Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
Chapter 9
Behavioral and
Organizational Issues
in Management
Accounting and
Control Systems
QUESTIONS
9-1
In the context of a management accounting and control system, control refers
to the set of procedures, tools, performance measures, systems and incentives
that organizations use to guide and motivate all employees to achieve
organizational objectives.
9-2
The four stages that are needed to keep the organization in control are:
1. Plan: develop an organization’s objectives, choose activities to
accomplish the objectives, and select measures to determine how well
the objectives were met;
2. Do: implement the plan;
3. Check: monitor by measuring and evaluating the system’s current level
of performance; compare feedback about the system’s current level of
performance to the planned level in order to identify discrepancies and
prescribe corrective action;
4. Act: take appropriate actions to return the system to an in-control state.
9-3
The two broad technical considerations that designers of management
accounting and control systems must address are the relevance of the
information generated and the scope of the system.
9-4
When addressing the relevance of a MACS, designers should develop a system
that provides information that is timely and accurate enough to be relevant and
useful for decision making. The system should provide a consistent framework for
the organization, in the sense that the language used and the methods of producing
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management accounting information do not conflict within various parts of the
organization. Finally, employees should be able to use the system’s available
information in a flexible manner so that it can be customized for the decisions at
hand.
9-5
The four major behavioral considerations in MACS design are: (1) embedding
the organization’s ethical code of conduct into MACS design, (2) using a mix
of short- and long-term qualitative and quantitative performance measures (or
the balanced scorecard approach), (3) empowering employees to be involved in
decision making and MACS design, and (4) developing an appropriate
incentive system to reward performance.
9-6
The scientific management view of motivation is that most people find work
objectionable, money is the key to inducing performance, and people have little
desire to be creative on the job or make good decisions. In this view,
management must tightly monitor and control employee behavior and break
down tasks so employees need only focus on production, not decision making.
9-7
The human relations movement view of motivation is that people have needs
that go well beyond performing simple repetitive tasks and that money is only
one aspect of what people desire. In this view, employees desire respect, a
feeling that they contributed something valuable to the organization, and
discretion at their jobs. Management’s task is to develop a better working
environment for people with the goal of improving employee morale, job
satisfaction, and performance.
9-8
The human resources model of motivation view is that people do not find
work objectionable. Instead, they want to participate in decision making and
have specific goals that they are trying to achieve. Individuals have information
and knowledge that they can contribute to the organization; further they are
creative, responsible, and wish to improve the organization. The task for
management is to create a working environment that will allow creativity to
blossom.
9-9
There are a number of choices that individuals can make when ethical conflicts
arise. These include: point out a discrepancy or problem to a superior and
refuse to act unethically, point out a discrepancy to a superior and act
unethically, go to an ombudsperson or mediator, work with respected leaders in
the organization to change the discrepancy, go outside the organization
publicly, go outside the organization anonymously, resign and go public, resign
and remain silent, and do nothing and hope that the problem will dissolve.
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9-10 An ethical control system is a system that promotes ethical decision making in
an organization. Key elements include the following:

A statement of the organization’s values and code of ethics.

A clear statement of the employee’s ethical responsibilities for every job
description and a specific review of the employee’s ethical performance
as part of every performance review.

Adequate training to help employees identify ethical dilemmas in
practice and learn how to deal with the dilemmas.

Compelling evidence that senior management expects organization
members to adhere to its code of ethics. This means that management
must provide a statement of the consequences of violating the
organization’s code of ethics, establish a means to deal with violations of
the code of ethics, provide visible support of ethical decision making,
and provide a private line of communication from employees directly to
the chief executive officer, chief operating officer, head of human
resource management or board of directors.

Evidence that employees can make ethical decisions or report violations
of the organization’s stated ethics without fear of reprisals from
superiors, subordinates, or peers in the organization.

An ongoing internal audit of the efficacy of the organization’s ethical
control system.
9-11 The three key dimensions of motivation are: direction, the tasks on which an
employee focuses attention at work; intensity, the level of effort expended by
the employee; and persistence, the amount of time an employee will stay with
a task.
9-12 Goal congruence occurs when individuals are able to align their goals at work
with those of the organization.
9-13 Managers use diagnostic control systems to monitor organizational outcomes
and correct deviations from predetermined performance standards. A diagnostic
control system tends to run in a routine way, without regular monitoring by a
manager. Interactive control systems, in contrast, rely heavily on dialogue
among managers and subordinates about data generated by the system and
steps to take based on the data. In interactive control systems, managers must
spend more time monitoring the decisions and actions of their subordinates.
9-14 Task control is the process of finding ways to control human behavior so a job
is completed in a prespecified manner. Results control focuses on measuring
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and comparing employee performance against stated objectives. Task control is
most appropriate when there are legal or safety requirements, when employees
handle liquid or precious assets, or when the organization can control the
environment sufficiently to eliminate the need for judgment. Results control is
most effective when organization members understand the organization’s
objectives, and have the knowledge and skill to respond to changing situations
with sound decisions and actions. In addition, the performance measurement
system should be designed to assess individual contributions, to provide
suitable motivation.
9-15 The two categories in task control are preventive control and monitoring. In
preventive control, discretion in performing a task may be minimized because
of the precision required or the nature of the materials involved. Monitoring
involves inspecting the work or observing the behavior of employees while
they are performing a task.
9-16 Quantitative financial measures of performance in a manufacturing
organization include:

cost per unit

profit per unit

return on investment
9-17 Quantitative financial measures in a service organization include:

cost of service

profitability of service

service revenue
9-18 Quantitative nonfinancial measures of performance in a manufacturing
organization include:

yield rate

quality

schedule adherence

number of process problems

defective rate

on-time delivery percentage
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9-19 Quantitative nonfinancial measures of performance in a service organization
include:

number of customer complaints (in a restaurant)

number of errors in processing claims (in an insurance organization, for
instance).

number of repeat customers (for all service organizations)

percent of flights with on-time arrival (in the airline industry)
9-20 Qualitative measures of performance include:

