs
• All out-off-pocket monetary costs that required to design and implement MCS (e.g.
bonuses or internal audit staff)

Indirect Costs
• caused by harmful side effects

Behavioral Displacement: MCS actually produce/ encourage behaviors which are not in line
with the organizational goals (incongruence) ! most common with results or action
accountability
• Behavioral Displacement + Results Controls
o E.g. sales quotas might lead the staff to focus on the easiest sales not the most
pro table ones
o Focus set on easily quanti able results, which capture the desired results
insuf ciently
o Results controls are incomplete: the relative importance of different aspects of a job
have to be captured, otherwise the employees will not allocate their time properly
• Behavioral Displacement + Action Controls
o Means-end-inversion: employees pay attention to what they do (means) rather than
to what they are to accomplish (ends)
o E.g. managers focusing on small projects within their decision power, which might
be not the optimal strategy
o Undesired outcomes arise from incongruence or from the fact that controls
promote rigid, non-adaptive behaviors ! primarily associated with bureaucratic
organizations
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 o Rather appropriate for stable environments with centralized knowledge ! establish
compliant, reliable, and ef cient routines
• Behavioral Displacement + Personnel/ Cultural Controls
o Results from employing the wrong type of people or providing insuf cient training
o Implementing them in the wrong setting they will be ineffective and encourage
unintended behaviors
Gamesmanship: actions employees take to improve KPIs without producing positive effects
for the organization ! rather associated with results and action accountability
• Creation of Slack Resources
o Slack: consumption of resources by employees in excess of that is required for the
objectives
o Budget slack: when tight results control is in place manager might negotiate
“easier” targets which are deliberately lower than what they actually expect
o Slack obscures true underlying performance and information necessary for
decision making
o Slack resources can be used for innovation or reduce stress
• Data manipulation
o Falsi cation: reported data is errored
o Data management: actions undertaken to change reported results, while creating
no real economic advantage (through accounting methods or operating methods)
! sometimes even illegal!!
o Those actions can harm customer satisfaction, employee productivity, and quality
o The whole MCS is rendered ineffective through such actions
o Accuracy of the information system in the company is harmed ! decision making is
harmed
o Often fostered by excessive short-term performance pressures
Operating Delays:
• Consequence of the pre-action review / behavioral constraints types of action controls
• E.g. the requirement of various approvals/ signatures before anything gets cleared !
impacts on market/ customer responsiveness
• In competitive markets slow decisions can lead to costs
Negative attitudes:
• E.g. job tension, con ict, frustration and resistance ! often coincide with other harmful
behaviors such as gameplaying, lack of effort, ...
• Causes are complex, they can arise from economic conditions, personal dif culties, or
administrative procedures
• Negative Attitudes + Results Controls
o Lack of employee commitment to the performance targets ! e.g. when they
consider them too dif cult, not meaningful, not controllable, imprudent, …
o Also arise from problems in the measurement system: things beyond the control of
the employee, wrong rewards or punishments
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 o Negative attitudes can be reduced by incorporating employees in the process of
target setting
o Attitudes are important because they can also evoke the engagement in other
forms of harmful behavior
• Negative Attitudes + Action Controls
o E.g. if pre-action reviews are not reviewed to serve a useful purpose

Back to Gloassary

Adaption Costs
• Costs arising from the adaption of MCS to the context where they operate, particularly in
multinational rms or SBUs
• Trade-off: adaption to speci c circumstances can be costly, yet standardization might yield
indirect costs (see above)
• Multinational organizations (! decentralization!): information asymmetry about the local
environment, limited space for employing action controls (geographic separation)
• National culture: different attitudes towards norms, values, personal priorities, ore
responses to interpersonal stimuli
o Evaluate MCS in the light of Hofstedes framework: individualism, power-distance,
uncertainty avoidance, and masculinity; e.g. more individualistic cultures might be
inclined to favor individual rather than group-oriented work arrangements, or
performance evaluation/ pay
o Consider also corporate goals (e.g. strategic focus on different stakeholders)
• Local institutions: legal situation, banking systems, corporate governance regulations
• Differences in local business environments: environmental uncertainty, in ation, and the
availability of quali ed personnel
o Uncertainty: Political stability, con icts, terrorism; government interventions
o In ation: creation of nancial risks
o Talent: when talent is in short supply the rm’s ability to do business and its capacity
to affect good control are more likely to be compromised
• Foreign currency translation: risks through uctuating currency values ! managers can
either be shielded from or exposed to those currency risks

Key take-aways
1. Negative side effects are not limited to one form of control
2. For some controls negative side effects seem to be unavoidable
3. Likelihood of severe harmful side effects is greatest when there is either a failure to
satisfy one or more of the desirable design criteria or a mis t between the chosen
control and the situation
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 4. Design imperfections or inappropriately used controls implies when tighter controls
are employed the risk and severity of harmful side effects is more likely
5. Dif cult to cope with side effects as often there is no 1-1 relationship between the
control and the side effect

Back to Gloassary
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Merchant & Van der Stede (2017) – Chapter 6: Designing and Evaluating
Management Control Systems

• Two basic questions need to be addressed when designing and improving MCSs

a) What is desired?
• Objectives and strategies provide important guides to the actions that are expected
• The better one understands the strategy and objectives, the better control systems can be
designed; reduction of the likelihood for behavioral displacement
• Identify the key actions that need to be performed in order to achieve the key results

b) What is likely to happen?

• Assess the likelihood of occurrence of each of the control problems
• Do employees understand what they are expected to do/ accomplish, are they motivated
and to they have the appropriate resources and skills?

! If what is likely is different from what is desired, then controls have to be implemented.
Thereby two questions have to be answered: What controls should be used? & How tightly
should each control by applied?

a. Do I have knowledge about the necessary actions that will result in good outcomes?
b. Do I have good measures available to evaluate the performance of my employees?

• Consider which type of control tackles which management control problem (Lack of
direction, employee motivation, personal limitations)
• Choose the controls which yield the highest “net bene ts”
• Imperfect understanding of the situation could lead to MCS failure ! often associated with
rapid growth and transformational/ disruptive change in the market
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 Decision 0: Initial consideration of personnel and cultural controls
• Relatively few harmful side effects and low out-off pocket costs
• Considering personnel and cultural controls st can serve as a basis for other forms of
control ! assess how effective they are and how they have to be supplemented with other
forms of control
• Hire employees with the right mind set
• De ne goals and vision

Decision 1: Choice of controls: Advantages and Disadvantages of action/ results controls

Advantages Disadvantages
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 Action Most direct form of control: especially Feasibility limitation ! knowledge about
Controls bene cial, when decision are costly and what is desirable only exists for highly
dif cult to reverse routinized jobs

Documentation of the accumulation of Focus on known/ established actions of

knowledge as to what works best !
knowledge transfer
Organizational coordination ! policies
and procedures; predictability of
actions (standardization & routinization)
lesser importance ! easier to monitor
(behavioral displacement; means-end-
inversion)
Discouragement of adaption, innovation,
and creativity ! employees become
passive; resistance to change

Induction of sloppiness ! prone to cut

corners; check-lists

Causation of negative attitudes

Costly, in particular when pre-action reviews

are involved (time/ salary of reviewers)

Results Feasibility ! effective control even Congruence/ alignment problems due to

Controls where knowledge as to what actions are imperfect knowledge of desirable results
desirable is lacking
Measurement issues ! less-than-perfect
Behavior can be in uenced by indications of whether good actions had
maintaining a signi cant amount of been taken; measures fail to meet the good
autonomy ! bene cial for creativity, measure qualities
commitment and motivation; on-the-
job training Uncontrollable Factors: results measures can
be affected by other things than employee
Inexpensive; particularly in comparison skills and effort ! measurement noise; when
to action controls ! often measures are employees are exposed to that risk also a
collected anyways for planning higher compensation is demanded
purposes etc.
Impossible to optimize the performance
targets as part of results-control systems
(such as budget-targets); targets have
different functions: motivation, planning,
and coordination

! ensure that there at too many targets to be met ! confusion!

Decision 2: Choice of Control Tightness

• Tight control should be applied with caution and only on strategically important areas than
over minor ones
• Determined by 3 questions:

a) What are the bene ts of tight controls?

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 • Tight controls should be applied to key actions or results, which have the greatest
impact on the success of the organization; e.g. inventory levels in retail superstores
• The potential bene ts of tight controls tend to be higher when performance is poor
b) What are the costs?
• C.f. Chapter 5
c) Any harmful side effects?
• If knowledge about how the control object relates to the desired ends, is not present
harmful side effects can arise, in particular when controls are tight
• Tight action controls would likely cause behavioral displacement and sti e creativity in
highly creative/ uncertain environments ! issues when setting targets

• Simultaneous tight-loose controls

o Loose: allow and encourage autonomy, entrepreneurship, and innovation
o Tight: people in the organization share a set of rigid values ! policies, procedures
are not necessary
o Considered to be tight on objectives and core values but loose on procedures

• Adapting MCS to change: with the evolvement of needs, capabilities, changes in the
environment ! e.g. growing organizations increasingly need to complement personnel/
cultural controls with other forms of control
o Factors provoking the need for change: intensifying competition, global expansion,
or technological change

• Keep behavioral focus: bene ts and side effects are dependent on how employees will
react to controls and particular circumstances ! dif cult to predict
o Variations in reaction according to countries or organizational entities !
effectiveness of control depends on those different reactions
o Different reaction to proposed rewards
o The bene ts of MCS can only be derived from the reaction of employees

• MCS failure is often associated with an incomplete understanding of the setting and effects
of MCS
• Facing rapidly changing environments it is not easy to keep nely tuned MCS in place over
a long time
• MCS that might seem inadequate, might do a good job in mitigating harmful side effects
! critical when removed
• Trade-off between control and autonomy
• MCS only reduce the probability of poor performance, they do not eliminate it
• Perfect MCS are impossible to achieve; there is no single way to reach good control; MCS
must be netuned according to changing circumstances using the best assessment,
knowledge, and insights available

Back to Gloassary
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 Moers (2006): Performance Measure Properties and Delegation

• Do contractible performance measures affect delegation choice?

• The ability to resolve the incentive problem (agent acts in the interest of the principal)
depends on
o the quality of contractible performance measures and in particular on
o the quality of performance measures that aggregate information about all actions
! comprehensive nancial (accounting) measures
• The relative incentive use of aggregate nancial performance measures increases
delegation when these measures have good incentive properties ! nancial measures do
play a role in the decision to delegate
• The more sensitive, precise and veri able nancial measures are relative to non- nancial
measures, the less costly it is to contract on nancial measures
o Sensitivity: performance measure is in uenced by the manager’s actions
o Precision: to what extent is the measure in uenced by factors outside the control of
the manager
o Veri ability: to what extent is the measure in uenced by the measurement process
itself?
• Main ndings
o The greater the relative sensitivity and precision of nancial performance measures,
the greater the returns of delegation, when using these measures for incentive
purposes
o The greater the relative veri ability of nancial performance measures, the greater
the extent of delegation
o If nancial performance measures are “poor” (low scores in quality dimensions)
then using these measures for incentive purposes creates an incentive-related cost
of delegation ! decrease in delegation
o If nancial measures are “good” incentive measures, then using them for incentive
purposes complements the delegation choice ! increase in delegation
! When it is dif cult and costly to contract on nancial performance, rms reduce the need for
incentive contracting by lowering the extent of delegation

• Delegation is affected by internal and external environment ! Delegation increases when

its marginal bene ts are higher
• More education ! decentralization is possible
• The most important reason for decentralization/ delegation: managers do not have to
knowledge themselves
o Managers could acquire the knowledge themselves, however this is very costly!
(knowledge transfer costs)
• When should managers delegate?
o When the principal does not know what to do ! hire a subordinate to do the job
for him
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 o When the quality of the nancial measures is high, and you know what the
outcomes should be
o Key: Delegation decision is dependent on whether you have good measures! You
rst need to decide whether/ how you can implement good measures and then you
delegate! Not the other way round
o Incentives are vital when delegating to ensure employees act in the company’s best
interest ! principal-agent-problem
• Measures need to be of a good quality, this implies they have to measure what is actually
relevant
o How do sensitivity, precision, and veri ability help there? They make sure what you
incentivize on is also measured accurately

Back to Gloassary
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 Session 4 – Responsibility Accounting

BuzzWords: Responsibility Centers, Learning & Monitoring, Transfer Prices

Guiding Questions

a) What is the connection between delegation of decision rights and learning?

b) What is the connection between responsibility centers and delegation of decision rights?

c) What are nancial results controls and what do organizations need to consider when
implementing them?

d) What is the purpose of transfer prices and how are they de ned?

