Performance Measurement (Evaluation Systems)

1. Performance Measurement (Evaluation Systems) Next class: Amos Police Force Assignment #2 available on-line due March 17th

2. CMA • CMA NS Information Session • Date: March 24 • Time: 11:15am • Location: 190 Schwartz

3. Performance Measurement • Performance measurement systems are an integral part of the management control systems • Management control is a process through which management ensures that resources are obtained and used effectively and efficiently in accomplishing the organization's goals • To be most effective performance measures should be tied to the strategic objectives of the organization • Two key principles of performance measurement • Measurement of performance • Compensation based on measured performance

4. Performance Measurement: Theories of Incentives and Behavior Expectancy theory (from applied psychology) • People are motivated to act in ways that they expect to provide them with desired rewards and to prevent the penalties they wish to avoid. • So incentive plans must: • Provide the proper rewards and penalties • Make it likely that the desired behaviors will lead to those rewards or penalties Agency theory (from financial economics) • An employee contracts with an employer to perform certain work, and the employer wants to be sure that the work is duly and well performed. • So incentive plans must: • Motivate the employee to work • Align the employee’s goals with the employer’s

5. Effective Performance Measurement System

6. Uses of Performance Measurement • 1) Monitoring • 2) Decision Making • 3) Attention Focus • 4) Legitimization • 5) Compensation – income is not guaranteed but dependent on performance • 6) Translating and implementing strategy

7. Dysfunctional Outcomes of Performance Measurement • Fundamentals problems exist in performance measurement if the unintended behavior is created • Designers of incentive plan can be surprised to find that these systems create unintended behavior • Examples: • Credit Lending– performance measurement was $$$ of credit extended • Enron – performance measured by stock price and revenue recognition

8. What makes an effective performance measurement system?

9. Effective Performance Measurement System • Given the goals of the company which alternative incentive will motivate the desired behavior? • Unlikely a single measure or even several measures will effectively assess performance • assesses progress toward organizational goals and objectives - promote intended behavior • includes critical success factors • a mix of financial and nonfinancial – multiple measures • congruent with reward systems – pay performance link • participatory and easy to understand by employees • absolute vs relative evaluation • Various types of compensation (e.g. salary, bonuses, options)

10. Effective Performance Measurement System • feed back provided • Include both short and long term measures • employees in appropriate jobs & appropriate performance expectations • attainable performance levels • measures are observable (objective vs. subjective) • responsibility and control is considered (overall vs. divisional) • limit ability to manage/manipulate outcome measures

11. What are some traditional measures of performance?

12. Traditional Performance Measures • Some monetary measurement of income is used by virtually all businesses to assess performance • Financial measures do not address issues of competitive reality • 1) Cash flow • 2) Return on Investment • 3) Residual Income • 4) Economic Value Added

13. Why are traditional performance measures inadequate?

14. Problems with Traditional Measures • 1) Overly aggregate • 2) Not Timely • 3) Backward looking • 4) Promote dysfunctional behavior in the short term. • 5) Not one measure or type of measure can realistically capture performance.

15. What are non-traditional performance measures?

16. Nonfinancial Performance Measures • Traditional financial measures are easy to measure but inadequate • Non-financial measures are being used increasingly instead of traditional systems • Focus on the leading indicators of profit • Recognition of the time lags between non financial and financial performance.

17. Nonfinancial Performance Measures (cont’d) • Non financial performance measures create shareholder wealth • Non financial measures better predict future cash flows • A large scope of nonfinancial performance measures relate to critical success factors. • Intellectual capital becoming the basis of competitive advantage • What gets measured gets done • Customer service is an important measure

18. Why are nonfinancial measures not well utilized in performance measurement?

19. Non-Financial Measure - Current Practice • Importance-measurement gap • Measurement-use gap • Susceptible to measurement problems • Difficult to measure effectively (accuracy, ambiguity, timeliness) • Lead-lag relationship