image of a product

reputation of a product

measures of customer satisfaction.
9-21 Gaming a performance indicator occurs when an individual alters his or her
actions in an attempt to manipulate a performance indicator through job-related
acts.
9-22 Data falsification occurs when an individual falsifies information in favor of
himself/herself. It is considered illegal.
9-23 The single most important factor in making major changes to an organization is
having top management support, often at the level of the CEO and other senior
managers. The change process often relies on a champion who is charged with
spearheading the process.
9-24 Earnings management occurs when managers knowingly manipulate reported
income. Smoothing, which is the acceleration or delay of a preplanned flow of
data without changing the organization’s activities, is an example of earnings
management. For example, a manager who wants to meet a net income target
may defer expenses to the next period or book future revenues in the current
period.
9-25 Empowering employees in MACS design requires two essential elements—
allowing employees to participate in decision making and ensuring employees
understand the information they are using and generating.
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9-26 The two interrelated behavioral issues are (1) designing the budget process,
which includes how budgets should be determined, who should be involved in
the budgeting process, and the level of budget difficulty, and (2) influencing
the budget process, which includes how people try to influence or manipulate
the budget to their own ends.
9-27 The three most common methods of setting a budget are: (1) authoritative
budgeting in which a superior tells subordinates what their budget will be
without requesting input from the subordinates, (2) participative budgeting in
which the setting of the budget is done jointly between a superior and
subordinates and (3) consultative budgeting in which a superior asks
subordinates for their ideas about the budget but then determines the final
budget alone.
9-28 Research has shown that the most motivating type of budget is one that is
“tight”—those with targets that are perceived as ambitious, but attainable.
9-29 A stretch target is one that exceeds a previous target by a significant amount
and usually requires an enormous increase in effort to achieve.
9-30 Budget slack occurs when subordinates (a) ask for excess resources (more than
needed to accomplish budget objectives) and (b) distort information by
claiming they are not as efficient or effective at what they do, thus lowering
management’s performance expectations of them.
9-31 An intrinsic reward is a benefit that a person experiences, without the
intervention of anyone else, as a result of doing a job.
9-32 An extrinsic reward is a reward that one person provides to another person in
recognition of job performance.
9-33 Incentive compensation is a monetary reward that is based on measured
performance.
9-34 The six attributes of effective performance measurement systems are: (1) the
person must understand the job and the reward system, and believe that the
system measures what employees can control or contribute to the organization,
(2) the performance measurement system must reflect careful choices about
whether it measures employees’ inputs or outputs, (3) the job’s performance
measures should reflect the organization’s critical success factors, (4) the
performance measurement system should set clear performance standards or
targets that are acceptable to employees, (5) the performance measurement
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system should accurately assess performance, and (6) the reward system should
focus on individual or group rewards depending on the nature of the job.
9-35 Organizations where employees have been given the responsibility to make
decisions are best suited for incentive compensation systems because these
organizations create the environment where the individual’s decision making
can affect the organization’s outcomes.
9-36 A cash bonus is a cash reward tied to measured performance.
9-37 Profit sharing is a cash bonus incentive compensation plan where the total of
all cash bonuses paid to all employees is determined by a formula involving the
organization’s, or an organization unit’s, reported profit.
9-38 Gain sharing is a cash bonus incentive compensation plan where the total of all
cash bonuses paid to all employees is determined by a formula involving
performance relative to some target.
9-39 In a stock option plan, employees deemed to be able to affect the value of an
organization’s shares are given the option to purchase those shares at a
specified price that is usually higher than the share price at the time the option
is issued.
EXERCISES
9-40 The mission statement becomes a basis for the organization’s accountability to
those stakeholders. The notion “company’s value” is ambiguous—perhaps
deliberately. It may be ambiguous because it is not expected to be taken seriously,
or it may be ambiguous so that if it is taken seriously it makes no real commitment.
The following interpretations might be made of “company’s value”: by
customers—service, quality, and cost; by employees—competitive wages, good
working conditions, and security; by shareholders—a competitive rate of return on
investment; and by society—conformance to laws and progressive social activities,
such as affirmative action.
9-41 When addressing the relevancy of a management accounting and control
system, designers should develop a system that provides information that is
timely and accurate enough to be relevant and useful for decision making.
Information that is insufficiently accurate will lead to errors in evaluating
profitability of cost objects and may lead to poor decisions. Timely information
is important because the most accurate information that appears after
evaluations or decisions are made is irrelevant with respect to those evaluations
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or decisions. The system should provide a consistent framework for the
organization, in the sense that the language used and the methods of producing
management accounting information do not conflict within various parts of the
organization. For example, having two divisions with different costing systems
makes it more difficult to understand and compare results across divisions. If
one division of an organization uses activity-based costing principles and
another division, especially one that is very similar in goals and function to the
first, uses volume-based overhead allocation methods, the information system
does not meet the consistency criterion. Finally, employees should be able to
use the system’s available information in a flexible manner so that it can be
customized for the decisions at hand. If the management accounting and
control system cannot accommodate the specialized needs of each major user,
users may develop ad hoc local systems, which can lead to poor decisions or
confusion in communications between the users and the rest of the
organization.
9-42 The scientific management view of motivation sees employees as the vehicles
by which management’s goals can be accomplished. People are thought of as
simply means to an end, and management treats them almost like machines by
timing their actions and trying to make them work more and more efficiently.
The underlying philosophy is that most people find work objectionable, dislike
decision making or creativity, and find money to be the driving motivator.
The human relations school understands that employees want much more from
work, including respect, autonomy, and satisfaction; financial compensation is
just one of the things workers desire. Management attempts to create a better
work environment to increase employees’ satisfaction and performance.
The human resources view goes even further than the human relations school in
that employees are seen as key suppliers of ideas and information about how
their jobs and the work environment can be improved. This view holds that
employees find work enjoyable and desire to make decisions, develop
objectives, and attain goals. Individuals are motivated by financial and
nonfinancial compensation. Individuals are assumed to have considerable
knowledge about their jobs, and to be highly creative, ethical, responsible, and
supportive of change in their organizations. The task for management is to
create a working environment in which employees can use their information to
its fullest ability and in which creativity can flourish.
9-43 The hierarchy of ethical considerations are (1) legal rules—actions prohibited
by law, (2) societal norms—actions that society has deemed unacceptable, (3)
professional memberships—actions that professional memberships discourage,
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(4) organizational or group norms—actions that are unacceptable to an
organization or group, and (5) personal norms—actions that each individual
deems unacceptable. The hierarchy is listed in descending order of authority.
9-44 If the organization’s code of ethics is stronger than the individual’s, then the
employee can either resign or adhere to the organization’s rules. In some cases,
the organization will strongly enforce its code, and if the individual complies,
there may be no problem. If the individual’s code of ethics is stronger than the
organization’s, the individual can quit, do nothing and try to live with the
situation, or try to work with the organization to change its code or norms of
behavior. Employees faced with ethical conflicts should document the events
and discussions and list the parties involved.
9-45 First, the individual must make sure that the facts are correct and that there is
clearly a conflict. The individual should speak to superiors and determine
whether the conflict is institutional or reflects the actions and beliefs of a few
individuals. If there is a true conflict, the individual can (1) point out the
problem to superiors and refuse to act unethically, (2) point out the problem to
superiors and act unethically, (3) talk to an ombudsperson (mediator in the
organization), (4) work with organizational leaders to resolve the problem, (5)
go outside the organization to publicly resolve the issue, (6) go outside the
organization anonymously to resolve the issue, (7) resign and go public, (8)
resign and remain silent, and (9) do nothing, and hope the problem will go
away. Most experts recommend alternative (4) but any of the alternatives may
be appropriate depending on the circumstances.
The organization’s stated values may conflict with practiced values if
individuals see unethical or illegal behavior practiced by co-workers or the
organization’s leaders, and infer that such behavior is accepted and sanctioned.
Organizational leadership therefore plays a critical role in fostering a culture of
high ethical standards.
9-46 Any control situation is useful here. The exercise is intended to provide an
opportunity to discuss the appropriate matching of the approach to control with
a situation. For example, some governments are now advocating that people
who have been convicted of drunk driving have their vehicles equipped with a
device that prevents the vehicle from being started unless the driver can
accomplish a series of dexterity tests on a keypad. This is an example of
preventive control.
9-47 Many aspects of work require a variety of actions and decisions, and using only
one measure of performance will not capture the complexity of the employee’s
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job. The advantage of having multiple measures is that employees will not
focus on a single measure and only perform those acts that maximize
performance on that measure.
The performance measurement system conveys what the organization values,
how the individual contributes to what the organization values, and what the
employee should do to earn personal rewards and satisfaction. Therefore, if the
performance measurement system does not measure some facet of performance,
the system not only provides no direct motivation to the employee, who
receives no personal benefit in pursuing unmeasured performance goals, but
also implies to the employee that the particular facet of performance is
irrelevant. An example is a grocery store clerk. If the clerk has been told that
accuracy and speed are critical, the clerk may infer that answering customer