Merchant & Van der Stede (2017) – Chapter 7: Financial Responsbility Centers

• In nancial results control systems (FRCS), results are de ned in monetary terms
• Three core elements
o Focus topic in CH 7: Financial responsibility centers (FRC)
o Planning and budgeting systems: used for a number of control-related purposes
(e.g. setting performance targets and evaluating performance)
o Incentive plans/ contracts: de ne links between results and rewards

Advantages of nancial results control systems

• Managers monitor success in nancial terms and use nancial measures to direct employee
actions
• Financial measures provide a summary measure of performance by aggregating the effects
of variety of actions/ initiatives
• Ubiquity and usability of nancial measures help managers to set corporate goals,
decompose the corporate goals into multiple FRC, and then monitor only a few results
measures
• Management by exception: Getting involved only when problems appear
• Financial results controls reduce the amount of information the managers need to process
and evaluate
• Financial controls are rather unobstrusive: they provide control while allowing those being
controlled autonomy
• Financial measures are relatively precise and objective

Types of nancial responsibility centers

• Def.: Financial responsibility centers are responsibility centers in which the assigned
responsibilities are de ned at least partially in nancial terms
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 • There are different types of FRCs and managers are held accountable for different types of
performance indicators according to the type

• Revenue Centers: e.g. sales managers

o Revenue: nancial output measure
o Revenues provide incentives to attract and retain customers
o However, it must be ensured that all sales are more or less equally pro table,
otherwise sales managers might be inclined to focus on easy instead of pro table
sales
• Cost Centers
o Managers are hold accountable for some costs occurring in their RS
o Costs are a nancial measure for inputs or resources consumed by the RS
o Standard cost centers (e.g. manufacturing): Direct relationship is given when there
is a direct relationship between inputs and outputs ! control can be exercised by
comparing what should have been consumed and what costs actually incurred
o Discretionary Cost centers (e.g. R&D): evaluating the performance is usually also
kind of subjective; control is exercised by ensuring that the CC adheres to
expenditure limits and ful ls its tasks
• Pro t Centers
o Managers are responsible for the revenues generated and the costs associated with
the generation of those revenues
o The (internal) customers must also have the possibility to buy their supplies form
outside the rm, so that the pro t center has an incentive to be ef cient
o Pro t Center Managers are held accountable for pro ts but not for the investments
made to generate them
o There are various types of Pro t Centers ! the central question is whether manager
have signi cant in uence on both, revenues and costs
o Limited type of pro t center: responsibility for gross margin (e.g. in sales focused
entities, when managers are held accountable for the standard cost of the products
sold)
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 o Pro t centers do not necessarily need to generate pro ts outside the rm; they
actually sell most of their products to internal customers ! transfer prices

• Investment Centers
o Managers are responsible for some income statement and some balance sheet line
items ! pro ts/ accounting returns and investments mad to generate those
o Corporations can be seen as investment centers ! executive level employees can
be seen as investment center managers
o Can be measured employing ROI, ROE, ROCE, RONA (return on net assets),
ROTC,…

Back to Gloassary

Choice of nancial Responsibility Centers

• Lines between different types of FRCs are not clear cut, but rather uid
• Rather assigning decisions not labels to FRCs is important ! Which managers should be
held accountable for which speci c nancial statement line items? ! Those choices affect
behavior! ! Hold managers accountable for the line items you want them to pay attention
to
o Managers do not need to have full control over the line item they need to pay
attention to, but at least to some extent!
• E.g. in a functional organization, functional managers are often cost center managers,
whereas in a divisional organization the division managers are responsible for pro t
centers (s.u.)
• When designing an organization, the decision about organizational structure and
responsibility centers complement each other ! decision authority and results
accountability meet there
• Strategic choices also inform the decision about the design of responsibility centers (e.g.
customer focus is more associated with accountability for pro ts/ revenues)
• Some strategies might even suggest that managers should not be held accountable for
line items over which they clearly have in uence (e.g. charging entity managers with costs
for R&D and IT tools, might lead to less use of those)
• As business models change, so should responsibility center structures
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The transfer pricing problem
• FRC often supply products or services to other FRCs of the rm ! mechanisms for
establishing the transfer prices must be established
• Transfer prices affect the pro ts of the selling and the buying unit
• Setting the “wrong” transfer prices can imply severe consequences for important decisions
such as production quantities, sourcing, resource allocation, evaluation of managers

• Purposes of transfer pricing

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 o Provide proper economic signals so that affected managers make good decisions
! buying and suppling unit (how much is necessary/ ef cient production)
o Provide information that is useful for evaluating the performances of the pro t
centers and their managers ! otherwise resource allocation can be adversely
affected (suboptimal)
o Move pro ts purposely between rm locations (e.g. minimize taxes, when the rm
enjoys lower taxes in some international subsidiaries ! politically/ legally
controversial!)
o Trade-offs between different purposes are possible, as not all methods for transfer
prices serve all purposes equally well
o Transfer price interventions undermine the bene ts of decentralized decision-
making ! reduce pro t center autonomy, cause decision-making complexity and
delay

Transfer Pricing Alternatives

• Marginal costs are rarely used; rather market prices of variations of full costs

• Market-based transfer prices: Either the listed price of an identical/ similar product, actual
price charged for external customers, or competitor price
o When there is a perfectly competitive external market it is optimal for decision-making
and performance evaluation purposes to set transfer prices at market prices
o If the selling unit cannot earn pro t by selling at the external market price, then the rm
should shut down the unit and get the supply externally (same true for buying unit)
o Manager of the selling and the buying unit are more likely to make optimal decisions !
good information for evaluation purposes
o Many rms use quasi market prices and allow for adjustments to re ect the savings of
marketing, selling, …that would occur when selling to external customers

• Marginal-cost transfer prices: variable/ direct cost of production (standard or actual costs)
o Advantageous from a cost accounting/ price setting perspective: the total contribution
equals the selling price of the nal product minus the marginal costs of the last
production stage
o Dif cult for the responsibility centers: sometimes cannot recuperate their full costs
o Provides only poor information for evaluating the economic performance of the selling/
buying unit: Losses for selling unit; overestimated pro ts for buying unit
o Marginal costs are dif cult to determine anyway through indirect costs associated with
the process

• Full-cost transfer prices: full costs of providing the product (standard or actual costs)
o Measure for long-run viability: to be economically sustainable the full costs for a
product (not just marginal costs) must be recuperated
o Relatively easy to implement
o Lower distortion for evaluation purposes: full costs of supplying unit are covered
o However full costs do not re ect the actual, current cost of production ! poor cost
accounting system involving poor overhead cost allocation
o The selling unit has no incentive to sell internally, since there is no mark-up
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 • Full costs plus a markup
o Allow the selling unit to make up pro t on their products
o Proxy for the market price

• Negotiated Transfer Prices

o This only works, when the negotiating units have external options and are not captive
to each other ! bargaining power erodes
o Costly, in terms of management time, accentuates con icts
o Depending on the negotiating skills of the managers involved
o Bargaining power can be uneven, depending on the external options

Back to Gloassary

Variations
• Marginal costs plus a xed lump-sum fee: The lump-sum fee is designed to compensate
the selling pro t center for tying up some of its xed capacity for producing products that
are transferred internally.
o Goal congruence: additional unit transfers are made at marginal cost.
o It preserves information for evaluation purposes because the selling division can
recover its xed costs and a pro t margin through the lump-sum fee.
o It stimulates intra- rm planning, coordination and communication because the selling
and buying entities must discuss the bases for the lump-sum fee.
o The major problem: managers involved must predetermine the lump-sum fee based
on an estimate of the capacity that each internal customer will require in the
forthcoming period. If this is incorrect the capacity will not be assigned to the most
pro table uses.
• In dual transfer prices the selling pro t center is credited with the market price, but the
buying pro t center pays only the marginal cost of production
o the managers of both the selling and buying pro t centers receive proper
economic signals for their decision-making.
o It almost ensures that internal transactions will take place
o However, it can destroy the internal entities' proper economic incentives

• To serve different transfer pricing purposes one might employ multiple methods at the
same time ! virtually impossible to employ methods which are simultaneously serving the
decision-making and evaluation purposes ! managers would make decisions in the light
of the numbers for which they are evaluated
o When multiple methods are used, one is used for internal purposes (decision
making and evaluation) and one to affect taxable pro ts
o Arm-length transfer price: price charged to the associated entity as the one
between unrelated parties for the same transactions under the same circumstances
• Advantages/ Disadvantages of responsibility accounting
o Easy way to manage your company ! delegation and control
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 o How to delegate decision rights? However, appropriate control systems are
necessary then
o When designing control systems, trade-offs have to be considered!
o What are the responsibilities of the different entities?
o How do you allocate overhead costs? ! Transfer prices
o Transfer prices have huge economic implications ! how do you set them, price of
your nal product

Key Take-Aways
• The larger the decision rights, the more you move in the direction of an investment center
• Incentivize what you are able to control
• The type of FRC also depends on the goal of your company. Do you want to expand? Do
you want to harvest?

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 Campbell et al. (2011): The Learning Effects of Monitoring

• Tighter monitoring ! higher implicit incentives (sharp increase in employee termination)

linked to excessive use of decision-rights
• Employees, which are controlled more tightly are less likely to use decision rights and to
adjust for information from historical performance data in their decisions
• Learning is concentrated in business units with “loose monitoring” and absent in ones with
“tight monitoring”
• The delegation of decision rights to lower-level employees yields bene ts from effective
and timely use of local information ! no knowledge transfer costs; however, it must be
ensured that employees act in the best interest of the organization (MC problem!)
• Direct monitoring via management reports or review processes ! employees have a
certain action frame, in which they can make decision (e.g. price discounts)
• Two possible assumptions
o Experimentation hypothesis: monitoring ! less use of discretion ! less
experiments are performed ! fewer opportunities to learn
o Selective utilization hypothesis: Inherent threat of detection in monitoring !
employees are more selective in utilizing decision-rights ! enhanced learning
• Employees, who are tightly monitored face strong implicit incentives to experiment less
and deviate less often from explicit decision guidelines ! experimentation hypothesis

LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

• Conceptual context: learning by experience
• Literature recognizes experimentation as an important antecedent to learning ! trial and
error
• Decision rights are characterized as a form of experimentation, where employees deviate
from formal guidelines, observe the outcome and learn from that
• “tight” = frequent/ intense monitoring
• “hard” information = veri able and objective (e.g. historical performance data on
customers or projects)
• “soft” information = unveri able and subjective (e.g. unique knowledge about individual
customers)
• H1: Decision-rights are exercised less frequently in business units with tight
monitoring than in those with loose monitoring
o Con rmed: employees in tightly monitored units are less likely to use their decision
rights
• H2: There is no difference in the use of hard information for decision making
between business units with tight monitoring and those with loose monitoring
o Rejected in this null form
o Loosely controlled employees are more likely to employ hard information
• H3: The effectiveness with which decision-rights are exercised is increasing in
employee experience ! decision quality rises with experience gained from exercising
those, observing outcomes and learning from those outcomes
o con rmed
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 • H4: The rate of improvement in the effectiveness with which decision-rights are
exercised as employees gain experience is no different in business units with tight
monitoring than those with loose monitoring ! loose control would imply more
experimentation (experimentation hypothesis); tight control to more selectively using
decision rights and collection more pre-decision information (Selective utilization
hypothesis)
o Null form is rejected in favor of the experimentation hypothesis
• Monitoring in the MGM hotels: hosts decide about comps for customers; decisions are
agged for review at the CFO just when they exceed a certain limit
o Loose monitoring: the exception report is used in a relatively lax way (e.g. detect
cases of comp misuse)
o Tight monitoring: exception reports are used more intensively (e.g. every day and
call hosts with weak performances)
• Learning effects are strong when employees are loosely controlled and almost entirely
absent when they are tightly monitored
o Tightly monitored employees face implicit incentives to experiment less in
decisions ! fewer opportunities to experiment
• Types of controls in place in MGM-Mirage
o Action controls: Reports

Back to Gloassary
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Session 5 – Planning, Budgeting, and Target Setting

BuzzWords: Amount of Challenge, Scenarios, Top-down vs Bottom up, Incentive

Guiding Questions

a) What is planning, budgeting, and target setting and why do rms need them?

b) How can proper targets be set and what are challenges when de ning the targets (e.g.,
participation, information when setting targets, how to de ne the proper target level,
adjusting the targets within the year…)?

Merchant & Van der Stede (2017) – Chapter 8: Planning and Budgeting

Purposes of planning and budgeting

• Planning: encourage employees to engage in strategic, long-term thinking
o Plans and Budgets serve as a form of action control
o Forward-thinking decision-making process enhances the rm’s responses to its
competitive environment
o Effective planning processes make control systems proactive
• Coordination: force sharing of information across the organization: top-down and bottom-
up ! Decisions are more likely to consider all perspectives
• Facilitating Top-management-oversight: Plans are frequently discussed, examined, and
approved throughout the process ! Arrive at challenging yet realistic performance target
• Motivation: Plans and Budgets become targets which turn into organizational rewards !
Goals help to focus, evaluate performance, assess whether to maintain a course, enjoy a
sense of achievement, …

Planning Cycles
• Planning cycles are arranged in a hierarchical manner
• The planning is more formalized in large rms, sometimes different cycles are also
performed simultaneously
• Strategic planning (3-5 or 10 years): broad process of thinking about the organization’s
missions, objectives and how to achieve them
o An organization wide strategy is derived as well as for various entities
o Strategic planning provides a framework for more detailed planning activities
• Capital Budgeting / Programming (1-3 or 5 years): identi cation of speci c action programs
over the next years
o Translate each entity’s external strategy into internally focused action sets
o Way more detailed than strategic planning
o Assessment and modi cation of existing programs and allocation of scarce
resources
o Through intense communication and review processes the lack-of-direction
problem is mitigated and the pre-action review serves as a form of action control
o Bottom-up communication: opportunities, threats, requests for capital funds
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 o Successful capital budgeting leads to a consistent strategy
• (Operational) Budgeting: preparation of a short-term nancial plan for the next scal year
for the single entities (responsibility centers)

Target Setting
• Plans and budgets become targets affecting managers’ motivation ! linked to
performance evaluation and incentives
• Review discussions focusing on deviation from targets provide the chance for intra-
organizational communication and evaluation of what is working and what isn’t
• Targets motivate managers and direct attention towards relevant activities, uncover
knowledge gaps, …
• Targets are of nancial nature: expressed as annual budgets, match RS structure, annual
performance reviews

