Session 6 Subjective and Team-Based Performance Measures

1. Session 6Subjective and Team-Based Performance Measures

2. This course explores the links between organizational architecture and performance Strategy/Scope (Sessions 12-15):What business(es) are we in? Assumptions Values Interests Power Political Cultural Structure (Sessions 8-11): Who makes the decisions? Architectural Incentive Systems (Sessions 2-7): How is performance measuredand rewarded? IncentivesStructures Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

3. Continental’s bonus plan resembles a professional partnership’s N partners. Revenues are shared equally. Work hard € 300 € 2000 Shirk € 0 € 1000 Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

4. Partners balance personal benefits and costs Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

5. Source of the teams problem: partners ignore externalities Let N = 5 €1000Total benefit of my effort €200Personal benefit of my effort €800External benefitof my effort Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

6. The teams problem resembles a Prisoner’s Dilemma (Same payoffs as before with N = 2 and cost of working hard = €600.) Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

7. Continental Airlines 1995 • Net profit of $224 million($837 million turnaround from 1994) • Large operational cash flow surpluses • Top half for on-time arrivals in 9 of 11 months • Bonus payouts of $3 million per month • Delay-related savings of $8 million per month Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

8. Why did it work? (Same payoffs as before with N = 2 and cost of working hard = €600.) Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

9. Repeated interaction can solve the teams problem Partner B’s Strategy (Grim Trigger): • Work hard. • If Partner A shirks, shirk forever. Partner A’s payoffs: • If work hard • If shirk Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

10. Cooperative team relationships are more likely if: • Group membership is stable. • The group is small. • Group members interact frequently. • Group members can easily evaluate each other’s contributions. • Group work is highly interdependent. • Group members are of similar ability. Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

11. The Role of Beliefs Assumes on-time bonus of 65 and effort cost of 10. Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

12. Continental Takeaways • Reward systems based on group performance are a logical choice when work is highly interdependent. • These systems can suffer from the teams problem: the costs of cooperation are concentrated, but the benefits are shared. • This prisoner’s dilemma can be overcome through repeated interaction among team members. • Your odds of success can be increased by paying attention to the structural factors that support self-monitoring teams. Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

13. The Story of Corey White Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

14. Subjective performance evaluations are regulated by implicit contracts The firm’s offer:“If you do a good job, we will give you a €75,000 bonus.” 50 200 Outrageous fee Superhuman Slightly less outrageous fee 0 Insane 100 Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

15. Implicit contracts resemble a Prisoner’s Dilemma Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

16. What sustains the implicit contract? Employee’s Strategy (Grim Trigger): • Exert superhuman effort. • If firm reneges on bonus, exert merely insane effort forever after. Firm’s payoffs if it pays bonus every period: Firm’s payoffs if it reneges in first period: Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

17. Implicit incentive contracts are more sustainable if … • Commitments are institutional. • The firm is financially stable. • Management turnover is low. • Organizational transparency is high. Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

18. One Complicating Factor *Of those stating clear agreement or disagreement. Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

19. Subjective evaluation systems must be both subjective and objective • Subjective: “pertaining to or characteristic of an individual; personal; individual” • Objective: “not influenced by personal feelings, interpretations, or prejudice; based on facts; unbiased” Critical Success Factors: • Trust in the System • High IRR (Inter-Rater Reliability) Definitions: Random House Dictionary Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures

20. Takeaways • Group performance measures and the teams problem • Subjective performance measures and fragile “implicit contracts” • Prisoner’s Dilemmas and repeated games Frank ▪ Strategy, Structure and Incentives ▪ Session 6 - Subjective and Team-Based Performance Measures