questions and making simple remarks to the customer reflecting common
courtesy are unimportant.
9-48 What performance is measured, how it is measured, and what rewards follow
from measured performance define the causal link between performance and
rewards. Without a clear link, employees do not understand how their effort
results in increased rewards and personal satisfaction.
9-49 If the performance measurement system includes factors beyond the
employee’s control, motivation likely will decrease. However, one might argue
that many people held responsible for nominally uncontrollable performance
factors will develop means to control these factors.
9-50 The president, who controls overall policy and sets the organization’s direction,
should be evaluated and rewarded based on the trend of key success factors
such as profitability, customer satisfaction, employee satisfaction, relations
with suppliers, and image in the community. The middle manager, who designs
and puts in place systems, should be rewarded based on the overall contribution
of the system to the organization’s key success factors. These measures might
include: the time between when an order is taken and when it is filled, the cost
of filling an order, overall system accuracy, and the performance of this system
relative to competitors’ systems. The employee who fills orders operates within
the existing system. This person should be evaluated based on the speed and
accuracy of work done relative to the potential of the existing systems and the
suggestions made that are used to improve the system. In general, the
performance measurement systems are similar in their focus on the same broad
factors—the organization’s critical success factors. However, they differ in
focusing on what each manager controls.
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9-51 Some management thinkers believe that the best type of organizational culture
is one in which pay for performance is unnecessary. In this view, people will
perform well if the owners pay the people a good salary. Other management
thinkers believe that tying rewards to performance in the form of bonuses or
other incentives is highly motivating because people will exert extra effort if
they know they will receive a bonus for good performance. This may lead to
greater goal congruence between individuals and the organization, although the
empirical evidence is mixed regarding this claim.
9-52 The key difference is that gaming does not involve any falsification of data or
information, only the altering of one’s actions to do better on a performance
indicator.
9-53 Budget slack can be created by budgeting excess resources that are not really
needed to attain the goals of the budget. Slack also can be created by
employees who understate their performance capabilities and choose a lower
level standard or budget than they know they can attain. Creating slack is a
gaming activity designed to facilitate achieving high performance evaluations.
9-54 Workers may believe gaming behavior is an appropriate response (to survive in
an organization) if the organization has set up a performance measure that is
impossible for employees to attain. For example, in an assembly line, if the
average worker can make 10 units of output an hour, but management raises
the standard to 16 per hour, workers may take a number of actions that they
normally would not take if the standard were reasonable. Such actions would
include lowering the quality of output to meet the standard, cutting deals with
high producing coworkers to supply them with output, etc. In this situation,
workers may simply be trying to keep their jobs. Such behavior will continue
until management employs a reasonable standard.
Managers may believe it is appropriate (necessary) to game the budgeting
process by building in budget slack when they know through experience that
upper management automatically reduces the submitted budget. If managers
submit budgets reflecting an accurate estimate of their need to accomplish the
company’s stated goals, they are unlikely to achieve the goals with a reduced
budget.
9-55 The employee who participates in decision making will generally be more
committed to the decisions made (such as attaining the participatively set
budget) and often will experience greater job satisfaction and higher morale as
a result. The result can be enhanced productivity, which benefits the
organization. In addition, workers may have critical information that can
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greatly benefit management. For example, workers still perform the major
portion of work in non-automated industries, so they have superior knowledge
regarding how to improve products and processes.
9-56 Participation in the budgeting process involves a subordinate setting the budget
with a superior jointly. In other words, the superior and the subordinate meet
and negotiate the budget directly. Consultation, on the other hand, involves the
superior seeking the subordinate’s input on the subordinate’s budget, but no
joint decision-making occurs. Once the superior has the subordinate’s input,
the superior makes the final budget decision.
9-57 From the employee’s (subordinate’s) perspective, the benefits from building in
slack are twofold. First, the employee may be able to obtain excess resources to
achieve desired goals. This may take a lot of pressure off the employee and
reduce job anxiety. Second, senior management may lower their work
expectations of the employee. This may also lead to lower pressure on the
employee to perform. Both of these types of slack building are designed to
reduce job stress for the employee. However, if incentives are graduated in
such a way that achieving higher and higher goals provides the employee with
more and more compensation in the form of bonuses, then the employee may
lose income by selecting lower goals.
From senior management’s point of view, employees who build in slack are
either using unnecessary resources to achieve a goal that should have been
achievable with fewer resources, or they are understating their performance
capabilities. Thus, the organization is either not running as efficiently as it can,
or is losing potential productivity from employees who are not working as hard
as they can. In some cases, senior management may believe that employees
build in slack to relieve job pressure. If burnout of employees has been
occurring in the organization then perhaps senior management may be more
forgiving and view some slack building as necessary to keep their employees
from quitting.
9-58 Budgeting games occur when managers or other employees attempt to
manipulate information and targets to achieve their specific goals, such as
achieving the assigned objectives with the allotted funding, or attaining as high
a bonus (given that there is a bonus tied to budget attainment) as possible. One
well-known way that employees engage in budgeting games is through the
participation process. For instance, employees might ask for resources above
and beyond what they need to accomplish their budget objectives. This results
in a misallocation of resources for the organization as a whole. Employees may
also distort information by underrating their efficiency or effectiveness, thereby
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attempting to lower management’s expectations of their performance. If
employees succeed in this type of negotiation, they will find it easy to meet or
exceed their budgeted objectives. Again the organization suffers, because it is
not obtaining the most accurate information available to assess and improve its
operations. Both requiring excess resources and distorting performance
information fall under the heading of creating budget slack.
9-59 This question distinguishes between people who are driven exclusively by
extrinsic rewards, most often monetary, and people who receive satisfaction by
intrinsic rewards as well. This is a matter of individual preference but provides
the opportunity for people who do not value intrinsic rewards to understand
why some people value them.
Extrinsic rewards are rewards provided to the individual by someone else.
Examples are bonuses, promotion, and recognition. Monetary rewards such as
cash, trips, and stock options convey a direct value. Nonmonetary rewards,
such as recognition in the company newsletter, convey value to people who
take pride in having their accomplishments recognized by others. An intrinsic
reward is a benefit that a person experiences, without the intervention of
anyone else, as a result of doing a job. It reflects satisfaction from doing a job
well, satisfaction from growth opportunities, or pleasure from helping others
learn or grow.
9-60 The choice of the mix of performance measures and the decision about whether
those measures are input-based, output-based, or a combination of measures
make up one of the most difficult tasks in the design of performance
measurement and compensation systems. In general, the greatest alignment
between employees’ and the organization’s interests is provided when the
performance measurement system monitors and rewards outcomes or employee
outputs that contribute to the organization’s success. Rewarding a person
based on outputs such as good units, or outcomes such as customer satisfaction,
forces the person and the organization to direct attention and behavior toward
understanding and doing what promotes organization success. However,
outcomes and outputs may reflect circumstances and conditions that are beyond
the employee’s control, and when they do, the weaker link between
individuals’ efforts and measured results decreases the motivation provided by
the reward system. In addition, it may be impossible to measure outcomes
consistently and outcomes may be too expensive to measure.
Under circumstances where outcome measurement is problematic,
organizations often choose to monitor and reward inputs (such as employee
learning, demonstrated skill, and time worked). Knowledge-based pay
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remunerates based on an employee’s training and job qualifications, which can
be upgraded by training. The employee’s compensation is based on time input
and an hourly rate or salary reflecting the deemed level of skill input, and
salary increments can result from new knowledge rather than a promotion or a
job change. For example, in some manufacturing organizations, employees can
take on-site classes at night to increase their skills. Once these classes are
completed, and the new skills mastered, the employees are moved to a higher
wage level. Governments often use knowledge-based pay to motivate public
servants to improve their skills. For example, a social worker might be given a
10% salary increase, within the same job, for acquiring a diploma in social
work.
9-61 This is a deep issue that has been the subject of many articles. The purpose of
the question is to identify the issues rather than to reach any definitive
conclusion. There are two clear requirements to this question—comparing the
pay of this executive to other executives (the relative level) and the absolute
pay of executives in general (the absolute level).
Business Week and Fortune magazines, among others, have published many
articles that compare the compensation of executives with the compensation of
other executives. These articles define various measures of success, such as
growth in the value of the firm’s share price, and look at the correlation
between executive compensation and these success measures. Then the articles
rank the executives based on how closely the change in compensation is related
to the change in the success measure. This approach hinges on the ability to
define and measure appropriate success measures. This comparison focuses on
whether the pay was appropriate given the level of the organization’s
performance relative to other organizations.
However, the issues in compensation are deeper and require a consideration of
the purpose, effect, and scope of motivation. Do these people really need to be
paid the amounts that they command to do the work that they do? A
competitive issue concerns what we have to pay, given the market opportunity
for this executive, to keep this person. However, a related issue, which cannot
be solved in the short run, is whether these people are worth the compensation
they are receiving—perhaps they are worth more or less. An obvious, and
related, issue is the level of compensation paid to professional athletes.