Types of nancial performance targets

• Model-based, historical, and negotiated targets

o Model-based: derived from predictions of possible performance; e.g. in production
departments, where one can observe a direct relationships between inputs and
outputs (engineered targets) ! physical quantities required can easily be turned
into nancial targets (intense planning and forecasting activities)
o Historical targets: derived directly form performance in prior periods; budgets
without taking historical performance into account are called zero-based
o Negotiated: superiors and subordinated discuss budgets; higher-level managers
have a more general knowledge about the overall objectives and resource
constraints, whereas lower-level managers know more about business prospects
and constraints at the operating level ! join forces!
o Tight controls are easy to implement for engineered targets because of the direct
link between effort and result ! performance deviation immediately indicate a
problem
o Applying tight results controls to negotiated targets is more dif cult: deviations can
also imply that assumptions about the future were wrong or that the negotiation
was biased
• Fixed versus exible targets: exible targets are adjusted according to the conditions faced
during the period
o Targets may vary with changing volumes, input prices, interest rates,…
o Flexible targets are rather used at lower levels, whereas xed targets are employed
at pro t/ investment center levels
• Internal versus external targets: usually budgeting processes are internally focused
o Externally focused budget targets are derived from benchmarks with competitors
o Benchmarking: Comparison with best-in-industry; many performance aspects can
be benchmarked (either organizational outcomes ! performance; or best practices

Common nancial performance target issues

• The effects of results control systems can be undermined by wrong targets or if targets are
not properly set; two main issues need to be considered
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a) The appropriate amount of challenge
• Three possibilities: stretch goal, best guess, or conservatively ! depends on emphasized
planning process purposes
• Planning Purpose + unbiased best-guess: equal to expected performance ! decision-
making guidance for resource allocation
• Motivation Purpose + Stretch target: push employees to perform at higher levels !
more likely to lead to innovation rather than just incrementalism

• The optimum is also different for different personalities/ capabilities and the setting
(uncertainty, uncontrollable factors)
• Highly achievable targets have advantages for motivation, planning, and control:
o increased manager commitment: protection against uncertainty and performance
impacts through unforeseen circumstances ! not as easily thrown off track
o protection against optimistic projections: forecasting sales too optimistically will
lead to excess resources ! better set targets conservatively (achievable) and
acquire additional resources only when necessary
o higher achievement: achieving targets gives managers con dence and thus fosters
motivation, aspiration, and entrepreneurial spirit in the future
o reduced cost of intervention: management by exception; attention of high-level
executives is drawn to the most severe operational problems
o reduced gameplaying: as consequences for (not) achieving budget targets are
high, motivation for playing games is high; set incentives for exceeding budget
targets
o Sometimes, managers set high targets to stress necessary efforts or a budget
focused form of scenario planning to de ne a best-/ middle-/ and worst case
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 b) How much in uence should subordinates have in setting their targets?
• Top-down or bottom-up budgeting process?
• Many organizations lead to bottom-up target setting at managerial levels: gathering input
form departmental, regional, channel, or product managers
• Commitment to achieve the target: involvement leads to more understanding, acceptance
and thus commitment to the target
• Information sharing: lower-level managers can provide useful information about business
potentials and risks
• Cognitive bene ts: clarifying expectations and think about how best to achieve targets
• However, setting performance targets can sometimes be completed more effectively when
executed in a top-down manner
o When the corporate manager has suf cient knowledge of their entity’s prospects
and issues or when he/ she has the knowledge that subsumes the knowledge
possessed by the entity managers ! for engineered targets/ reliability on historical
trends
o When higher-level managers have the information available for evaluating
performance on a relative basis (homogeneous entities in a stable environment)
o When lower-level managers are not good at budgeting
o When lower-level managers’ thinking is dysfunctionally bound by historical
achievements
o Mitigate biases lower-level managers might impart to the budgeting process:
targets set higher or lower than desired (e.g. operating managers usually have a
conservative bias)

Back to Gloassary

Planning and budgeting practices, and criticism

• A key factor impacting the planning horizon is the business life cycle, i.e. the lag between
an investment and its payoff ! depending on the industry and uncertainty
• Large, decentralized organizations have a high need for coordination, managed mainly by
numbers
• Drawbacks of budgeting
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 • Alternatives: rolling plan processes, relative performance standards, subjective
performance evaluations
• The different purposes of budgeting often come with trade-offs
• Adapting plans quickly to shifting business conditions is often dif cult
• Beyond-budgeting philosophy aims at increasing the adaptability of organizations
o Employed in companies with simple structures, at hierarchies, exible peer-to-
peer networks
o Assumption: organizations are capable of self-organization and self-regulation
• Key dif culty: get the needed exibility while maintaining foresight
• Plans must not become too xated ! allow for adjustments and responsiveness
• Integrating planning, budgeting, and forecasting is challenging
• Forecasting can actually foster exibility!
• Effective plans must match the business conditions faced by the rm, assign
responsibility and accountability for performance
• Budgets turn plans into performance targets that affect employee motivation

• Through the planning and budgeting process objectives, strategies and performance
targets are de ned

• The planning process usually follows the following triad: targets-incentives-measurement

Back to Gloassary

Insights from the Case – Royal Wessanen NV

• Role of company size in employing a bottom-up/ top-down approach: information

asymmetry
• Inherent trade-off: information asymmetry and setting of lower targets to create bonuses
• In uncertainty maybe some less challenging targets would be bene cial ! slight changes
in environment might have a huge impact on the achievability of the target
• Too high targets can lead to unsustainable actions to reach it ! consider quality/ quantity
in your targets
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 Advantages Disadvantages

Top-Down Stable environment; when Information asymmetry

lower level managers are not
skilled enough for
budgeting; faster more
ef cient, in particular in face
of a crisis

Bottom up Valuable input about Lacking oversight, sometimes

customers, markets, …; might are not aware of all
Motivational, commitment “consequences” of their
aspect budget demands; sometimes
Detect inef ciencies lack of direction;

Clarify Expectations Creation of slack?

Budget Revision
• Does revising budgets make sense? Changing helps to more a realistic target, but
should not be done all the time

Yes No

Outdated; wrong direction; demotivation Credibility; uncertainty for externals; cost

to follow unrealistic targets time and money

Scenario Planning
• Does scenario-planning make sense?
o Depending on environment; the comparable we use, …
o Adapting for all scenarios is impossible
o How serious is the planned scenario? Not too many scenarios, however, the
company should be prepared (consider cash positions)
• Altering the budget is faster when done top-down
• Having multiple scenarios can have an impact on motivation/ commitment to the
common goal = budget
• Depending also on the industry
• Instead of scenarios one could also employ relative measures ! absorb the
randomness of environmental shocks ! however one might oversee when the whole
industry gets obsolete and one might run out of cash; in a crisis cash management is
essential
o You need to take the right peers and there have to be peers available
o Benchmarking might be backward looking if classical accounting gures are
employed, yet comparing stock indicators is rather forward looking
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Back to Gloassary
 Session 6 – Financial Performance Measures

BuzzWords: Accounting Measures, Market Measures, ROI-Measures, Residual Income/ EVA,

Suboptimization, Myopia

Guiding Questions

a) Which different types of measures are available and what are the (dis-)advantages of
the various measures?

b) How do the measures in uence manager’s decisions?

c) How do rms choose the appropriate measure (e.g., different industries, life-cycle
stages…)?

d) What are important characteristics that guide the choice of the performance measures?

Merchant & Van der Stede (2017) – Chapter 10: Financial Performance Measures and
their Effects. Back to Gloassary

• Managerial “truism”: what you measure is what you get

• Value created/ added by a rm over a certain period is called economic income
• There are 3 broad categories
o Summary measures: re ect the aggregate impacts of multiple performance areas:
(1) market measures, (2) accounting measures
o Combination of measures: can include either type of the summary measures and
disaggregated measures, such as revenues, or non nancial measures
• Consider the evaluation criteria: congruence, controllability, precision, objectivity,
timeliness, understandability, cost ef ciency
• Value can be increased by increasing the size future cash ows, accelerating the timing of
those CFs, or by making them more certain/ less risky (lower discount factor)
• One can differentiate between economic and accounting income, that has impact on
management control decisions
• Accounting information is important for incentives as they protect managers from “noise”
inherent in the stock price ! using relative performance evaluation can mitigate those
problems

Market measures of performance

• Market value is regarded as the best (yet imperfect) measure for the rm’s true intrinsic
value
• Stock based incentive payments reward employees for creating shareholder value
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 • Market measures not always align managers’ incentives with the long-term value of the
rm, indeed it can even have adverse effects
• Exclusive reliance on market measures is likely ineffective
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 Measure Description Advantage Disadvantage

Market Based on Relatively direct indications Controllability problem: affected

measures of changes in of changes in rm value signi cantly by TMT ! little
performance the rm’s (congruence) information about the
market value, performance of lower-level
and/ or For publicly traded rms employees; they have only very
return to market values are available limited in uence on stock price
shareholders on a daily basis (timely) (could be demotivational)
(dividends
+/- change in Stock market valuations are
Precise: no or little random
market value affected by factors beyond the
errors
of the stock) control of managers
(macroeconomic factors, political
Accurate: no systematic
climate, monetary policy, industry
biases, assuming an
events, competitors ,..)
ef cient information
environment
Market values re ect
expectations and not always just
Objective: not as easily
realized performance
manipulatable by those
(overreaction to news)
who are controlled

Underlying rm value is not fully

Understandable and cost
re ected
effective

Opportunistic motivation for

managers to manipulate stock
prices

Congruence: sometimes
managers withhold information or
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Accounting measures of performance
• Summary/ bottom line measures
• Measurement congruence: correlation between accounting pro ts and rm value; the
congruence increases with the length of the measurement period ! trade-off with
timeliness
• Despite drawbacks many managers employ accounting measures; pay attention to
behavioral displacement problems ! myopia

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 Accounting There are two Timely, precise (based on In some types of rms, they are
measures of basic forms: standardized accounting “meaningless” (e.g. start-ups !
performance Residual rules), objective accounting losses! As they focus on
measures (independent audits) long-term investments, thus there is
(accounting a lack of congruence between
pro t Congruent with earnings and rm value)
measures): organizational goal of pro t Lagged indicator of economic
net income, max. income
operating Can be controlled by those
pro t, managers who are evaluated Accounting systems are
EBITDA, ! tailored to the authority of transaction-oriented ! value
residual different managers; are not changes not incorporated in a
income as severely affected by transaction are not recognized in
uncontrollable effects like accounting pro ts (e.g. patent)
Ratio market prices Dependent on choice of
measures measurement methods (e.g. choice
(accounting Understandable: managers of depreciation method)
return know what they represent
measures): and how it can be in uenced Conservative bias: slow recognition
ROI, ROE,
of gains; fast for losses; acute when
RONA, ro risk-
Inexpensive: in many cases it measurement periods are shorter
adjusted
is necessary to track nancial than rms’ investment payoff
return on
performance anyway horizon
capital
(auditions, funding,…)
(RAROC)
Some economic value and value
changes are ignored: e.g.
investments in intangible assets (of
great importance nowadays!)

Pro t re ects the cost of borrowed

capital but not the cost of equity
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 Investment and operating myopia
• Myopia of accounting performance measures: either investing or operating decisions
• Investment myopia: held accountable for short-term pro ts might induce managers to
postpone investments that promise payoff in the future, even though they have a positive
present value
o Associated with the conservative bias and the ignorance of intangible assets with
predominantly future pay-offs
o Understatement of pro ts: gains can only be realized when they occur, whereas
costs have to be recognized immediately
o Managers held accountable for short-term pro ts are induced to achieve this by
postponing investments; might even induce manipulative earnings management;
threat to organizational culture; destroy customer/ employee satisfaction
• Operation myopia: too aggressive short-term focused behavior (increase sales “at all
costs”)
o Channel stuf ng: boost near-term sales through offering lower prices to
distributors, by potentially hurting later sales
o Manipulative earnings management
o Boosting current sales at the expense of goodwill

Back to Gloassary

Return-on-Investment measures of performance

• Especially employed on divisionalized rms
• ROI = accounting pro ts earned / investments tied up in the division

• Those charts are also helpful for linking performance at various organizational levels
• Most commonly ROI, ROE, ROCE, RONA or, for a speci c entity/ division ROCA (return on
controllable assets) are employed
• Comprehensive measure that re ects the trade-off between revenues, costs and
investments
• Common denominator used for comparing returns on dissimilar businesses
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 • ROI are comparable to other nancial returns (e.g. for stocks and bonds)
• Understandable: managers know what the measure means and how to in uence it !
inherent self-disciplining mechanism
Problems caused by ROI-type of measures

• Numerator is the accounting pro t: ROI incorporates all limitations of pro t measures (e.g.
myopia)
• Suboptimization: decisions that appear to be locally optimal might not be optimal globally
(for the whole rm)
o Gradually capital will be allocated away from pro table divisions towards less
successful ones ! counter-productive to the goal of overall value maximization
o Form of behavioral displacement ! needs to be monitored through strategic
planning and budget setting

• Misleading signals about performance of investment centers: dif culties in measuring the
xed asset portion of the denominator
o Values on the balance sheet do not always represent the economic value of the
assets available for earning current returns
o Book value might say little about the current economic value of assets, i.e. the
ability to generate future cash ows ! net book value overstates ROI
o When the ROI is calculated employing NBV, it automatically rises over time, if no
new investments are made (effect of depreciation)
• When assets are leased instead of bought, they are not recognized in the balance sheet
and thus not included in the denominator of the ROI

• Effects on management behavior

o Tendency to retain assets beyond their optimal life span
o Distorted capital allocations
o Distortions in evaluating performance, if managers are unaware of these effects
o Alternatively, the gross book value or adjusted NBVs can be used (non-linear/
slower/faster than depreciation rates allowed for nancial accounting or taxation
purposes)

Residual income measures as a possible solution to the ROI measurement problems

• Overcome the suboptimization problem
• Residual income = Pro t – capital charge for net assets tied up in an investment center
! the charge is at an equal rate to the weighted average corporate cost of capital (could
even be adjusted to the risk pro le of each investment center)
• All division managers have an equal incentive to invest ! regardless of individual level of
return, managers are motivated to invest in projects that promise higher or equal rates of
return than the corporate cost of capital
• Motivation for debt nancing is reduced ! RI takes cost of debt and equity into account
(WACC)
• Distortion for investment in xed assets is not addressed
• Some scholars suggest the EVA (economic value added) as a measure: EVA = modi ed net
operating pro t after tax – (Modi ed Total Capital x Weighted average cost of capital)
o “modi ed” refers to adjustments to standard accounting treatments
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 o Addresses several shortcomings of accounting pro ts or return measures

Advantages EVA Disadvantages EVA

Re ects the economic income better than
accounting pro ts
Mitigate investment myopia ! capitalization
of important intangible assets is involved
Advantages of a residual income measure
(overcome suboptimization; reduce
motivation for debt nancing)
Still a proxy for economic income
Still re ects primarily the results of
transactions during a period ! past focused;
economic income re ects changes in future
cash ow potentials
Objectivity problem: judgement for
adjustments required ! can be biased by
managers

Controllability Problem; additionally

understandability problems (complex, not
widely familiar)

Expensive: development with consulting rm

+ training time
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Back to Gloassary

Balachandran (2006): How does Residual Income affect Investment? The Role of prior
performance measures

• Research focus: Investment in rms, which switch to residual income (RI) based
compensation from earnings vs ROI based compensation plans
• No evidence of changes in investment associated with the implementation of RI before
differentiation the former compensation, i.e. earnings or ROI based ! there are signi cant
differences between the two sub samples
• Consistent with the notion “you get what you pay for” ! investment behavior differs as
predicted by the change in incentives

Development of Hypotheses
• Firm’s implement RI to improve delivered RI
• Manager bonus is then typically based on improvements in delivered RI ! incentive

H1: Ceteris paribus, the implementation of RI-based incentives will be associated with an
increase in delivered RI ! con rmed

H2: Ceteris paribus, changes in investment for rms switching form earnings will be opposite
the changes for rms switching form ROI
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 Financial Performance Measures and Industries and Industry Life Cycles
• Which industries should employ which performance measures?
o Balachandran: textile, utilities, and durable goods are overrepresented among the
implementors of RI measures, whereas nancial institutions, real estate, computers,
and service industries are underrepresented
o Industries heavily depending on intangible assets might better use market-based
measures, as accounting based measures do not represent the value of intangibles
accurately
o In dynamic industries market measures might also represent an advantage:
accounting measures are relatively backward focused
o RI makes sense when the industry is asset intense ! charge managers for the usage
of assets
• What measures are suitable for which stage of the industry?
o Introduction stage: Accounting based measures do not make sense ! no past
values; accounting losses; (ROI might seem reasonable) ! in small rms
suboptimization does not seem to be that much of an issue; although there are
high investments necessary they should still pay off; market-based measures might
be dif cult to apply too ! no market information available; rather employ non-
nancial measures and subjective judgement
o Growth Stage: market-based measures? Benchmarks ! still not a lot accounting
data; similar to Introduction stage
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 o Maturity Stage: RI measures ! charge managers for capital, avoid suboptimization
and myopia; add non- nancials and judgement for innovation units; ROI/ ROE,
pro ts
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 Session 7 – Non-Financial Performance Measures

BuzzWords: Balanced Scorecard, Myopia Remedies, Motivated Reasoning, Causal Chain

Guiding Questions

a) Why do you need non- nancial measures?

b) How are non- nancial and nancial measures connected?

c) What is the BSC and what are the (dis-)advantages?

d) How to design it? Give also examples to see the difference between objectives, measures,
targets, and actions?

Merchant & Van der Stede (2017) – Chapter 11: Remedies to the Myopia Problem

Pressures to act myopically

• Every manager has to strive for both an reconcile a trade-off between short term and the
long-term sustainable development of the rm
• Pressure can arise form
o Market reactions to short term-pro ts: steady pro ts and beating the market is
preferred
o However, markets also react to M&A, new manager appointments, announcement
of R&D projects ! accumulate information about future earnings
• Gamesmanship and myopia are the two most common forms, when referred to earnings
management; some rms are “famous” for engaging actively in earnings management (GE
example)
• However, some rms follow a strict long-term/ investment strategy without paying attention
to short-term pro tability (Amazon example p. 450)
Reduce pressures for short-term pro t
• Weighting placed on the annual pro t targets can be reduced/ zeroed and in turn
emphasize longer-term performance indicators such as market share/ technical
breakthroughs (Johnson & Johnson example; entirely subjective salary and bonus reviews)
• Make short-term target easier to achieve ! risk of slackness; trust in managers is necessary
• HSBC introduced a balanced score card and made qualitatively better sales

Control Investments with pre-action reviews

• Some rms reward operating performance only, i.e. they cut investments out of the
equation, so that managers are not tempted to cut investments to improve their earnings
• Distinguish between operational (necessary for achieving current pro ts) and
developmental (necessary for future pro ts) expenses
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 • Investments are monitored in a separate process ! capital budgeting; monitored against
the accomplishment of prede ned milestones
• Fund investments at higher organizational levels
• Separation in today and tomorrow businesses within the rm (e.g. Google turning into
Alphabet)
o Today: charge managers with making the business lean/ ef cient, pro table ! tight
nancial results controls
o Tomorrow: development of new business opportunities ! combination of
non nancial performance indicators and action controls
o Drawback: a clear distinction between operational and developmental
expenditures cannot be made/ is often dif cult ! room for gamesmanship
o Drawback: which developmental expenditures should be funded by corporate
management? ! when corporate managers are not informed enough about the
necessary key investments, resource allocation can be distorted

Extend the measurement horizon (use long-term incentives)

• Improve the congruence between accounting measures of performance and economic
income
• The longer the measurement period the more likely accounting measures are congruent
with economic income ! congruence can be enhanced by providing incentives tied to
performance over a longer period (e.g. require managers to hold shares for at least 5
years)
• Long-term incentive plans (LTIs) are very diverse but usually comprise rewards either for
stock appreciation, or for the attainment of performance targets, such as EPS ! lengthen
manager horizon and mitigate myopia
o Performance targets are more prevalent (ROI, TSR or EPS) ! suggests that LTI
compensation re ect an effort to respond to shareholder feedback and align
executives’ pay with performance
o Elements in LTIs also re ect speci c industry necessities (e.g. cash ow in the
automotive industry)
• Claw-backs: bonuses or incentive payouts are rescinded if long-term performance is poor;
e.g. performance bonds ! bonds forfeit when future performance turns out to be bad

Measure changes in value directly

• Measure economic income/ shareholder value creation directly by estimating future
cash ows and discounting them to PV
• Compare the DCF at the beginning and the end of a period
• This method suffers from feasibility ! dif cult to determine future CFs accurately; who is
preparing the forecasts?; precision and objectivity problem
• Estimates have to be controlled/ reviewed to ensure that they are not biased

Improve the accounting measures

• Improve accounting income measures ! make them more congruent with economic
income
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 • Adjust depreciable lives of xed assets to actually useful economic lives ! not
conservatively short
o Capitalize more expenditures made for the generation of future cash ows ! better
matching of revenues and expenses if future CFs are coming from these
investments
• Mark-to-market accounting: assets on the balance sheet are held at market value, rather
than their historical cost
• Charge Depreciation for older assets that are already considered as fully depreciated for
nancial reporting purposes ! incentive for replacement, when necessary
• Those measures differ from the accounting standards, which makes it necessary to track the
numbers separately ! costly! Processing, reporting, reconciliation, confusion

Measure a set of value drivers

• R&D accomplishments, product quality or customer satisfaction are value drivers that are
leading indicators of future nancial performance ! supplementing accounting measures
with those indicators can mitigate the managers tendencies to overemphasis short-term
pro ts
• Measurement combinations ! e.g. balanced scorecard!!
• Four perspectives of the balanced scorecard
o Financial perspective ! only rather short-term one
o Customer perspective
o Internal perspective
o Innovation and learning perspective
• Main idea for combining measure systems: organization tracks the right set of leading
indicators and gives them proper importance weightings ! then pro ts will follow
inevitably
o Carefully choose the value drivers and the assigned weights
o Economic effects on shareholder value/ management accomplishments/ failures
should be re ected more quickly when those approaches are implemented
o Shift the balance to more long-term orientation and force managers to consider the
trade-offs between short and long term ! more timely
o More congruent/ complete: no single performance measure can re ect
performance suf ciently; combined measures capture more aspects of
performance
o Flexibility: information can be disaggregated, and weights can be adjusted
o Re ect the interests of other stakeholders not just shareholders
o Understandability: give managers a greater direction for how to increase entity
value; the balance scorecard indicates what the manager has to do to improve
nancial performance, which is in the end of the casual chain

o Dif cult to evaluate effectiveness due to a huge variety

o How should the correct KPI be identi ed? What measures are necessary?
o Including too many measures can be confusing and dilute the effect
o How to ensure that managers do not just assign their “own” weights to certain
categories?
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 o Depends on the rm which level of emphasis/ weight is optimal ! align with
strategy
o Consider costs!

Back to Gloassary
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The Balanced Scorecard. Back to Gloassary
• The BSC helps to de ne strategic objectives and communicate them throughout the
organization
• The balanced scorecard comprises four different dimensions
o Customer perspective: How do our customers perceive us?
o Internal perspective: What must we excel at? What processes are key?
o Learning and Growth perspective: How can we ensure future value creation?
o Financial perspective: How can we ensure nancial health? Create shareholder
value?
• Every Dimension of the BSC consists of four distinct parts

• Advantages and Disadvantages of the BSC

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 Advantages Disadvantages

Balancing the trade-off between short term Measurement is not management: even
and long-term performance though the BSC tells you how you’re doing it
does not provide insights on how to improve
Communicate the strategic vision throughout current performance
the rm
Confusion through multiple measures
Forces to speci c objectives and appropriate
measures Not every measure might also be a value
driver in the end: does improved quality
Foster the understanding of causal linkages really contribute to customer satisfaction?
(see also Tayler paper)
Does not address the goal of appropriate
Understand critical success factors target setting

Re ect a stakeholder view of the rm Issues about weighting

Costly ! data, development

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Tayler 2010: The Balanced Scorecard as a Strategy-Evaluation Tool: The Effects of
Implementation Involvement and a Causal-Chain Focus

Introduction

• Multiple measures provide a balanced perspective on rm performance

• Research suggests that the dimensions of the BSC have to be tied up into a causal chain of
performance
• Motivated reasoning: propensity of decision-makers’ reasoning to be in uenced by
motivations ! begins with the manner how evidence is assembled and evaluated
• When information is noisy motivated reasoning is prone to occur: evaluators can rely on
preference-consistent information, while maintaining an appearance of objectivity
• Examine this effect: involvement in strategy selection ! subsequent evaluation of that
strategy using the BSC; what features can mitigate that effect?
o Framing the BSC as a casual chain rather than merely as a balanced set of
measures: limit the effect of motivated reasoning on strategy evaluations?
o Does managerial involvement in measure selection increase the effectiveness of
framing the BSC as a causal chain?
• The causal chain format emphasizes hypothesized causal linkages
• Framing the BSC as a causal chain and involving managers in measure selection mitigates
the effect of motivated reasoning related to managers’ involvement in initiative selection !
merely reframing the BSC is not enough
• BSC implementation: the impact of the BSC is increased through involvement in measure
selection as well as motivated reasoning is mitigated; the latter effect also reduces the
likelihood that unsuccessful strategies are perceived as successful
• BSC does not only serve performance evaluation, but also for developing and evaluating
strategy

Background and Hypotheses

The Balanced Scorecard

• Four dimensions: nancial, customer, internal processes, and learning and growth
• BSC is also viewed a tool for de ning strategic objectives and communicating them
throughout the organization, identifying initiatives to achieve objectives and evaluating
whether those objectives have been achieved
• Scorecards are tied to strategy through a strategy map ! translate expected results into
testable hypotheses ! if those are proven wrong, then the scorecard/ strategy can be
adjusted
• Steps of BSC implementation: selection of measures ! collection of scorecard-related data
! formatting of scorecard reports ! dissemination of scorecard information

Motivated Reasoning
• Def.: Individuals tend to evaluate and interpret data in ways consistent with their
preferences
• Individuals are prone to stop searching for information once they have collected suf cient
preference consistent data; or they just engage in super cial analysis
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• As the BSC focuses on non- nancial performance measures, which are by nature more
noisy, subjective, and ambiguous than nancial indicators, it provides fertile ground for
motivated reasoning
• Once a reasonable amount of supportive data is gathered, managers are likely to stop
searching for discon rming evidence or overlook/ reinterpret con icting data

H1: Managers using a balanced scorecard to analyze the success of a questionable initiative
will perceive the initiative as more successful if they were involved in the selection of the
initiative. ! supported

Causal Chain Back to Gloassary

• Focus the managers’ attention on the need to test hypothesized linkages between
scorecard components when assessing the success of a strategic initiative ! reducing the
space for interpreting data in the managers preferred manner
• Providing a causal chain is likely to reduce cognitive complexity in the evaluation task

H2a Managers involved in initiative selection will be less likely to perceive a questionable
initiative as successful if the scorecard is framed as a causal chain of performance ! not
supported; results suggest that the reframing is not suf cient to overcome the effects of
motivated reasoning

Involvement in Measure Selection

• Most critical task is to select the performance measures ! involvement of middle
management! They know their KPIs, success factors, …
• Involvement in measure selection should increase attention to causal linkages ! a good
measure can be used as a predictor of performance further down the causal chain

H2b Managers involved in initiative selection will be less likely to perceive a questionable
initiative as successful if the scorecard is framed as causal chain and managers are involved in
measure selection ! supported

Mediation Analysis
• Participants involved in initiative selection place less emphasis on the nancial perspective
than participants how were less initiative selection
• The effect of initiative selection involvement on the rollout judgement works partially
through the extent to which initiative selection involvement leads participants to decrease
their emphasis on nancial performance in evaluations

Conclusion

• Involvement in selection of BSC measures + reframing as causal chain: mitigate optimistic

assessments of strategies
• Managers involved in the strategy selection are less affected by motivated reasoning, if the
BSC is reframed
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 The results suggest that management involvement in initiative selection directs attention more
to the direct effects of those initiatives ! to avoid myopia here it is important to frame the BSC
as a causal chain and involve management in measurement selection

Session 8 – Statistical Testing of Non-Financial Measures

BuzzWords: Hypothesis Testing, Correlation

Guiding Questions

a) Why do you need to statistically test cause-effect relations?

b) How can you test such relations?

c) Conduct and interpret basic statistical analyses (e.g., summary statistics, correlation,
regression…)

d) This session also prepares you for the hand-in case, where you have to conduct statistical
analysis yourself.