Approaches might be to compare the compensation of the president with the
salary of a managing partner in a comparably sized public accounting or
consulting firm, or to the salary of a senior partner in a law firm.
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9-62 Incentive compensation plans are suitable when employees have the skill and
authority to react to conditions and make decisions, and in organizations
subject to changing conditions. A cash bonus is often related to activities
oriented to short-run performance that should be rewarded immediately to
provide a reinforcement effect. Cash bonuses are best tied to measures of
achieved operating performance such as quality improvement, sales increases,
and success at short-run cost control. These bonuses can be paid to individuals
or groups.
9-63 Incentive compensation plans are suitable when employees have the skill and
authority to react to conditions and make decisions, and in organizations
subject to changing conditions. Profit sharing is used to focus organization
members engaged in team activities to improve the organization’s short-term
performance.
9-64 Incentive compensation plans are suitable when employees have the skill and
authority to react to conditions and make decisions, and in organizations
subject to changing conditions. Gain sharing is best used when there is a visible
and agreed performance standard, and the employees can work as a group to
improve performance relative to that standard.
9-65 Incentive compensation plans are suitable when employees have the skill and
authority to react to conditions and make decisions, and in organizations
subject to changing conditions. Stock options are best used to focus attention of
senior people, who can affect the organization’s long-run performance by their
decisions.
9-66 The car design group is deliberately created to design a car. There is no place
for individual stars in this group—the key is to develop a successful product.
Therefore, the individuals in that group should be evaluated based on their
ability to work as a group to achieve their assigned goals, which should
contribute to the group goal of designing a car. However, the safety
researcher’s job is more individualistic. The more individualistic the effort and
the more that individual talent can affect the outcome of the group, the greater
the potential for individual, rather than group, rewards.
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PROBLEMS
9-67 This question is designed to get students to reflect on the idea that a MACS
reports the results of human action and decision making, and therefore
motivates behavior. If MACS designers do not understand basic elements of
motivation, then the MACS design will be faulty and incomplete.
A brief discussion of the scientific management school of motivation and the
human relations movement is important to set the stage for the human
resources approach. Students should focus their answers on (a) that most (but
not all) people desire to work, (b) that people are now working in complex
information-filled environments, and (c) that people desire to be creative and to
solve problems. If MACS designers focus on out-of-date assumptions about
human motivation and behavior, then the system will be designed
inappropriately in today’s environment. In addition, the major role of control
systems is to motivate behavior congruent with the objectives of an
organization. System designers need to consider the behavioral implications
and consequences of MACS.
9-68 The four major behavioral considerations in MACS design are (1) embedding
the organization’s ethical code of conduct into MACS design, (2) using a mix
of short- and long-term qualitative and quantitative performance measures (or
the balanced scorecard approach), (3) empowering employees to be involved in
decision making and MACS design, and (4) developing an appropriate
incentive system to reward performance.
(1)
The MACS design should incorporate the principles of an organization’s
code of ethical conduct to guide and influence behavior and decision
making as people face ethical dilemmas on the job. Often managers are
subject to intense pressures from their job circumstances and from other
influential organizational members to suspend their ethical judgment in
certain situations. The ethical framework embedded in system design is
extremely important because it will influence the behavior of all users.
(2)
The ways in which organizations and individuals measure performance
sends signals to all employees and stakeholders about what the
organization considers its priorities. If organizations choose performance
measures without careful consideration, then behavior incongruent with
the organization’s goals can occur. The Balanced Scorecard integrates an
appropriate mix of short- and long-term financial and non-financial
performance measures used across the organization, and helps
organizations grapple with their intangible or intellectual assets. The
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Balanced Scorecard is a systematic approach to performance
measurement that translates an organization’s strategy into clear
objectives, measures, and targets.
(3)
Empowering employees in MACS design requires two essential
elements—allowing employees to participate in decision making and
ensuring employees understand the information they are using and
generating. Encouraging participation has a two-fold benefit for
organizations. First, research has suggested that employees who
participate in decision making evince greater feelings of morale and job
satisfaction, as well as commitment to the decision. In many instances,
these heightened feelings translate into increased productivity as
employees begin to feel that they have some ownership and control over
what they do at work. Second, the organization is able to gather
information about improving jobs and processes from the individuals
who are closest to those jobs and processes.
The second critical element of empowering employees is ensuring that
they understand the information they use and on which they are
evaluated. If employees at all levels understand the organization’s
performance measures and the way they are computed, the employees
can take actions that lead to superior performance.
(4)
MACS design involves choosing the most appropriate reward systems to
motivate desired behavior. Although intrinsic rewards are sufficient to
motivate some people to choose behavior consistent with the
organization’s goals, a system of extrinsic rewards often provides
additional motivation for desirable behavior.
9-69 Reasons individuals may feel justified in cheating at golf include the
following:
 It’s only a game.
 My competitors are doing it.
 Everyone does it.
 It does not hurt anyone.
 The ends justify the means.
 They don’t see anything wrong with it.
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There is certainly concern that individuals who cheat at golf are also
likely to cheat in business, as stated by Jeff Harp in the In Practice
materials on cheating at golf. Also in the In Practice materials,
behavioral economist Dan Ariely expressed concern that cheating at golf
reveals attitudes about bending the rules in other arenas. He further
expressed concern that cheating at “small” things could lead to cheating
at larger things and become an accepted practice in business.
9-70 This question is based on a situation described in an article by Andrew W.
Singer, “Can a Company Be Too Ethical?” Across the Board (April 1993), 17–
22 (copyright by The Conference Board). One option is to report nothing about
the packet and revise your bid lower than your competitor’s, with the
expectation that you will have spared jobs and provided a better return to
shareholders. Singer reports the company’s alternative response: The CEO
informed its competitor and the U.S. Government about the packet, and let its
original bid stand. The competitor won the contract. The CEO believed he
made the appropriate decision (that is, not “too ethical”), despite the fulfilled
predictions of lost jobs and reduced profits. The CEO reasoned that his
company’s reputation for ethical behavior would enhance the company’s longrun prospects.
9-71 This type of situation is probably not uncommon. You can confront her again
and ask that she resubmit the report, and encourage her to discuss the
company’s policies on flexible scheduling to accommodate the family
responsibilities she described. If she refuses then, you can tell her that for her
sake and the good of the organization, you will have to tell your boss. Chances
are she will rectify the report.
9-72 This is a thornier situation than that portrayed in some of the earlier questions.
In this situation there is a threat that you, the employee, will lose your job if
you don’t comply. A possible course of action is to not comply and go to your
immediate superior, who in this case is the controller, and ask his/her advice.
The controller may be able to talk to the executive in an indirect manner and
have him back off. In this case the executive may disavow any knowledge of the
incident; however, this still leaves you at risk. Another alternative is to have
your superior go to other more senior management in the firm to describe the
situation. Because you and the executive were the only ones to have the
conversation this becomes a difficult situation. However, once senior
management is alerted to the problem they may be able to monitor the executive
and begin a file of his activities.
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9-73 (a)
Preventive control: Preventive control is usually used in situations
where there is the possibility for the employee’s actions to deliberately or
accidentally cause damage, risk, or loss either to the employee or to the
organization. In preventive control, discretion in performing a task may
be minimized because of the precision required or the nature of the
materials involved. The examples chosen should indicate why preventive
control is appropriate and should clearly illustrate an approach where the
organization is designing the job to try to prevent some undesired
employee behavior.
(b)
Monitoring: Monitoring involves inspecting the work or observing the
behavior of employees while they are performing a task. Monitoring is
most useful in settings similar to those indicating preventive control.
While preventive control focuses on designing the job or the process to
prevent the undesired activity from happening, monitoring relies on
random observation to enforce the operating rules. Therefore, unlike the
preventive control situation, there is no attempt to design the job to avoid
the undesired behavior. The examples chosen should reflect an
appropriate setting for monitoring and should demonstrate an
understanding of the differences between preventive control and
monitoring.
(c)
Results control: Results control is most useful in situations where
employees understand the organization’s objectives and their
contribution to those objectives, and employees deliver a high
component of skill, knowledge, or commitment to their jobs. For results
control to be effective, the organization must clearly define its
objectives, communicate them to appropriate members, and design
performance measures consistent with the objectives. This method does
not directly monitor or control the tasks to be performed, often because it
is difficult to measure the components of what the employee delivers to
the job. The disadvantage of results control is that results can be affected
by circumstances beyond the employee’s control. Therefore, results
control is often conditioned by assessing performance relative to a
standard that reflects the circumstances the employee faced. The
examples chosen should reflect situations where the employee
contributes skill, knowledge, or motivation to the job that cannot be
directly assessed.
9-74 The discussion should focus on examples showing that most employees in
complex work environments perform a variety of tasks. Clearly, not all
performance on all tasks is monitored, but as soon as one begins to consider
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that more qualitative measures such as quality and customer satisfaction are
important, it becomes evident that a mix of measures is appropriate.
It may be useful to come up with examples from different work contexts. You
might consider how to measure the performance of people in the following
jobs:

a used car salesperson

a nurse in a hospital

an auto mechanic

a university professor (this is pretty close to home, however!)

a fund raiser

an insurance underwriter
The discussion can then be focused to what happens at the workgroup level.
With teams or workgroups, performance evaluation becomes more difficult, but
there are qualitative variables such as group morale and satisfaction that should
also be assessed. Issues related to group output measures such as quality and
timeliness are also measurable.
Qualitative divisional measures are harder to determine, but again, the overall
quality and reputation of a product reflects on a division. Customer satisfaction
at this level can also be a sound qualitative measure.
9-75 The competitive characteristics are low price, conformance to specifications,
short cycle times, high quality, good service and on-time delivery. These
objectives are consistent with just-in-time manufacturing systems. Important
performance measures would include: cycle times (including the time taken to
fill a customer order from start to finish, and production time), first-pass yield
(proportion of good items to total items produced at the final inspection
station), number of production system failures, conformance to schedule, cost
per unit, customer satisfaction scores, number of customer complaints and
material yield.
9-76 Both participation in decision making and education to understand information
received in organizations contribute to employee empowerment in MACS
design. The reason is that the MACS is the central information system in most
organizations. Like all information systems, its benefits are a direct function of
the quality of the information contained in it, and whether employees find it
useful for decision making. Asking for input about system design and the kinds
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of information that should be generated from the system from those employees
who work with a MACS on a routine basis (and in some cases even for those
who only use the system on a limited basis) has several effects. First, the
system is updated with information that comes from employees who are closest
to their jobs and hence know what information they need. Second, through
participation employees will feel that they are having a direct effect on their
work environment and this could increase their motivation and morale. Third,
the organization as a whole benefits because it is able to obtain the most up-todate information and at the same time potentially increase motivation for its
employees to perform. The situation that organizations want to avoid is one in
which uninformed people design the information system without really
understanding the information needs of employees. When this occurs,
employees believe that the system is useless and begin to develop their own
private information systems to get their work done and gauge their
performance. Clearly, if many employees are developing their own systems,
there is little coordination throughout the organization regarding information,
and a formal system is largely ineffective.
In order for a MACS to function well, employees must be constantly reeducated as the system and its performance measures change. If employees
understand the organization’s current performance measures and the way they
are computed, the employees can take actions, resulting in superior
performance measurements that lead to intrinsic and extrinsic rewards for
employees, and achievement of the organization’s goals.
9-77 (a) This form of budgeting is called consultative.
(b) The pros of consultative budgeting are that the organization can gather
information from subordinate managers about their local operations. Local
managers have more insight and experience than those far from the
operation. Some organizations hope that allowing subordinates input in the
budgeting process will increase their motivation to achieve the budget.
Other advantages are that it is quicker than participative budgeting and
participative budgeting may be impractical.
On the con side, the superior has the final say on the level at which the
budget is set. In some situations, the final budget may be far from where the
subordinate manager thought it should be. In this case, employees morale
and commitment will decline. In the worst case, the superior has no
intention of using the subordinate’s input. This form of consultation is
called pseudo-participation and can have very negative effects on the
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subordinate’s morale if he or she finds out the entire procedure was a
charade.
9-78 In participative budgeting, budgets are set jointly between superior and
subordinate managers. This means that both parties negotiate the budget and
once both parties leave the negotiating table, what has been decided will stand.
Participative budgeting has many advantages, such as allowing superiors to
obtain the subordinate manager’s information about local conditions, and
increasing the subordinate manager’s commitment and motivation to achieve
the budget. In some very large firms with many managers and many budgets,
participation of this kind may be impractical given the time and energy
involved in meeting with each manager.
Setting budgets authoritatively is very efficient. Senior management can
simply determine by fiat what each subordinate manager’s budget will be. This
may be the most appropriate method if subordinate managers are not very
knowledgeable about the budgetary process or if the organization is simply
trying to save time and the resources involved with the other two types of
budget-setting methods. The disadvantage of setting budgets in an authoritarian
manner is that subordinate managers have very little ownership of the budget,
since they were not involved in any way with setting the budget. This lack of
ownership could lead to decreased motivation to achieve the budget. Further,
managers never really learn about the budgeting process and will always be left
in the dark. Finally, the organization misses out on the insight and information
about local operations that subordinate managers may have.
When budgets are set via consultation, the organization is attempting to gather
information from subordinate managers about their local operations. The idea
is that local managers have more insight and experience than those not close to
the operation. The organization is also hoping that allowing subordinates input
will increase their motivation to achieve the budget. The concern with
consultation is that the superior has the final say on the level at which the
budget is set. In many cases the final budget may not be close to where the
subordinate manager thought it should be. In the worst case, the superior has no
intention of using the subordinate’s input. This form of consultation is called
pseudo participation and can have very negative effects on the subordinate’s
morale if he or she finds out the entire procedure was a charade.
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9-79 (a) The motivation of the sales group is to understate their sales estimates in
order to increase their expected sales commission.
(b) The organization’s budgets will understate sales. If capacity is planned
based on understated sales, then capacity will be too low and the
organization will continuously be using overtime to meet demand.
(c) The need is to develop a scheme that eliminates the motivation of the sales
force to understate their sales expectations. The idea would be to decouple
the sales estimates and the sales targets. One approach would be to
eliminate the sales commission—however, this is likely not a choice that
would be considered seriously. Another possibility is to base sales estimates
on historical trends. The organization might undertake to link industry sales
to demographic or economic indicators in order to end the reliance on sales
force forecasts. Another approach would be to reward the sales person for
two things: (1) the accuracy of the estimate and (2) the level of sales.
9-80 Woody is engaging in the process of building slack into his budget. Many
believe that this is a “rational” thing for Woody to do to protect himself from
any kinds of uncertainties in the environment that he might face. For example,
if his key source of raw materials dries up and Woody has to find an alternative
source which, on short notice, will cost him three times his usual costs, extra
money in the budget will allow him to purchase the materials. Having those
excess resources may also allow him to achieve his production goals without
exceeding his budget. Of course, if everyone in Woody’s organization pads his
or her budget, the organization will be run very inefficiently and ineffectively.
One way for the organization to reduce slack building is to modify the way that
it evaluates Woody and his fellow manager’s performance. If, in the past, harsh
penalties have been levied on those who did not achieve their budgets, then
slack building behavior will be encouraged. Instead, the organization may
determine performance schemes that reduce the pressure to meet the budget, by
providing a 5% or 10% confidence interval around the actual level of the
budget. If a manager falls in this range, then he or she is not penalized. Or, a
system can be set up that is based on multi-year performance in which a
manager is not evaluated just on one year, but over several years. Thus, if a
manager does not meet the budget in one year, but does well in the others, he or
she is not penalized. Either of these approaches may reduce the amount of slack
that Woody would be inclined to build into his budget.
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9-81 Tying pay to performance has taken hold of U.S. business. Some believe that
paying a good, fair salary should be motivating enough, and that using pay-forperformance sends the wrong signal to employees. That is, such incentive
schemes signal that employees will only do their best work if they get a bonus.
Others believe that it is psychologically more motivating to link pay to
performance. Some organizations that use pay-for-performance compensation
pay employees a lower flat wage than other non-pay-for-performance firms and
then add a bonus that brings up the total compensation package to be
approximately equal to the non-pay-for-performance firm.
A possible disadvantage of tying pay to performance is that employees may
focus only on the item(s) used to determine the bonus, leading to dysfunctional
behavior as employees lose sight of what is best for the organization.
Furthermore, employees may give little attention to qualitative factors and they
may focus only on short-term goals.
9-82
Organization
Unit
Symphony orchestra
Government welfare
office
Airline
complaint desk
Control room in a
nuclear-generating
facility
Basketball
team
What Behavior Should
What Is an Appropriate
Be Rewarded?
Incentive System?
Number of tickets sold,
Market wage plus profit-share
Group-oriented performance
Number of cases processed, Market wage plus
Success in helping clients performance-related bonus
Customer
Market wage plus
satisfaction
performance-related bonus
Operating equipment
Market wage
as required
Individual performance
for some players plus
team success
Wage plus performancerelated bonus
9-83 This is a practical question designed to put the student in a situation of
managing a business where employees cannot be supervised directly and have a
strong impact on repeat sales. The dilemma is that the jobs are relatively low
skilled (although the job is manual and quickly learned, there are important
skills relating to dealing with customers) and the economics of the competition
do not allow this organization to use higher wages to attract and keep
motivated employees.
Most responses will suggest some type of profit sharing system where the
employees are paid a market wage to attract them to the organization and then a
profit share to motivate them to do their work conscientiously and to develop
their people skills. Note that it is the customer, not the company, that absorbs
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the unfavorable labor efficiency variance under the current pricing scheme
since the customer pays for hours worked. This may have an unfavorable effect
on the organization by causing higher prices and losing customers.
The company might consider moving to a charge that is based on work done
rather than time worked. This would provide the opportunity of shielding the
customer from unfavorable labor efficiency variances and allow the use of a
gain sharing type of plan that pays workers bonuses based on their ability to
beat time targets for the individual jobs. However, if this approach was used it
would be critical to use customer satisfaction surveys to ensure that quality is
not being sacrificed to beat the time targets. The company might offer a bonus
after a given number of days of employment to increase the retention of good
employees. The company might also offer a bonus for very satisfied customers
identified through surveys.
9-84 (a)
This is a deep issue that plagues all research and development activities
in profit seeking organizations. The question is how to draw the line
between letting people do research that is so basic that it may never
result in profitable patents but, if it does, may represent a profound
competitive advantage, and other research that is totally oriented to
developing profitable products. The key is that the organization must
develop a policy which states that no more than a certain proportion of
the research and development activity can be devoted to basic research
(that is research that is not devoted to developing any product in
particular but may pay off in some unspecified way). The key is to
debate and establish that proportion.
There does appear to be a problem at the moment. If we define research
and development productivity as the rate of new product introduction
divided by the expenditures on research and development, this
organization is not doing well. In the long-term, competitive pressures
will not allow this organization to continue in this way.
(b)
The focus will be on identifying market opportunities and directing the
attention of the research staff toward meeting these opportunities. A
share of the income provided by a new product could be paid to people
who develop that product. The compensation plan needs to be changed.
Currently, scientists are rewarded based on their level of education and
the number of research papers published in scientific journals. The
number of research papers published should be dropped as a
performance metric. Compensation should be tied to the number of new
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prototypes developed, the number of new products developed, or the
number of patentable inventions.
9-85 (a)
Some obvious positive points: this plan is very specific, it focuses on
profit performance, it rewards group performance, and it can be adjusted
for good or bad conditions that the organization members cannot control.
(b)
Some obvious concerns: profit performance is a short-run performance
measure and there is no discussion of how the pool proceeds are
distributed to individual employees. Like all group incentives, this plan
suffers from the problem of people who do not do a good job pulling
down those that do. The upper limit will encourage people to pull back
their effort if they believe the organization performance is approaching
the upper limit. Also, employees may have somewhat limited ability to
control earnings from operations if external economic factors play a
large role in earnings.
(c)
(d)
9-86 (a)
 332  320 
4% + 3% × 
= 4.51428%
 390  320 
Profit-sharing pool = 4.51428% × $332,000,000 = $14,987,410
(rounded)
Tightening standards every period reduces the motivational effects of
this system. This is because process improvements provide benefits for
fewer periods than if standards remain the same. Perhaps the plan should
only tighten the standards every 3 years.
Profit sharing pool 
lower of [45,000,000 – (100,000,000 × 18%)] × 40% or 7,000,000 =
lower of (45,000,000 – 18,000,000) × 40% or 7,000,000 =
lower of 27,000,000 × 40% or 7,000,000 =
lower of 10,800,000 or 7,000,000
Profit sharing pool  $7,000,000
(b)
68,000
25,000,000
Marg Watson’s bonus  7,000,000  0.00272
Marg Watson’s bonus  $19,040
Marg Watson’s bonus  7,000,000 
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(c)
This profit sharing plan is specific and has justifiable economic
properties. The target profit level probably is intended to provide the
required return to shareholders and is desirable.
(d)
The plan pays nothing unless a certain level is achieved. This may be
unfair when times are bad. That is, with severely depressed economic
conditions, the employees may do a good job and earn no bonuses. It is
not good enough to say that if the owners do not do well the employees
should not do well. It is not the role of employees to bear this type of
risk. Their job is to do the best they can under the conditions that they
find. This is an undesirable feature of all profit-sharing plans.
The choice of 18% should reflect the return available to shareholders for
comparable investments—the shareholders’ required rate of return. The
required rate of return is likely to be lower; therefore the 18% is too high
and should be adjusted downward.
Basing the profit share on salary rather than performance assumes that
the employee’s contribution is proportional to salary. While this makes
the plan easy to administer, it does not tie the reward to the performance
level. A more appropriate approach would set performance targets for the
individual and base the individual’s share of the total bonus pool on
achievement of the performance targets.
The upper limit of $7,000,000 is desirable from the perspective of the
shareholders but dampens motivation from the perspective of the
employees. That is, when performance reaches the level where the bonus
pool is $7,000,000 the employees may slack off.
The 40% profit share seems a bit low. Some plans are as high as 50%. It
is difficult to say but the lower proportion may dampen the motivational
effect of the plan. Furthermore, the individuals considered may have
limited ability to control earnings.
9-87 (a)
Target hours
= (0.2  200,000) + (0.15  220,000) + (0.25  130,000) +
(0.1  240,000) = 129,500 hours
Savings  (target hours – actual hours)  wage rate
Savings = (129,500 – 110,000)  $16 = $312,000
Gain share = $312,000  50% = $156,000
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(b)
It is clear and it is based on something that the employees can control
directly. A gain share of 50% of the savings seems reasonable.
(c)
It is not clear whether this amount is substantial enough to have any
motivational effect on the employees. If the bonus is shared equally
among the workers, the bonus amounts to about 8.9% ($156,000 
[110,000 × $16]) of wages paid. The employees may or may not find this
a strong motivator.
9-88 (a)
The Scanlon plan base ratio would be determined as follows
payroll costs
3,000,000
Base ratio 