Ittner & Larcker (2003): Coming up short on non- nancial performance measurement

The Idea in Practice

• Non- nancial performance measures offer a more holistic view on rm performance and
strategic objectives; corrective actions can be taken faster/ more precisely

Don’ts
• Not linking measures to strategy: causal links between different measures must be clear;
also, how non- nancial measures ultimately contribute to nancial performance ! will
enhance measurement selection
o Which non- nancial measures (NFM) should be tracked?
o The BSC must not be regarded as an “off-the-shelf” tool ! should be customized to
strategies and objectives; causal links should be identi ed
• Not validating the hypothesized links
o Often the hypothesized links are not evaluated and looked into their actual impact
on future nancial results
o Managers argue that those links are self-evident
o Often rms also end up measuring too many things ! peripheral, trivial, or
irrelevant measures
o Not being able to weigh measures makes it hard to allocate resources according to
their most bene cial uses or create meaningful incentive plans
• Setting the wrong performance targets: often targets are set too high
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 o Outstanding NFM are not always bene cial ! “too much of a good thing”
o Are 100% satis ed customers really willing to pay more than 80% satis ed ones?
o Gradually adjusting the measures instead!
• Measuring incorrectly: invalid measures, not capturing what they are supposed to
o Metric lacking statistical validity
o Validity: extent to which a metric succeeds in capturing what it is supposed to
capture
o Reliability: degree to which measurement techniques reveal actual performance
changes and do not introduce errors of their own
o Collecting data before they determine what to nd out
o Inconsistent measures throughout the rm ! hard to assess the overall progress
and to compare
Do’s
• Core problem: Which NFM have the most powerful effects on long-term economic
performance?
• Develop a causal model
o Develop a causal model on the hypothesis in the strategic plan
o Test different causal models: proven models, will lead to more acceptance and a
sound strategic roadmap
• Gather data: concrete, consistent measures for the entire organization
o Many companies already track a lot of NFM in their day-to-day operations ! use
that database!
• Turn data into information: use statistical analyses to validate the links of the causal
model
o Additionally, one-to-one interviews and focus group can help to gather relevant
information
• Continually re ne the model: deepen the understanding of non- nancial drivers &
economic performance
o Environmental changes can make measures irrelevant
o The re nement process should be never-ending
o What are the drivers of drivers?
• Base actions on ndings
o The conclusions drawn from data analysis must cater decision making for improving
nancial performance
• Assess outcomes: do actions produce the desired results?
o Do investments in non- nancial activities actually pay off? ! post-audits

• With statistical analysis you can just determine whether there is correlation, not causation
• Steps in evaluating
o Build the causal model
o Get the data
o Turn data into information
o Perform analysis: rst descriptive statistics (boxplots ! outliers), single regressions/
correlations, multiple regression
o Re ne the model
o Actions based on analysis/ ndings
o Assess outcomes again
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 • Basic indicators for the multiple regression
o Multiple R: Measure for the relation between the dependent and the independent
variable; takes values between 0 and 1; the closer to 1, the stronger the correlation
o Multiple R-squared: Explains how much of the variation in the dependent variable
is explained by the independent variables; how much percent can be explained by
the independent variables? 0 = independent variables do not explain dependent
variable
o Adjusted R-squared: adjusted for the number of independent variables, because
when more variables are included R-squared automatically increases ! adjustment;
better for multiple regressions!
o Standard error: how far can the estimation deviate from the actual value?
o P-Value: indicator that the explanation is not random; 5% or 10% indicates
signi cance
o Coef cient: extent of the in uence
o Beta: standardized regression coef cients; higher beta is better; alternatively, one
could also exclude a variable of interest and see how much explanatory power i.e.,
how much adjusted R-squared is lost
o Include rather many variables, because otherwise the effect of the other
independent variables might be overestimated ! however: do not over t the
model!
o In order to assess whether the relationship between an independent and a
dependent variable is linear one needs to examine the impact of the squared
variable, e.g. MT2
o Over tting: occurs when a model has too many terms for the number of
observations ! in this case the coef cients rather represents the noise (standard
error) then the relationship between the independent and the dependent variable;
can stem from the chase for a higher r-squared; detected through predicated r-
squared ! compare to regular r-squared (is there a big difference?)

Amy Gallo (2015) – A refresher on Regression Analysis Back to Gloassary

What is regression analysis?

• Sort out which variables do actually have an impact?
• Guiding questions: Which factors matter most? Which can be ignored? How do the factors
in uence each other? How certain are the factors?
• Dependent variable: factor you try to understand or predict
• Independent variable: the factors you suspect to have an impact on the dependent
variable

How does it work?

• Every regression includes an error term because independent variables are not a perfect
predictor for the dependent variable in reality
• Error terms tell you how much attention you should pay on the variable: how certain are
you about the regression line? The larger the error term the less certain the regression line
• Goal: minimize the error term
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A note about “Correlation is not causation”
• One can say that there is a relation between two variables, but not about whether one
variable really causes the other
• Use data to guide more experiments, not to make conclusions about cause and effect

What mistakes do people make when working with regression analysis?

• Give analysts clear instructions: Which factors should be examined?
• Keep in mind, whether or not you can do something about the independent variable
• Analyses are sensitive to bad data
 Session 10 – Discussion of the Hand-in Case

BuzzWords: Pros and Cons of Statistical Testing, Mediation Analysis

Guiding Questions

a) How to use data for decision making?

b) How to apply statistical testing for analyzing your data?

c) What is the difference between mediation and moderation analysis?

d) When are organizations more/less likely to apply statistical testing for their non-
nancial measures/business models?

Huelsbeck et al. (2011): On testing Business Models

Introduction
• Strategy map or a causal business model should articulate the economic logic of how an
organization creates and delivers value ! basis for every performance measurement
system
• Those models are grounded on ex-ante hypothesis about cause-and-effect relationships;
otherwise, aspects are measured that don’t matter that much to overall performance
• Managers often fail to do the necessary test because of laziness, thoughtlessness, or
mendacity ! data manipulation
• Yet, statistical tests are not powerful enough to provide conclusive evidence that the
business model is (not) valid
• Corrective actions taken are often not represented in the data
• The expected value of testing a BM decreases with managers’ prior con dence in the
model; the EV further depends on the availability of data from rm’s performance
measurement system, opportunity costs of implementing the BM, and direct costs for
conducting the analysis
• The expected cost of test increase with the prior management con dence in the BM
• Prior beliefs and cost-bene t analyses impact the assessment of the value of testing a
business model
• The insights from testing are less useful in rms where managers assume the BM is correct
and/or where the con dence level and power of test are lower
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 Re ections on the Value of Testing a Company’s Business Model

• Used data might be insuf cient to be conclusive

• Managers should evaluate the costs and bene ts of testing their companies’ business
models ! depending on several factors
• Strength of prior beliefs (how much probability do they assign to the correctness of the
underlying beliefs):
o Lower value: expect to nd evidence that is consistent with the current BM (no need
to improve actions)
o Higher costs: costs for changing actions, leading to other data which could then be
tested; a rich data set would be required to impact the managers’ con dence !
also costly to acquire
• Data available from the rm is considered: e.g. cost for gathering additional data or key
variables are not measured yet ! additional costs
• Opportunity costs for implementing the BM
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 • Direct costs of conducting empirical test: e.g. hiring a consulting rm
• Managers in the research setting were not concerned about lack of validation in their BM
o Managers’ con dence in their BM was built on more than a decade of experience
with its implementation, and its considerable success
o Statistical tests were not powerful enough to provide conclusive evidence that the
BM is not valid
o BM implementation rather than testing leads the executives to keep performance
drivers at what they believe to be the “optimal” level ! decrease in measurement
variation ! decrease in the overall power of the statistical tests

Advantages Disadvantages

Value drivers Strong priors

Examine, if there really is a relationship Availability of good data

Indication about what performance drivers Cost of gathering data

you should focus on
Corrective actions which have been taken,
Setting the wrong targets: Diminishing return but are not re ected in the data
from a certain factor?
No added potential bene ts/ potential
What factors actually in uence nancial bene ts exceed the cost
performance?
Opportunity costs

Mediation Analysis

• Mediation and Moderation help to understand the relationship between the independent
and dependent variable better ! both check how a third variable ts into the relationship
• Moderation: check whether the third variable in uences the strengths or the direction of
the relationship between an independent and the dependent variable
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 • Mediation: a mediator mediates the relationship between the independent and dependent
variable ! it carries the effect
o The independent variable induces change in the mediator which in turn in uences
the dependent variable ! usually only tested for correlation, not causality!
o Purpose: determine if the in uence of the mediator is stronger than the direct
in uence of the independent variable

Back to Gloassary
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 Session 12 – Subjective Performance Evaluation

BuzzWords: Uncontrollables, Promotion (sorting vs incentive), Subjective Evaluation

Guiding Questions

a) What is subjective performance evaluation, and which different forms does it take?

b) Why do rms use it? In which circumstances is it useful?

c) What are some potential negative consequences?

Merchant & Van der Stede – Chapter 12: Using Financial Results Controls in the
Presence of uncontrollable Factors

• Businesses are often affected by unanticipated events, which could not be considered in
their (budget and target setting) planning activities ! “black swans”
• In those situations, the question arises, whether the responsible managers should be held
accountable for not meeting the targets
o According to the controllability principle, managers should not be held
accountable in those cases ! employees should not be penalized for bad luck
o Such distortion effects can be reduced by employing certain measures
o However, some effects are only partially uncontrollable, and managers might tend
to not focus on mitigating the effects of severe impacts, when they are completely
protected against uncontrollable
• Organizations must determine whether and to which extent they should adjust the results
measures for the in uence of uncontrollable factors
• In uenceability principle

The controllability principle

• Holding employees accountable for uncontrollable risks yields costs, as individuals tend to
be risk averse ! employees prefer that their rewards stem directly from their actions
• The degree of risk-aversion depends on the character, career type/ stage, …
• Risk-aversion is the primary argument supporting the controllability principle
o Risk-bearing employees would have to be provided with a higher expected value
of compensation ! otherwise the rm will face other forms of cost (inability to hire
talented employees, loss of motivation, increased turnover probability, …)
o Employees might seek to protect themselves against uncontrollable, if the rm
does not, e.g through managing earnings or creating budget slack
o Cost in the form of lost time ! employees try to nd excuses
o The risk should be left to owner-investors (can diversify risk) or owner-
entrepreneurs (reward is received from the risk)
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 Back to Gloassary
Types of uncontrollable factors
• Economic and competitive factors, which affect results measures
o Pro t can be impacted by changes in consumer demand, prices, factor costs
o Demand is affected by business cycles, competitor actions, changing tastes,
boycotts, changing laws, …
o Costs are affected by changes in factor prices, supply and demand for raw material,
labor, capital, …
o Virtually every results measure can be affected by economic factors: stock prices,
customer satisfaction, on-time delivery, ...
o Nevertheless, managers should take actions to counteract those impacts ! usually,
managers are not entirely protected against those risks; risk is shared within the
organization
• Force majeure: unpredictable and abnormally severe events caused by natural or other
forces: natural catastrophes or rm speci c events, such as res, thefts (if not caused by
negligence)
o Those forces are sometimes two-sided: they can also provide opportunities
o Managers should take actions to mitigate the effects / recover from the impacts of a
force majeure; in fact, they must respond to those impacts
• Interdependence: entities are not completely self-contained but dependent on other
entities within the rm
o Pooled interdependencies: occur when different entities use common resource
(pools); managers are protected from increasing prices through xed contracts
negotiated during the annual planning
o Sequential interdependencies: outputs of one entity are the inputs for another
entity ! particularly, high for vertically integrated rms
o Reciprocal interdependencies are bidirectional sequential interdependencies: high
in related-diversi ed rms; rms usually set up transfer-pricing systems to deal with
this problem
o Interventions form higher-level management: force a decision on an entity manager
and in uence measures which are tied to rewards (e.g., not approving decisions)
however, entity managers could have exerted more in uence in the negotiating
phase

Controlling for the distorting effects of uncontrollable

• Before the measurement period: include only factors which are controllable by managers
• After the measurement period: adjust for effects of remaining uncontrollable factors
• In both cases costs and bene ts have to be balanced

Before the measurement period

• Insurance: many events are insurable: the company accepts small, incremental costs for
being covered in the (unlikely) event of large damage
o low frequency, high impact events
o Bene t comes from risk transfer to the insurer
• Responsibility structures: hold employees accountable for the performance area you want
them to pay attention to
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 o Companies aim to “match” an entity manager’s scope of decision authority with the
line item for which they hold the entity manager accountable
o Question: when should managers be expected to pay attention to items, they can
only control to a limited extend? E.g., overhead costs such as administrative or IT
o At some point costs will be larger than bene ts: when holding managers
accountable for too many things they have too little control over

Back to Gloassary

After the measurement period

• Objective valuations: variance analysis, exible performance standards, relative evaluations
• Variance Analysis: method to explain why actual results differ from predetermined
standards, budgets, or expectations
o segregate controllable form uncontrollable variance
o Variance is broken down into material, labor, and overhead cost variance
o Compare planned and actual values: this analysis is conducted for every factor
assumed to impact the variable of interest
• Flexible performance standards: performance that employees are expected to achieve
given the actual conditions faced during the measurement period
o Flexible performance standards are might set to vary with pertinent uncontrollable
factors; e.g. budget adapted to currency exchange rates
o Particularly useful when a dominant input factor changes beyond normal variations
o To some extent managers are expected to mitigate the effects of unfavorable
developments
o Development of contingency plans for black swan events: better deal with those
events, take pre-emptive action ! take known-unkowns into account: at the end of
the measurement period managers are held accountable for the target described
in the plan which best ts reality
o Update performance standards more frequently: rolling budgets ! re-evaluating
budgets monthly/ quarterly ! Costs, myopia!
• Relative performance evaluations: performance is not evaluated in absolute terms but in
comparison with each other or with the closest industry competitors
o Peer groups must roughly face the same task, threats and opportunities
o In many cases good peer groups do not exist
• Subjective performance evaluation: evaluators make a judgement whether the results
generated re ect a strong or poor performance without doing formal calculations
o Might create tension and resentment ! arbitrary decisions? Bias?
o Outcome effect: evaluator’s knowledge of other results in uences the performance
evaluation
o Hindsight effect: events that have occurred are seen as more controllable than they
actually were when they occurred ! inaccurate assessment of reality ex post facto

Advantages Disadvantages
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 The superior can correct for aws in the Subjective evaluations vest a source of power
results measures, which are rarely re ect in superiors over their subordinates
performance accurately and completely
Biases: Hindsight and outcome effect

Evaluators can use their knowledge of the
situation as well as the results measures for
making an informed judgement
Do not (punish) reward employees for (bad)
good luck
Bene cial in highly uncertain environments
and when tasks require a lot of creativity (e.g.
early stage companies)
No feedback on how the performance was
evaluated ! inhibit learning and motivation
Employees might have dif culties to
understand the judgements ! motivational
problems through perceived biases
Excuse culture and costs (through time
commitment)
Favoritism ! create resentment and tension;
arbitrary decisions?

Back to Gloassary

Other uncontrollable factor issues

• Uncontrollables should not be treated identically for all reward purposes
• Direction of adjustments: adjustments are only made for bad luck to protect managers but
not to protect shareholders form paying rewards for good luck

Grabner & Moers (2013): Managers’ Choices of Performance Measures in Promotion

Decisions: An Analysis of Alternative Job Assignments

Introduction
• Choice of performance measures in promotion decisions: emphasis on current job
performance and subjective assessments of ability
• Important role of promotion: sort employees to jobs in higher hierarchical levels,
corresponding to their ability
• Current job performance is not informative about the ability to perform the role after the
promotion
• Peter principle: people are promoted to their level of incompetence ! arises when there is
incongruence between the skills needed for the current and the future job
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 Back to Gloassary

• Traditionally, promotions are seen as an incentive mechanism in the accounting literature

• Sorting perspective to examine the weighting of current job performance and subjective
assessment of ability in promotion decisions
• When the tasks between the current and the next job are not signi cantly different, the
ability to master the current job also re ects the potential for the next job ! Current
performance is highly informative about future performance ! Peter principle is not an
issue
• When the task congruence is less, the Peter principle becomes an issue
• When the nature of tasks varies and objective measures for job performance are less
informative the manager has to rely more on measures which are unrelated to current
performance
• Measurement of ability for future jobs is then inherently subjective
• The greater the change in the nature of the tasks, the more weight is placed on subjective
performance measures relative to objective measures for current job performance
• Assumption: sorting role of promotion is more important than the incentive role
• Individual managers do make distinctions in their evaluation criteria for different types of
job assignments
• Only promotions that involve a signi cant change in tasks are strongly driven by subjective
assessment of ability
• The more the nature of tasks varies, the less managers rely on objective measures of
current performance and the more they rely on subjective assessments of ability
o Current performance is only signi cantly related to promotions that involve almost
no or small change in nature of tasks
• Firms try to avoid the Peter principle by tailoring the weights on performance measures to
the type of promotion decision
• The sorting role is more important than the incentive role, in particular when the next job is
the rst on managerial level
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H1: The greater the change in the nature of tasks upon promotion, the less weight the
manager puts on current objective job performance in making promotion decisions !
supported

H2: The greater the change in the nature of tasks upon promotion, the more weight the
manager puts on supervisor’s subjective assessment of ability in making promotion decisions
! supported

Conclusion
• In order to make accurate judgement the supervisors have to have a high level of
experience and leadership skills ! selection of appropriate managers is crucial

Back to Gloassary

Session Insights
• Objective performance measures: not biased or prejudiced by feelings, opinions,
perceptions or mental lters
o Calculation based
o Based on enough data to discern signals from random variation
o Comprehensive enough to avoid bias or discrimination in the data

PlentyLeads case
Why use subjective performance evaluation?
a. PlentyLeads is still a Start-Up with few signi cant KPIs, apart from sales & marketing
department
b. Uncertain environment due to development of new software (rapidly changing
environment)
c. Core values like commitment, proactivity and honesty not objectively measurable
Why should they not use subjective performance evaluation?
a. Social Media Marketing yields a high amount of quantitative data suited for objective
evaluation
b. Customer Surveys could be conducted to receive feedback, which can be quanti ed
c. Prone to supervisor biases (outcome effect, hindsight effect) ! untransparent
d. Could lead to “excuse culture”
e. Generally, time intensive/expensive/resource intensive
Measures/criteria for subjective performance evaluation
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 a. Teamwork, professionalism
b. Number of initiatives brought forward by employee
c. Quality of skills
d. Number of trainings participated in to improve skills (additional skills)
Problems implementing the measures
a. Provide scalability of personal skills
b. True performance not obvious, wrong estimation of skills
c. Trust issues
 Session 13 – Relative Performance Evaluation

BuzzWords: Performance Evaluation Bias (Leniency, Compression), Measurement Diversity,

Forced vs Free Ratings

Guiding Questions

a) What is the connection between subjective performance evaluation and forced ratings?

b) What is relative performance evaluation and why would rms use it?

c) In which situations are relative performance evaluation systems used?

d) What is the relation to forced rating systems?

e) What are positive and negative aspects of relative performance evaluation?

Moers (2005): Discretion and Bias in Performance Evaluation: The Impact of Diversity
and Subjectivity

Introduction
• Focus is set on the choice of performance measures in incentive systems
• Informativeness Principle: No single performance measure is likely to be complete !
incentive contracts should include multiple performance measures ( nancial + non-
nancial measures)
• Assigning weights to different performance measures in a BSC, however, is often dif cult !
general tendency to overemphasize objective and common measures of performance
• Goal: identify the impact of performance measure diversity and the use of subjective
performance measures on performance evaluation bias
o Performance measure diversity = use of multiple performance measures for
incentive purposes
o Subjective performance measures = superior’s subjective judgements about
qualitative performance indicators
• Several studies show that incentive contracting can be improved by incorporating more
diverse performance measures (including subjective performance measures) ! more
ef cient incentives
• Psychology research indicates that superiors compress performance ratings and give more
lenient performance ratings when these are used for incentive purposes ! problematic
bias! ! more dif cult to make the right personnel decisions
• Results indicate that performance measure diversity as well as subjectivity are positively
related to performance evaluation bias
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 o Multiple objective performance measures and the use of subjective performance
measures are related to more compressed performance ratings and more lenient
performance ratings
o Results suggest that increasing the number of performance measures and using
subjectivity leads to evaluations that make it more dif cult to differentiate among
subordinates ! problems for future incentives and personnel decisions
o Reasons for leniency and discretion (according to literature): superiors are not the
residual claimants the subordinates output, psychological cost of communicating
poor output, favoritism; opportunity for discretion (diversity in measures or
subjectivity)

Theory and Hypothesis Development

Diversity, subjectivity and incentives

• Purpose of incentive systems: spark effort and differentiate between highly and less skilled
employees
• Relating pay to performance is a strong incentive for higher performance
• The choice of performance measures is crucial in providing the correct incentives: direction
of employee attention
• Objective performance measures are only informative about the measurable aspects of an
employee’s job, not about more qualitative factors like cooperation or innovation !
therefore it seems logical to employ more diverse measures ! greater effort intensity from
the employee
• Moreover, multiple performance measures allow to choose incentive weights that
maximize congruence between the agent’s compensation and the rm’s outcome

Diversity, subjectivity and performance evaluation bias

• The assumption of an honest principle becomes crucial if the principal has discretion in
performance evaluation and incentive contracts are implicit
• Discretion in performance evaluation can lead to several problems ! performance
evaluation bias
o Superiors have an opportunity to let their preferences determine the allocation of
rewards
o Research indicates that evaluations are lenient, when used for incentive pay or
promotion decisions
o Superiors often differentiate insuf ciently among subordinates ! compression of
performance ratings
o Incentives for biasing performance evaluation of subordinates often result from the
psychological cost of communicating poor performance, favoritism, and
preferences for equity in rewards
• Biased evaluation involves various direct and indirect costs
o Direct: higher compensation costs
o Indirect: dif culties in making important personnel decisions ! all employees seem
to be above average performers; employees might become less motivated when
they are aware of the bias
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Back to Gloassary

Hypotheses

H1A: Performance measure diversity, with respect to objective performance measures, leads to
more lenient performance ratings

H1B: Subjectivity in performance measurement leads to more lenient performance ratings

H2A: Performance measure diversity, with respect to objective performance measures, leads to
more compressed performance ratings.

H2B: Subjectivity in performance measurement leads to more compressed performance

ratings

Discussion and Conclusion

• Performance measure diversity leads to more lenient performance ratings and less
differentiation among employees
• Subjectivity leads to bias in performance evaluation ! if more subjectivity is used in
evaluating and rewarding employees, superiors give higher performance ratings and
compress these ratings ! rm is unable to separate highly skilled employees from less
skilled employees
• When objective outcome measures are used forced rating systems can enhance
performance by triggering an incentive effect

Notes
• When you have more diverse measures on hand, you can accumulate more precise
information on the true performance ! accentuates the incentive purpose
• Residual Claimant: Superior is just someone in the rm and for him it is not that costly to
give lenient evaluations ! you rather have to live with the costs of giving severe ratings

Back to Gloassary
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 Cardinaels & Feichter (2020): Forced rating systems from employee and supervisor
perspectives

Introduction

• Supervisors often tend to be lenient and do not differentiate enough in the ratings of their
employees ! incentive effect of performance evaluation diminishes, and companies have
dif culties to identify more skilled employees
• As a consequence, rms install so-called forced-rating systems: employees have to be
rated according to a certain distribution (top 20% - middle 50% - lower 10%) ! forced
ratings can have detrimental effects when evaluation requires subjectivity
! excessive stress levels, frustration, hindered innovation
• Free rating systems: supervisors are not restricted in how they assign ratings to their
employees

• Subject of examination: The in uence of forced ratings on employees’ reaction on effort,

stress, and performance, and supervisors’ rating behavior
• Compared to free ratings, forced ratings can mitigate leniency and compression in the
performance evaluation
• Rating workers relative to each other or identifying someone as poor performer can be
very challenging when objective measures are not available
• Result: performance under a forced rating system is not higher than under a free rating
system
o There is no difference in effort, but forced ratings lead to higher levels of perceived
stress compared with a free rating system
o High levels of perceived stress mitigate the positive effects of effort on creativity
• Supervisors become less lenient when forced ratings are used
o Creativity of ideas has less impact on the ratings employees receive under forced
ratings compared to free ratings ! supervisors start to value aspects unrelated to
creative performance, which are easier to justify to their employees
• Eloquent language in uences supervisor rating more under forced rating systems
• Under forced rating systems supervisors start gaming by more frequently swapping
employees to different performance ranks across rounds
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 • When also manipulating the task (objective vs subjective) the results indicate that forced
ratings only increase performance for the objective task
o Worries about ratings increase in the subjective task when the ranking is forced;
employees worry less about evaluation then in the objective setting
o Worrying in uences stress that participants experience ! more stress leads to
decreases in the effort-performance relation for subjective task; for the objective
task stress does not have such an adverse effect but higher effort leads to higher
performance
! Forced ratings work differently in settings where performance needs subjective assessments

Back to Gloassary

Hypotheses

• Prior results show a positive relationship between forced rankings and the incentive effect
of evaluations by reducing compression and leniency for simple task settings where
performance can be measures objectively
! The extent to which the positive effect of forced ratings on the employee’s effort also holds
in a setting where performance is evaluated subjectively is not clear