 0.06
value of production 50,000,000
The quarterly amounts accumulated in the plan are shown in the
following table.
Quarter
1
2
3
4
Ratio
Plan Change
Cumulative
2,475,000
 0.055 45,000,000 × (0.060 – 0.055) = $225,000 $225,000
45,000,000
3,480,000
60,000,000
 0.058 60,000,000 × (0.060 – 0.058) = $120,000
 0.065 55,000,000 × (0.060 – 0.065) =
($275,000)
55,000,000
3,575,000
2,832,000
48,000,000
 0.059 48,000,000 × (0.060 – 0.059) = $48,000
$345,000
$70,000
$118,000
Therefore the amount available to be distributed to the employees at the
end of the year would be 35% of $118,000 or $41,300.
(b)
The Scanlon plan assumes that the payroll costs are highly variable. This
was likely true in the 1930s when the plan was originally proposed.
However, in today’s conditions many labor costs are essentially fixed
and may be very difficult to change in response to short-term
fluctuations in demand. The plan also assumes labor costs decrease over
time if labor efficiency increases, which may not be true in a highly
unionized setting. The plan also assumes that declines in labor costs are
due to labor efficiencies, which may not be true. The company may be
experiencing layoffs or production downturns.
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(c)
The Scanlon plan assumes employee participation and group effort.
Therefore, a reasonable proposal is to divide the distribution equally
among the employees covered by the plan. An alternative in a small
group, where all the employees know each other, would be to have the
employees vote on the distribution in a private ballot by ranking each
member’s contribution.
(d)
Under this approach, the base ratio for the following year would be
0.055, the ratio experienced in quarter 1. This is called the ratchet effect.
Its result is to quickly tax away any innovations that the employees
develop so that they experience no long-term benefit from their
innovations. This quickly dampens enthusiasm for, and the motivational
effect of, the plan. To avoid this, the base ratio should hold over a longer
period of time, perhaps three years, unless there is a system change, such
as new equipment, that creates a new standard for the base ratio.
9-89 (a)
Speeding up production was supposed to increase productivity and lower
costs—thereby making the company more cost competitive. Speeding up
production also allowed workers to meet shipping schedules.
(b)
Middle managers sacrificed quality for conformance to the directive to
speed things up. Many motorcycles were shipped with known defects
that the production people expected the dealers to repair.
(c)
The result was that the quality of the motorcycles declined and customers
began to move away from this company.
(d)
The system was modified by instructing the employees that the
organization was committed to quality and that no motorcycle was to be
shipped with any known defect. Front-line employees were given the
authority to stop the production line whenever they saw a quality
problem. This got the message to all employees and customers that
Harley-Davidson had changed; both quality and efficiency were now
important.
9-90 Denver Jack’s approach does not allow for participation on the part of
employees. Thus, he is losing many good ideas and probably stifling the
motivation of his employees. Further, Denver Jack is not getting the employee
buy-in from which he would benefit. On the other hand, some believe that a
top-down approach to decision making is efficient and does not tie up scarce
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human resources. Each kind of organization must decide what approach or
combination of approaches is the most appropriate for its purposes.
9-91 This incentive compensation plan seems to meet the most important
characteristics of effective incentive compensation plans. It clearly
distinguishes between wages and incentive compensation and does not attempt
to replace wages with incentive compensation.
The plan is precise in terms of what it rewards on the two elements of
performance—shorter-term performance measures that are subject to cash
bonuses (presumably these performance measures would relate to the
organization’s key success factors) and longer-term measures of performance
determined by share prices.
The stock price component of the plan has a time frame that is long enough to
promote a longer-term decision-making perspective, but short enough to
support the reinforcement effect of rewards. In order to distinguish between
market and executive effects on share prices, the longer-term plan could be
adjusted to eliminate market-wide effects by basing rewards on performance
relative to a peer group.
A key characteristic of the plan is that it relies heavily on decisions made by
independent outsiders. This improves the ethics associated with the
administration and operation of this plan.
9-92 (a)
This change is inconsistent with the idea that compensation should have
a fixed and a variable component and that the fixed component should
reflect the market opportunity.
(b)
The employees would likely complain about the risk imposed on them by
the new system. The employees would also now be unwilling to
undertake any activities that do not relate directly to earning a
commission.
(c)
Given the approach of all compensation being commission based taken,
an argument can be made that it is reasonable to set the commission so
that the wage bill would have been the same under the previous and new
systems. This approach seems to leave the workers equally well off
under the two systems. However, economic theory supports a position
that risk-averse workers must be compensated for bearing more risk
under the new system if they are to be equally well off in expected
utility. Thus, a different and better approach might to maintain a wage
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
and to provide motivation through a much lower rate of commission than
the new system uses.
(d)
The top employees will likely stay since their income will increase. The
weaker sales people will likely leave to find jobs where the income is not
so risky. In general, this system will tend to attract high-pressure sales
people who are sales-oriented and who will be unwilling to do anything
not directly related to earning commissions. The company will have to
decide if this is what it wants. The system rewards only one aspect of
employees’ behavior, which could be detrimental to the company. In
addition, employees may resort to data falsification and gaming in order
to increase their income.
9-93 (a)
This incentive scheme, which is traditional in government, is
inappropriate. It promotes building up staff without regard to the true
need for staff dictated by legislative initiatives and legitimate client
needs. It also promotes inefficiency among her subordinates; the longer
they work (perhaps due to inefficiencies), the more she gets paid.
(b)
The performance measurement scheme should reward the ability to
achieve outcome targets defined by client requirements that the
government is committed to meeting. Labor efficiency measures should
be put in place. Examples include number of claims processed by each
employee per day, client wait time for in-office visits, and number of
claims denied by each employee per day. Possible qualitative measures
include client satisfaction and number of client complaints per day.
9-94 (a)
Based on salary—easy to administer, likely to be considered fair and, to
the extent that salary reflects the relative ability to contribute to results,
is based on contribution; based on equal share—easy to administer,
likely to be considered fair and reflects how people often divide up
rewards when left to their own devices; based on position—same as
based on salary; based on individual performance—ties reward most
closely to performance and likely to have the highest motivational
impact.
(b)
Based on salary—may convince lower level employees that they have
little to contribute, does not necessarily reflect contributions; based on
equal share—may have little motivational effect, may lead to feelings of
inequity if some people contribute nothing; based on position—same as
based on salary; based on individual performance—may be difficult
and costly to administer, may lead to arguments about interpreting the
performance measure.
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(c)
The choice should be reasoned. The response should identify the
objective of compensation (to support the achievement of organization
goals) and the individual’s understanding of how rewards motivate
people. Any response is acceptable as long as it clearly reflects that the
goal is to promote achievement of organization performance and that the
reward design must reflect the belief of how rewards motivate individual
behavior.
CASES
9-95 Anne Wu should proceed carefully.
(a)
Anne Wu should approach this issue with Judy Choy by stressing that
the fast pace of work that is currently underway is contributing to the
10% error rate. As errors increase, the cost of correcting them increases.
There are probably other reasons for the 10% error rate and these reasons
need to be investigated before a faster pace of work is demanded.
(b)
The organization seems to be stressing quantitative information (volume
of claims processed) and not really focusing on quality (error-free work)
and customer satisfaction—both extremely important qualitative factors.
(c)
The organization should use a mixture of quantitative and qualitative
measures. Output per claims examiner is an important indicator, but so is
the error rate per examiner. The organization should also assess the
number of refiled claims per examiner as a way to help build quality into
the examiner’s work.
9-96 This response describes what is reported about Sherron Watkins’s experiences
at Enron. Numbers in square brackets refer to the references listed at the end of
the responses for this case.
(a)
Watkins discovered problems in the summer of 2001, while working on
an assignment for Andrew Fastow, who was then Enron’s chief financial
officer. Watkins was tasked with estimating the economic effect of
potential sales of some of Enron’s assets. In conjunction with this task,
Watkins evaluated each asset’s estimated book value and market value.
She stated the following [2]:
A number of assets were hedged with an entity called
Raptor. Any asset that was hedged should, for the most part,
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
have a locked-in sales value for Enron, meaning that despite
current market prices, Enron should realize the hedged price
of the Raptor.
It was my understanding that the Raptor special-purpose
entities were owned by LJM, a partnership run by Mr.
Fastow. In completing my work, certain Enron business
units provided me with analyses that showed certain of the
hedged losses that had been incurred by Raptor were
actually coming back to Enron. … the Raptor hedge had
declined in value such that Raptor would have a shortfall
and would be unable to fully cover the hedge price that it
owed Enron.
I was highly alarmed by the information I was receiving. My
understanding as an accountant is that a company could
never use its own stock to generate a gain or avoid a loss on
its income statement. I continued to ask questions and seek
answers, primarily from former co-workers in the global
finance group or in the business units that had hedged assets
with Raptor. I never heard reassuring explanations.
Watkins’s response is summarized in [4].
According to [5], Cooper’s trail of discovery began when an executive
told her that “corporate accounting had taken $400 million out of his
reserve account and used it to boost WorldCom’s income.” Despite
reassurances from audit firm Arthur Andersen and CFO Scott Sullivan,
as well as hostility from Sullivan, Cooper led her internal audit team to
eventually discover that the firm had capitalized billions of dollars of
expenditures that should have been expensed.
(b)
Watkins appears to have considered or attempted to implement options 1
or 4. Option 1 is to point out the discrepancy to a superior and refuse to
act unethically, understanding that this may lead to dismissal. When
Watkins became aware of the accounting problems at Enron, she did not
want to challenge Fastow or then-CEO Jeffrey Skilling about the
problems until she had another job lined up, because it would have been
“a job-terminating move” [2]. She interviewed for a position at Reliant
Energy and planned to “sign a new job contract and confront Skilling on
her last day at Enron” [4]. When Skilling suddenly resigned on August
14, 2001, the new CEO, Kenneth Lay, invited all employees to submit
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Atkinson, Solutions Manual t/a Management Accounting, 6E
questions for an August 16 meeting at which Lay would talk about
Skilling’s resignation. Watkins submitted to Lay an anonymous letter
with the statement, “I am incredibly nervous that we will implode in a
wave of accounting scandals” [4]. On August 16, Watkins discussed her
memo with Cindy Olson, then vice president for human resources. Upon
Olson’s advice Watkins arranged to meet with Lay personally, on August
22. Watkins prepared a memo detailing her concerns. She included the
following quote from a manager-level employee: “…I wish we would get
caught. We are such a crooked company” [2, 6 (p. 367)]. Watkins hoped
that after the first memo, “the company would act on her suggestions,
come clean, and avert disaster” [6, p. 321]. After Watkins met with Lay,
he promised follow up on Watkins’s concerns. Watkins asked to be
transferred from Fastow’s group. Thus, after Skilling’s resignation,
Watkins appears to have been following option 4: Work with respected
leaders in the organization to change the discrepancy between practiced
and stated ethics.
Watkins’s memos became public because her memos were part of the
many, many documents subpoenaed by the House Committee on Energy
and Commerce. Watkins and her memos became national news [6, pp.
345-347]. Reference [3] states that a congressional subcommittee
investigating Enron’s collapse released Watkins’ “letter to chairman
Kenneth Lay … warning him that the company’s methods of accounting
were improper”.
Cooper also attempted to implement options 1 and 4. She approached the
company’s audit firm, Arthur Andersen, and CFO Scott Sullivan about
the troublesome accounting issue. Reference [5] reports that Cooper
received assurances from Arthur Andersen; she was so concerned about
Sullivan’s angry response that she felt her job was at risk. After weeks of
investigation, Cooper ’s team confirmed that the firm had capitalized
billions of dollars of expenditures that should have been expensed. At
Sullivan’s request, Cooper explained what her team had found. Cooper
then conveyed her findings to the head of the audit committee, and to the
company’s controller, David Myers.
(c)
As stated in part (b), Watkins certainly felt pressured not to challenge
Fastow and Skilling, regardless of the issue. Her information raised
serious concerns about extremely serious accounting improprieties, and
conflicts of interest for Fastow. If Watkins dropped her concerns,
Enron’s executives and employees would benefit in the short term until it
became impossible to hide the wrongdoings.
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
Similarly, Cooper felt great pressure not to challenge CFO Sullivan. Her
information raised serious concerns about accounting improprieties that
the CFO and the company’s controller were aware of. And, similar to
Watkins’s situation, many felt that if Cooper dropped her concerns,
WorldCom’s executives and employees in Enron would benefit in the
short term, and some felt that the company might eventually turn itself
around financially.
(d)
Enron’s 2000 on-line annual report lists four key values: communication,
respect, integrity, and excellence [7]. Enron distributed illustrated
booklets listing these four values [6, p. 103], and Skilling and Lay
narrated a video discussing the four values. The video was given to all
employees [6, p. 104]. Nevertheless, top management did not
consistently demonstrate the stated values. When Watkins, Cooper, and
Rowley were asked why others did not do what these three did, they
agreed that it was “the value system at the top” [1]. For example, Lay
demonstrated lack of ethical leadership by insisting that Enron
employees use his sister’s travel agency [6, p. 36].
A job satisfaction survey at Enron in the mid-1990s revealed that many
people felt uneasy about expressing their opinions at Enron. Lay and
Skilling promised corrective action. Consistent with this, the company
distributed stick-note pads with this quote from Martin Luther King, Jr.:
“Our lives begin to end the day we become silent about things that
matter” [4]. In contrast to management’s official position encouraging
people to speak up about important matters, Watkins discovered that
very shortly after she met with Lay to discuss her concerns, Enron’s
lawyers provided information to management about legal issues related
to firing whistleblowers [4]. Watkins discovered this in February 2002.
She commented, “There’s nothing in there to remind them to remember
the code of conduct, the vision and values” [4].
According to [8], WorldCom CEO Bernie Ebbers and CFO Scott
Sullivan were “celebrated leaders” Sullivan had a “reputation of
impeccable integrity.” Their reputations apparently provided reassurance
to most employees when Ebbers and Sullivan made it clear that
employees should not question WorldCom practices. Also according to
[8], loyalty by employees and the Board of Directors was well
compensated, so that neither group had incentives to confront the leaders
on questionable practices.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
(e)
The Time interviewers described the three persons of the year as follows
[3]:
… none of them are rebels in the usual sense. The truest of true
believers is more like it, ever faithful to the idea that where
they worked was a place that served the wider world in some
important way.
Cooper explicitly mentioned “values and ethics that you learn through
your life” [1] and Rowley and Watkins appear to agree. In other
interview statements, Watkins refers to Johnson & Johnson doing the
right thing in response to the Tylenol scare [1]. After her meeting with
Lay to discuss the problems she had uncovered, Watkins felt that she had
“done the hardest thing in my life, but I had carried the torch and
dropped it off” [4]. Reference [4] describes Watkins as independent and
known for openly stating her opinions and being able to support them.
(f)
As mentioned in (d), Watkins discovered that very shortly after she met
with Lay to discuss her concerns, Enron’s lawyers explored the
ramifications of firing her in relation to whistle blowing [4]. Her hard
drive was seized, she was forced to move from her executive suite to a
plain office, and given work of little substance [4]. She feared for her
safety [4].
At WorldCom, employees were expected not to question the company’s
practices (see part (d)), and Cooper personally felt Sullivan’s hostility
(see part (a)). Cooper suffered great stress. Following the resulting
shakeup at WorldCom, Cooper suffered ostracism from some employees
and no senior executive at WorldCom thanked her for uncovering the
accounting impropriety [8].
(g)
This question is designed to challenge students to think about and
discuss how they will make ethical decisions, especially in the face of
severe personal consequences. In addition, students may propose other
courses of action that Watkins could have taken. For example, some
former Enron employees think Watkins should have informed the
Securities and Exchange Commission [4]. Watkins said that in
retrospect, she would have gone to the board [1].
[1]
Anonymous. “The Interview,”
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
http://www.time.com/time/personoftheyear/2002/poyqa.html, posted
December 22, 2002; 4:31 A.M. EST. Print version: New York:Time.
December 30, 2002-January 6, 2003, Vol. 160, Iss. 27; p. 58.
[2]
Anonymous. “Enron’s Many Strands; ‘Lone Voice’: Excerpts from
the Testimony of Executive Who Challenged Enron,” The New York
Times (February 15, 2002), Late Edition—Final, Section C, Page 7,
Column 1, Business/Financial Desk.
[3]
Lacayo, R. and A. Ripley. “Persons of the Year,” New York: Time.
December 30, 2002–January 6, 2003, Vol. 160, Iss. 27; p. 32.
[4]
Morse, J. and A. Bower. “The Party Crasher,”
http://www.time.com/time/magazine/article/0,9171,1003992,00.ht
ml, accessed February 5, 2011. Formerly at
http://www.time.com/time/personoftheyear/2002/poywatkins.html,
posted December 22, 2002; 4:31 A.M. EST. Print version: New
York: Time. December 30, 2002-January 6, 2003, Vol. 160, Iss.
27; p. 53.
[5]
Ripley, A. “The Night Detective,”
http://www.time.com/time/magazine/article/0,9171,1003990,00.ht
ml, accessed February 5, 2011. Formerly at
http://www.time.com/time/personoftheyear/2002/poycooper.html,
posted December 22, 2002; 4:31 A.M. EST. Print version: New
York: Time. December 30, 2002-January 6, 2003, Vol. 160, Iss.
27.
[6]
Swartz, M. and S. Watkins. Power Failure: The Inside Story of the
Collapse of ENRON. New York:Doubleday, 2003.
[7]
http://www.enron.com/corp/investors/annuals/2000/ourvalues.html,
viewed February 15, 2003.
[8]
Zekany, K., L. Braun, and Z. Warder. 2004. “Behind Closed Doors
at WorldCom,” Issues in Accounting Education, 19, 101-117.
9-97 See the solutions for Case 2-48.
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Atkinson, Solutions Manual t/a Management Accounting, 6E
9-98 Citibank Performance Evaluation, Harvard Business School Case (HBS Case
No. 9-198-048, teaching note No. 5-199-0471).
In the solutions here, notes are first provided for the textbook case questions,
followed by the published HBS teaching note.
Textbook case questions:
(a) Why has Citibank introduced its Performance Scorecard? What benefits
does Citibank expect the Performance Scorecard to provide?
As stated at the end of the first paragraph in the case, “… last year, the
California Division of Citibank had introduced a new performance
scorecard to highlight the importance of a diverse set of measures in
achieving the strategic goals of the division.” Also see the first three
paragraphs of the section titled “New Performance Scorecard.”
(b) What cause-and-effect linkages are implied in the Performance
Scorecard?
See TN-4 and the related teaching note discussion.
(c) What characteristics are desirable for measures used to evaluate and
reward performance? Discuss the Performance Scorecard’s measures in
relation to the characteristics you identified.
See TN-5 and the related teaching note discussion of characteristics such
as alignment with strategy, measurability, objectivity, completeness, and
linkage to value.
(d) Assume that you are Lisa Johnson. Complete Exhibit 1 to evaluate
James’s performance and explain your rationale for your rating on each
of the six dimensions and the overall evaluation.
1
Copyright © 1999 by the President and Fellows of Harvard College. Harvard Business School. This
note was prepared by Professor Robert Simons and Professor Antonio Dávila at IESE for the sole
purpose of aiding classroom instructors in the use of Citibank: Performance Evaluation, HBS No.
198-048. It provides analysis and questions that are intended to present alternative approaches to
deepening students’ comprehension of business issues and energizing classroom discussion.
Reprinted by permission of Harvard Business School.
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
See the teaching note discussion, beginning with the section titled
“Performance evaluation.”
Harvard Business School Teaching Note
Teaching Objectives
This case presents the costs and benefits of using multiple performance
measures to evaluate performance. The issues presented in the case include:
 Introducing a performance scorecard as a diagnostic system to implement