• Forced ratings are often used in human capital-intensive companies, where evaluation
actually requires signi cant subjective judgement
• Ratings in evaluating more subjective tasks might be up to discussion

H1: There is a difference in the employees’ effort under forced versus free rating systems ! not
supported

prior studies show a positive effect of forced ratings on employee motivation in settings where
objective performance measures are available ! this is not found in this study where
performance needs to be evaluated entirely subjectively

H2: Forced ratings lead to higher employees’ stress levels than free ratings ! supported

H3: High stress levels decrease the positive effect of effort on creativity ! supported

There are no performance enhancing effects in the research settings, where performance
needs to be evaluated more subjectively

H4: The relation between the actual performance and the ratings is different under forced
ratings compared to free ratings ! supported
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Additional Experiment

• It is expected that forced – relative to free ratings – cause more uncertainty for the
evaluation in the subjective setting ! unlikely to be observed in the objective setting
• Second Assumption: Stress stemming from the uncertainty in the evaluation may hinder
creative performance by mitigating the positive effort-performance relation ! not
expected in the objective task setting

• Forced ratings induce a better performance in the objective setting, when compared to
free ratings
• The performance in the subjective setting is not increased by the forced rating relative to
the free rating
• People worry more about their evaluation when forced ratings are used in a subjective
setting

! Forced ratings compared to free ratings do increase the worries about the evaluation
(stressors) that subsequently drive stress
! The stress has different effects in a creative – compared to an objective task setting;
individuals in the creative setting may not pro t from their high effort
! Higher levels of stress reduce the effort-performance relation ! no bene cial effect on
performance of forced rating in a creative setting

Conclusion
• No difference is found in the creative task performance between forced rating systems and
free rating system
• However, forced ratings increase stress experienced by employees in the creative task
setting ! high levels of stress reduce the positive effort-creativity relation
• For tasks where objective performance measures are available forced ratings actually
decrease stress with respect to the evaluation and a forced rating can lead to performance
enhancing effects
• Supervisor perspective: forced ratings decrease the link between the actual performance
and the performance ratings employees receive
• When tasks require considerable subjective judgement from the evaluator, performance
improvements from the employment of forced rating systems are unlikely to occur
• Higher stress levels induced by forced ratings can also have other adverse effects, such as
higher turnover rates, health problems, and lack of motivation
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Take-Aways from Session Case
• There is no general correct solution for rating employees
• Importance of subjective opinion
• Evaluations might be dependent on current needs
• Every decision maker tends to be biased
• Discretion may enable more lenient ratings and compressed results

Back to Gloassary
 Session 14 – Management Control through Self-Selection

BuzzWords: personnel & cultural controls, employee self-selection, recruiting, effort effect,
selection effect

Guiding Questions

a) How can organizations implement personnel and cultural?

b) What does self-selection of employees mean and how does it work?

c) What are (dis-)advantages of self-selection?

Campbell (2012): Employee Selection as a Control System

Introduction
• Literature suggests that when it is dif cult to align incentives by contracting on output,
aligning preferences via employee selection can provide an useful alternative
o Then, also more resources are devoted to employee selection
• Control problem in the studied organization: Motivating employees to use decision-
making authority effectively
o Are employees selected via channels that are likely to sort on the alignment of
employee preference with organizational objectives
o Organization recently shifted from a centralized, to a more decentralized structure
! employees hired after the shift into the new structure are supposed to be more
aligned with the decentralized organization’s objectives
o Two ways of employee selection: regular hiring process vs referral by existing
employees (used as an indicator for a better alignment of the employee with the
rm)
• Result: employees selected through a “more aligned” channel are more likely to use
decision-making authority in the granting and structuring of consumer loans
o Conditional on using decision-making authority, their decisions are also less risky ex
post
o Employee selection is important to organizational control systems
o Direct link between employee selection and better management control outcomes
o Evidence that control in organizations can be obtained by managing inputs (e.g.
employee selection) rather than outputs
• The ndings demonstrate that employee selection can be a solution to the accounting
problem of de ning and measuring output
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Prior Literature
• Process model of management control (input – process – output): control can be achieved
by managing inputs (including employees) rather than outputs
• Input control (also referred to as “personnel controls”): ex ante control mechanisms !
more effort placed on screening the employees, means less monitoring is necessary once
they are in the organization

Research Setting and Data

• The new system yields an obvious incentive alignment problem: motivating employees to
use decision-making authority in service provision ! also leading to a better nancial
performance in the future
• The organization has increasingly relied on employee selection
• The organization has actively sought to select employees with particular attributes that are
indicative of underlying preferences for these objectives

Empirical Tests and Results

• Employees who self-selected to stay in the organization after the system changed appear
to have adapted to the new system
• Employees hired into the new system are signi cantly more likely to use all types of
decision-making authority than old system employees
• New system employees referred by other new system employees show signi cantly higher
loan exception rates across all exception types

! Results provide evidence that the use of decision-making authority is signi cantly higher for
employees selected via channels that are likely to sort on the alignment of their preferences
with organizational objectives

! Those employees also show more effective use of decision-making authority

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Back to Gloassary
Banker et al. (2001): An empirical analysis of continuing improvements following the
implementation of a performance-based compensation plan

Introduction
• Prior research documents that performance-based incentive plans result in performance
improvements ! evidence on the factors leading to those improvements is lacking
• No formal empirical evidence on the effects on employee selection and retention
• Selection effect (agency theory perspective): performance-based incentives increase an
organization’s overall productivity by attracting and retaining more productive employees
! a performance-based compensation contract can act as a screening device that
encourages less productive employees to leave
! the underlying assumption from the agency perspective is that employees have
complete knowledge about their skills, yet usually they learn about their skills only over
time ! selection effect is not instantaneous
• Effort effect: a performance-based incentive plan motivates employees to learn more
productive ways to perform their tasks
• Economic theory: employees with a long multi-period decision horizon, in the presence of
performance-based incentives over multiple periods, are likely to devote effort to learn
more productive ways of performing tasks
• Objective: evaluate whether the continuing increase in sales performance is due to the
attraction and retention of more productive employees (selection effect) and/ or whether it
is due to individual productivity gains driven by the improvement in employee effort (effort
effect)

! Results suggest that both these effects contribute to continuing performance improvements

Hypotheses Development

• H1 + H2: incentive plan implementation results in the attraction and retention of more
productive employees

H1: The sales productivity of existing (pre-plan) employees who remain with the store after the
implementation of the performance-based incentive plan is greater than that of both existing
employees who leave and new employees who are hired but leave after plan implementation
! supported

H2: The sales productivity of employees hired after the implementation of the performance-
based incentive plan, and who remain with the store, is greater than that of existing (pre-plan)
employees who leave and new employees who are hired but leave after plan implementation
! supported

H3: The change in the workforce composition with the more productive employees replacing
the less productive employees occurs gradually over time rather than immediately after the
incentive plan implementation ! supported; results suggest that the performance-based
incentive plan induces a gradual selection effect on the composition of the workforce
H4: The sales productivity of continuing employees improves over time ! supported

H5: The sales productivity of continuing employees improves at a rate greater than that of
employees who leave the rm ! supported

H6: The sales productivity of existing (pre-plan) employees who continue with the store
improves at a rate greater than the rate experienced prior to plan implementation !
supported

Short-term effort Long-term effort

Effectively close sales Learn more productive ways to perform

selling task
Quickly restock merchandising
Build up a list of loyal well-serviced
customers

Encourage repeat purchases

Employees with a short-term decision horizon Employees with a long-term decision horizon
have less incentive to devote effort to can trade off the disutility of higher effort
improve selling skills against the expected utility of higher further
compensation
Short-term vs Long-term perspective

Back to Gloassary

Notes
• Cultural and personnel controls are INPUT controls!! ! input focuses on acquiring the right
resources and skills
o Preventive controls: when you hire the right people, you prevent control problems
to even occur (Scientology)
o Detective controls: controls detecting MC issues

Self-Selection of employees Selection of employees done by the rm

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Individual decision of employees whether
they want to stay in the company or team !
in line with their individual preferences?
Consequence of deliberate mechanisms that
encourage employees to take that decision
Self-Selection can be done when hiring or
when assigning employees to teams (!
create stable teams; let employees decide
what they want to work on); can be triggered
by the implementation of new-incentive
systems or through major organizational
changes
Advantages
Self-Selection in the recruiting process
Realistic job preview
More informed decisions
Mitigates the principal-agent problem
Increases staff retention rate
Self-Selection due to the implementation of a new incentive system
Attracts productive employees ! motivation
to perform well
Fosters feedback culture
Leads to higher performance
Higher retention rate in the long-term
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Responsibility of management to put the
right people on the right job
Procedure of matching organizational
requirements with the skills and quali cations
of people
Exp.: reference checks, pre-screening,
carefully designed interview process
Disadvantages
Internal politics – recruiters could be disloyal
to the company
Bias of recruiters
Loss of potential candidates
Employers may still be reluctant to provide
information that deter people from applying
Higher turnover in the short-term
Employees may not know their own abilities
with certainty
Increased competition between employees
and stress
Productivity decline for old employees before
quitting
Halo effect
• Self-selection can be triggered by different factors
o Not only incentive systems, career prospects, and compensation count, but also
sustainable business conduct, work-life balance, …
o Corporate purpose is of paramount importance for younger people and what is
their role in this whole
o Disadvantage of self-selection: group-think

Back to Gloassary
 Glossary

Term Explanation S

Session 2: Results Controls, Action Controls, Personnel Controls, Cultural Controls,

Management Control Problems (Lack of direction/ motivation; personal limitations)

Action Controls Ensuring that employees perform (do not perform) certain actions known 2
Most direct to be bene cial (harmful) to the organization; four basic forms: behavioral
form of constraints, preaction reviews, action accountability, and redundancy;
control address mostly motivational problems

Avoidance of Prevent control problems form occurring though activity elimination, 2

control automatization, centralization, and risk sharing (Session 2)
problems

Control employees know what to do and are motivated, but are not able to do so; 2
Problem might be of a personal nature: lack of aptitude, training, experience, task-
Personal speci c knowledge (Session 2)
limitations
Control employees perform inadequately because they do not know that the 2
Problem: Lack organization wants from them (Session 2)
of direction

Control employees do not perform as the organization expects, although they 2

Problem: know what is expected; personal and organizational goals do not coincide
Motivational naturally (Session 2)
problem

Controllability Employees need to have control over the areas for which they are 2
principle measured; in the face of uncontrollables the targets might have to be +
adjusted; when employees are held accountable for risks out of their 12
in uence, they also ask for higher compensation; underlying reason: risk-
aversion of employees
Cultural Designed to encourage mutual monitoring; powerful form of group 2
Controls pressure on individuals who deviate from group norms and values; codes
Soft control of conduct, group rewards, intra-organizational transfers, physical and
social arrangements, and tone at the top; mutual monitoring

Expectancy Individuals’ motivation/ effort is a function of their expectancies/ belief that 2

Theory a certain outcome will result from their behavior; and their valences/
strength of preference for those outcomes

Management all the devices or systems that managers use to ensure that employees are 2
Control consistent with the organizational objectives and strategies (Session 2)

Management Communality of all measures/ mechanisms that ensure control; 2

Control combination of results/ action/ cultural/ personnel controls
System
Management- Investigating and intervening when performance deviates from 2
by-exception expectations

Measurement Measures need to be congruent, controllable, precise, objective, timely, 2

Quality understandable, and cost ef cient
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 Optimal control can be said to have been achieved if the control losses are expected to be 2
smaller than the cost of implementing more control; good control must be
future-oriented and objectives-driven (Session2)

Personnel Build on employees’ natural tendencies to control or motivate themselves; 2

Controls personnel controls are implemented through selection and placement,
Soft control training, and job design and resourcing; can lead to self-monitoring

Poka-yoke Combination of administrative and physical constraints ! step built into a 2

process to prevent deviation from the correct order of steps

Preventive vs Controls can be either directed to prevent undesirable actions or to detect 2

detective them

Principal- When the principal is contracting someone to perform a task for him, he 2
agent theory cannot be sure that the agent acts in his best interest. There are several
types of asymmetry involved: hidden action, information and motivation

Results controls In uence actions and decisions: cause employees to be concerned about 2
the consequences of their actions and decisions; incentivize employees to
produce good results; degree of delegation and incentive systems
(Session 2)
Session 3: Indirect Costs, Direct costs, Control Tightness, MCS Design, Delegation

Adaption Costs Costs arising from the adaption of MCS to the context where they operate, 3
of MC particularly in multinational rms or SBUs; Adaption costs are connected
to differences in national culture, local institutions, and differences in local
business environments

Delegation When the principal does not control suf cient knowledge and it is too 3
costly to acquire this knowledge, it can be a good decision to delegate
decision rights. However, this depends on the quality of the incentive
measures in place i.e., to which degree they are precise, sensitive, and
veri able
Design of In order to design a proper control system the following questions need to 3
Control Systems be considered: what is desired and what is likely to happen?; if the desired
actions deviate from the likely ones, it has to be determined which controls
should be applied and how tight

Direct Costs of All out-off-pocket monetary costs that required to design and implement 3
MCS MCS (e.g. bonuses or internal audit staff)

Indirect Costs Costs caused by harmful side effects; indirect costs can take the form of 3
of MCS behavioral displacement, gamesmanship, operating delays, or negative
attitudes; distinct controls are prone to different indirect costs

Session 4: Responsibility Centers, Learning & Monitoring, Transfer Prices

Cost Center The respective manager is responsible for costs that are associated to the 4
production of goods and provision of services (to other parts of the
company)
Experimentatio Employees, who are only loosely monitored tend to engage more in 4
n Hypothesis learning, because they can make use of their decision-making authority,
experiment, and then learn from the observed outcomes; loose
monitoring ! discretion ! experimentation ! learning (see also:
Selective utilization hypothesis)
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 Financial Identi able segment within a company which has decision authority and 4
Responsibility accountability; their responsibilities are measured in nancial terms.;
Center managers are responsible for different income statement/ balance sheet
line items; it is paramount to match decision authority and responsibility
There are four basic types of responsibility centers: revenue centers, cost
centers, pro t centers, and investment centers

Financial Comprise three elements: Financial responsibility centers, planning & 4

Results budgeting systems and incentive plans/ contracts (link between results
Control and rewards)
Investment The respective manager is responsible for everything (ROI); the 4
Center improvement of margins and/ or productivity and utilization of assets; e.g.
subsidiaries
Pro t Center The respective manager is responsible for controllable margins i.e., the 4
difference between controllable revenues and controllable costs; there
are also four distinct types of pro t centers: gross margin centers,
incomplete pro t centers, before tax pro t centers, and complete pro t
centers
Revenue Center The respective manager is responsible for generating sales; as revenue 4
center managers mainly focus on sales, they are less incentivized on
controlling costs; condition: sales are equally pro table

Selective Employees, who are tightly monitored also engage in learning. Due to the 4
Utilization close monitoring, they tend to evaluate decisions more thoroughly and
Hypothesis only use their decision authority in a selective manner, which enhances
learning; Campbell et. al nd only evidence for experimentation
hypothesis!
Transfer Prices Transfer prices are necessary when one pro t center supplies another with 4
goods or services. The transfer prices have an impact on the selling and
the buying unit, which leads in total to a zero-sum. TPs serve as an
economic signal for good decision, as information source for performance
evaluation and offers a possibility for pro t shifting between rms (tax);
evaluation and decision-making purpose
Session 5: Amount of Challenge, Scenarios, Top-down vs Bottom up, Incentive

Beyond Countermovement questioning the sense of budgeting due to highly 5

Budgeting dynamic environments, organizational politics/ gameplaying; Alternative:
rolling plan processes ! increase adaptability of organizations; challenge:
get exibility while maintaining strategic foresight

Planning & Through engaging in those activities four purposes are pursued: planning 5
Budgeting (encourage employees to engage in long-term thinking), coordination,
facilitating top-management oversight, and motivation

Planning Cycle Planning cycles happen in a hierarchical manner: strategic planning 5

(overarching goals and framework) ! Capital Budgeting/ Programming
(resource allocation, translate strategy into action) ! (operational)
budgeting (short-term nancial plan for the next scal year for the single
responsibility centers); targets – incentives - measurement

Scenario Develop different scenarios for events, which are likely to occur to be 5
Planning prepared; however, one should only plan for the most likely ones, as
planning is costly or having multiple scenarios can impact motivation !
which target is the right one?
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 Target Setting Plans and budgets are ultimately translated into targets. Targets serve as 5
motivation for managers and direct attention towards the relevant
activities; they are matched with the type of responsibility center ! critical
to set the target with appropriate challenge + involvement in target
setting; there are 3 types of nancial performance targets: Model-based/
historical/ negotiated; exible vs xed; internal vs external
Session 6: Accounting Measures, Market Measures, ROI-Measures, Residual Income/ EVA,
Suboptimization, Myopia

Accounting Based on the values identi ed by the accounting department. There are 6
based two basic forms: residual measures (accounting pro t measures, such as
performance net income, operating income, EBIT, …) and ratios (ROI, ROE, RONA, …);
Measures accounting measures score high in all the quality criteria, yet they suffer
from a conservative bias, are past oriented and can cause myopia

Financial FPM can be divided into three broad categories: summary measures, 6
Performance which are further divided into accounting and market measures;
Measures combination measures which can include either type of the summary
measures and disaggregated measures, such as revenues; need to be
evaluated according to the quality indicators.
Market based Based on changes in the rm’s market value, and/ or return to 6
Performance shareholders (dividends +/- change in market value of the stock); they are
Measures considered to be timely, precise, cost effective and understandable;
however, they can also cause demotivation (not in uenceable enough)
and cause opportunistic behavior
Myopia Myopia occurs when managers place excessive emphasis on short term 6
pro ts at the expense of long-term pro tability (often induced by FPM);
there are two basic types of myopia: investment (investments with a
positive NPV are postponed because they impact short-term pro ts and
thus the managers bonus) and operating myopia (managers attempt to
increase revenues and decrease costs at the expense of long-term pro ts)

Residual Residual income measures are designed to overcome the suboptimization 6

Income problem. Managers are charged for the net assets bound in their
Measures investment center (WACC). Therefore, they are less inclined to use debt
nancing and only invest in projects which have a higher return than the
rms cost of capital. One form of RI: EVA
ROI measures In divisionalized rms often ROI measures are employed, as they are 6
of performance understandable and as it re ects the trade-offs between revenues, costs,
and investments. However, they can send misleading signals and cause
suboptimization

Suboptimizati Suboptimization: decisions that appear to be locally optimal might not be 6

on optimal globally (for the whole rm); Gradually capital will be allocated
away from pro table divisions towards less successful ones ! counter-
productive to the goal of overall value maximization

Session 7: Balanced Scorecard, Myopia Remedies, Motivated Reasoning, Causal Chain

Balanced The BSC combines nancial and non- nancial measures. Four dimensions 7
Scorecard are considers: customer, internal, learning & growth, and nancial
performance; for each of the dimensions objectives, measures, targets,
and initiatives have to be de ned.
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 Causal Chain Reframing the BSC as a causal chain emphasizes the hypothesized 7
linkages, reduces the space for data interpretation and reduces the
complexity of the evaluation task
Motivated Individuals tend to evaluate data in ways consistent with their preferences 7
Reasoning and stop searching for information once they have collected suf cient
data consistent with their priors; the BSC is prone to motivated reasoning
as it includes non- nancial i.e., noisy data; causal chain framing and
involvement in measurement selection mitigates motivated reasoning

Remedies to In order to resolve the myopia problem non- nancial measures can be 7
the Myopia added to the MCS. There are six factors which could reduce myopia:
Problem reduction of pressure for short-term pro t; Control of investments with
pre-action reviews; Extended measurement horizon (long-term
incentives); Direct Measurement of changes in value; Improvement of
accounting measures
Remedy I – Increase the weighting on longer-term performance indicators, such as 7
Reduction of market share/ technical breakthroughs, or make short-term targets easier
short-term to achieve
pro t
Remedy II – Investments can be taken out of the responsibility of lower-level managers 7
Preaction and be funded at higher organizational levels; moreover, one could
Review for distinguish between operational and developmental expenses (today and
Investments tomorrow business)

Remedy III – Improvement of the congruence between accounting measures and 7

Extended economic income/ performance; Implementation of long-term incentive
horizon plans (e.g. rewards for stock appreciation)

Remedy IV – Economic income/ shareholder value creation is directly estimated by 7

Direct estimating future CFs and discounting them to a PV ! Delta of DCFs at
measurement the beginning and end of the period; feasibility? Bias control?
of value
changes
Remedy V – Enhance the congruence of accounting measures with economic value; 7
Accounting hold assets at market value rather than book value; adjust depreciation
Measure method; charge managers for already depreciated assets ! more
Improvements realistic; Costly!

Remedy VI – Complement nancial measures with non- nancial measures such as R&D 7
Set of value accomplishments, product quality, or customer satisfaction ! BSC
drivers Track the right set of indicators and assign proper weightings; reconcile
the trade-off between long-term and short-term pro tability

Session 8: Hypothesis Testing, Correlation

Regression Regression Analysis try to shed light onto the impact a factor 8
Analysis (independent variables) has on a certain phenomenon (dependent
variable); to what extent do the independent variables explain the
dependent one? Do not confuse causation and correlation!
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 Statistical In order to perform successful statistical analysis, managers should pay 8
Testing attention to the following:
Don’ts: not linking measures to strategy, not validating the hypothesized
links, setting the wrong performance targets (or too high), measuring
incorrectly
Dos: Develop a causal model, gather data, turn data into information,
continually re ne the model, base actions on ndings
Session 10: Pros and Cons of Statistical Testing, Mediation Analysis

Mediation vs Moderation: check whether the third variable in uences the strengths or 10
Moderation the direction of the relationship between an independent and the
dependent variable
Mediation: a mediator mediates the relationship between the
independent and dependent variable ! it carries the effect
Session 12: Uncontrollables, Promotion (sorting vs incentive), Subjective Evaluation

Controlling the After the measurement period targets can be adjusted to uncontrollables 12
uncontrollable – either objectively (variance analysis, exible performance targets, relative
after m. period performance evaluation) or through subjective performance evaluation

Controlling the One can control for the effects of uncontrollable already before the actual 12
uncontrollable – measurement period through buying insurance and designing
before m. appropriate responsibility structure ! to what extent should managers be
period shielded?
Hindsight Associated to subjective evaluation: events that have occurred are seen as 12
effect more controllable than they actually were when they occurred !
inaccurate assessment of reality ex post facto

Objective Measures, which are not in uenced by feelings, personal biases, opinions, 12
Performance or mental lters. They are based on comprehensive calculations and
Measures suf cient data to control for bias and random variation (can be nancial or
non- nancial)
Outcome Associated to subjective evaluation: The evaluator’s knowledge of other 12
effect results in uences the performance evaluations even though the results
may not be informative of the evaluatee’s performance.

Peter Principle people are promoted to their level of incompetence ! arises when there 12
is incongruence between the skills needed for the current and the future
job; people are rewarded for performance and climb up the ladder until
their skills do not match any more the required skills

Promotion + When the skills required for the next job differ signi cantly from those in 12
Subjective the current job, supervisors tend to evaluate performance subjectively, as
Evaluation the current measures/ performance does not provide indication about the
capabilities for succeeding in the next job. When the tasks/ required skills
are similar objective measures are emphasized more

Promotion In general, one can distinguish two types of promotion purposes: 12

Purposes incentive purpose (promotion as reward for achievements) and sorting
purpose (promote employees with the right skills to the right position)

Subjective Evaluators make a judgement whether the results generated re ect a 12

Evaluation strong or poor performance without doing formal calculations
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 Uncontrollable Exert impact on the success/ targets of the managers but are beyond their 12
Factors control. There are three basic types: economic & competitive factors (e.g.
increase in prices), force majeure, and interdependencies with other
organizational units
Session 13: Performance Evaluation Bias (Leniency, Compression), Measurement Diversity,
Forced vs Free Ratings

Effects of Rating Research suggests that forced ratings have a positive effect on 13
Systems performance when tasks can be evaluated objectively. C & F do not nd a
difference in effort for subjective tasks under free and forced ratings, yet
they nd that forced ratings increase (decrease) stress for the subjective
(objective) setting and thus mitigates (accentuates) the effect of effort and
performance
Informativene Indicates that any performance measure that provides (incremental) 13
ss Principle information about the employees’ actions should be used for incentive
purposes. Since no single performance measure is likely to be complete,
incentive contracting should be improved by incorporating a more diverse
set of performance measures
Measurement Refers to the extent to which different nancial and non- nancial measures 13
Diversity are included in the evaluation or for incentive purposes. Diversity can lead
to increase effort intensity (as measures inform about different aspects of
the job) and congruence with principal objectives ! diverse measures are
valuable for incentive purposes

Performance When more subjective and diverse measures are employed, superiors 13
Evaluation Bias tend to bias the evaluation by compressing them or evaluating
subordinates too leniently. This can have severe consequences for
personnel decisions. The superior is not the residual claimant of the
subordinates’ output!
Rating Systems For relative performance evaluation one can distinguish between two 13
possible rating systems: free ratings (superiors can decide freely how to
evaluate subordinates) and forced ratings (subordinates have to be
evaluated according to a predetermined distribution)

Relative Evaluation of an agent’s performance relative to a peer’s performance. 13

Performance Hence RPE removes unnecessary risk from the agent’s contract and offers
Evaluation a more informative measure on his performance ! mitigate the risk of
uncontrollables
Session 14: personnel & cultural controls, employee self-selection, recruiting, effort effect,
selection effect

Banker et al. Banker et al suggest that the introduction of a performance-based 14

incentive plan leads to the retention and attraction of more productive
employees. Ultimately, this leads to overall performance improvements for
the rm; this can be attributed to the selection and the effort effect

Campbell – When employees are selected through a channel which is “more aligned” 14
Employee (regular hiring after org. shift and/ or referral by existing employees) with
Selection the overall company culture/ expectations, then they are also inclined to
make use of decision-making authority and the decisions are more
effective; there is a direct link between employee selection and better
management control outcomes
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Effort Effect Economic theory perspective: a performance-based incentive plan 14
Banker et al. motivates employees to learn more productive ways to perform their
tasks; motivation to adapt productive activities and eliminate unproductive
ones
Input Control Rather than controlling outputs (results controls) the inputs are considered 14
in the MC process; personnel and cultural controls can be viewed as ex
ante control mechanisms ! deliberate screening in the beginning means
less control afterwards; focus on acquiring the right resources and skills;
preventive control
Selection Effect Agency-theory perspective; when a performance-based incentive plan is 14
Banker et al. introduced more productive/ effective employees are retained and
attracted to the company, whereas less productive employees are
encouraged to leave
Self-Selection Refers to a process were employees can decide themselves whether they 14
want to be part of the company / team or not; either through the hiring
process, implementing incentive systems, or organizational changes;
opposed to selection by the company; associated to personnel/ cultural
controls