intended strategy.
 Evaluating the pros and cons of using a performance scorecard to evaluate
and reward performance.
 Identifying the characteristics of a good measure.
 Discussing the benefits and costs of using a subjective performance
evaluation.
Case Synopsis
The top management team of Citibank California is meeting to review the
performance of the bank’s branch managers and decide their bonuses. James
McGaran is next in the review process. The committee and students must
decide whether to give him an “above par” rating (with a bonus of 30% of his
salary), a “par” rating (with a 15% bonus) or a “below par” rating (with no
bonus).
James McGaran is the manager of the most important and toughest branch in
the Los Angeles area. His financial performance has been impressive since he
took charge of the branch in 1992. In 1996, his financial performance was,
again, outstanding, well above the targets defined by top management. But in
1996 Citibank introduced a performance scorecard including financial as well
as non-financial measures. Customer satisfaction was among the non-financial
measures used as leading indicators of future financial performance.
Unfortunately, James’ branch scored “below par” in customer satisfaction and,
according to established policies, he should receive, at most, an overall “par”
rating.
However, Lisa Johnson, his supervisor, is not convinced that a “par” rating
would fairly reward James’ effort. Some of the services measured in customer
satisfaction are not under James’ control including phone banking and ATM
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Atkinson, Solutions Manual t/a Management Accounting, 6E
services. Moreover, James would perceive a “par” rating as unfair because of
the difficulty in managing his branch, the excellent financials, and the
limitations that he perceived in the customer satisfaction measure. On the other
hand, this decision will be closely watched by the rest of the division as a test
of the new performance evaluation system.
Assignment Questions
1. Why has Citibank introduced a Performance Scorecard?
2. Assume that you are Lisa Johnson. Complete Exhibit 9-2 to evaluate
James’ performance.
Case Theory and Background
For background reading that describes the concepts and theory illustrated in
this case, see Robert Simons, Performance Measurement & Control Systems
for Implementing Strategy, Prentice Hall (2000), Chapters 9 and 10.
The case can be used to address several theoretical issues. James’ performance
in terms of customer satisfaction is a good setting to discuss the characteristics
of a measure. The discussion naturally evolves around the issues of
controllability and information content of a measure, reliability of a measure,
and the advantages and limitations of objective and subjective measures.
Citibank’s performance scorecard provides an excellent setting to evaluate the
advantages and disadvantages of using financial as well as non-financial
measures to communicate strategy and evaluate performance. The implicit
assumption when using non-financial indicators is the existence of a business
model that relates these non-financial measures to value creation. Through the
discussion, students can be asked to visualize the model used by top managers
at Citibank and assess its adequacy to implement the intended strategy.
Finally, the case presents a rich setting to explore issues around performance
evaluation and economic incentives. The evaluation process at Citibank
includes a target setting process, the use of financial, non-financial, subjective,
and objective measures, and objective and subjective performance evaluation
criteria. Each of these issues are useful to present concepts related to profit
planning and budgeting, measurement theory, performance evaluation, and
design of economic incentive systems.
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
Pedagogy
This case illustrates the tensions that emerge when the performance
measurement system is expanded to include measures beyond financial results.
Non-financial measures communicate the organization’s strategy but, at the
same time, remove autonomy from the people in contact with the customer who
have to work with the additional constraints imposed by the new non-financial
goals.
Strategy and structure
Before discussing James’ performance, it is a good idea to describe the strategy
and structure of Citibank California to have the important actors and their
objectives in the blackboard.
Citibank’s strategy can be described as: “build a profitable franchise by
providing relationship banking combined with a high level of service to its
customers.” Whereby “high level of service”, management means:
*
*
Careful personal attention and
A broad selection of financial products.
Exhibit TN-1 presents the relevant organizational structure.
Performance evaluation
After this brief introduction, the discussion can shift to evaluation of James’
performance where the tension of the case resides. In particular, students have
strong opinions on how Citibank measures customer satisfaction.
The discussion can start with the following question: “How would you have
rated James’ performance before the Performance Scorecard was used?”
Undoubtedly, his financials are impressive and it is very likely that he would
have gotten an above par rating which includes a 30% bonus and the prestige
associated with recognizing his accomplishments in the toughest branch of the
California region.
Next, the instructor can ask, “How do you rate James’ performance in each of
the five perspectives of Citibank’s performance scorecard?”
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In answering this question, the instructor should leave customer satisfaction
until the other five perspectives have been discussed. Most students will agree
that he deserves an above par rating in all of the perspectives (except for
customer satisfaction) because he performed above target. James’ impressive
performance can be emphasized by taking a close look at the financial
perspective where targets had been increasing throughout the period and James
over-performed every time. As a summary of James’ performance we can say:
In the financial perspective he was impressive: 16% over budget [for revenue]
in addition to a target that kept on moving up over time.
In strategy implementation he was above par in all quarters but one (the first
one). This is the only other perspective where some students may argue that the
performance was not that good. Usually, these students have decided to give
James a “par” rating and are looking for additional arguments to reinforce their
decision. But, the rest of the class will tend to dismiss this assessment.
In control he has been rated above par in all rated quarters.
In people, where Lisa has discretion to judge performance, James received an
above par in every single quarter.
Same for standards, were Lisa again showed her appreciation for James’ work.
While students discuss the various measures and dimensions of the
performance scorecard, it is helpful to build Exhibit TN-2 on one of the
blackboards and ask about the nature of each measure: is this an objective or a
subjective measure?” While standards and people are subjective measures,
control and customer satisfaction are less so, and strategy implementation and
financial are the most objective (if we accept the “objectivity” of accounting).
Certainly, leaving aside customer satisfaction, James would have gotten an
above par rating and full bonus as he did in previous years. But:
“How did James perform in terms of customer satisfaction?” (see Exhibit TN3).
His quarterly scores (66, 63, 54, and 72) are below the targets defined for this
performance dimension and, therefore, he should receive a “below par” rating.
But not all students agree on the adequacy of this performance measure. The
following table illustrates some of the points that students may bring to the
discussion.
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
In favor of a “Below Par” rating
In favor of a “Par” rating
*
Emphasizes
strategy.
Citibank’
*
He became branch manager in
1992 and he is still producing
good results => the measure may
not be a leading indicator.
*
Customer satisfaction is a
leading
indicator
of
performance and represents the
business model. A bad rating
will be reflected in financials
sooner or later.
*
The measure is not good
because only 25 customers per
quarter does not represent the
population. In addition, there is a
selection bias because only
customers that visited the branch
were eligible for the interview.
*
It focuses his attention and
that of the rest of the division
on the importance of customer
satisfaction to fulfill the
intended strategy.
*
James’ segment is more
demanding and therefore he
should get a lower rating.
*
Customers answering the
survey are also judging services
not controlled by James.
*
Too much emphasis on
customer satisfaction may force a
wrong asset allocation by James.
He may overinvest in customer
satisfaction.
The main arguments against customer satisfaction are:
It does not necessarily reflect strategy (i.e., it is not a leading indicator).
Few students will notice this underlying assumption. We will come back to
this issue later in the discussion.
The measure is unreliable because using 25 customers per quarter does not
have enough precision or because people answering the survey are a biased
sample. It is very unlikely (in terms of probabilities) that he got four bad
ratings because of “bad luck”. However, there is merit in the comment that
customers who visit the branch may not be representative of the full
customer population – especially to the extent that high net worth customers
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Atkinson, Solutions Manual t/a Management Accounting, 6E
prefer to use banking services by telephone, ATM, or even have banks visit
them in their offices or homes.
Related to the previous argument, some students may argue that the
questionnaire is badly designed. Usually, if questioned, the student means
that the measure includes things that James cannot control as described in
the following point. But some students may argue that the questionnaire is
wrong and then the argument focuses on the reputation and reliability of a
professional marketing research firm.
The measure includes things that are not controllable by James like ATM
and phone banking. Students feel very strongly about this issue as they see
it unfair. However, every branch gets the same ATM and phone banking
service and it is likely that some offices are above par in customer
satisfaction. Blaming ATM and telephone banking is also a handy “excuse”
for James. An additional reason to dismiss this argument is that any measure
includes uncontrollables if it is to be complete. Moreover, James can
manage the expectations of his customers regarding ATM and phone
banking, therefore having certain “control” upon these “uncontrollables”. A
useful example is to ask students what performance measure they would
choose for a CEO: share price or profits. The discussion will illustrate the
tension between the controllability principle and the importance of
including the results of all types of actions (“informativity” principle). If
students still feel strongly, the instructor can propose (as it was the case)
that the customer satisfaction measure included mostly branch-related
questions.
Finally, the standard for James should be different because his customers
are more demanding.
The conclusion of the above discussion is that customer satisfaction may not be
a perfect measure but this argument is valid for any measure that we can think
of because the perfect measure does not exist. It is always possible to find a
limitation in any measure and we have to work with the tools that are available.
It is not possible to ignore a particular measure because we don’t like what it
says.
Target setting
The last criticism on customer satisfaction (point 5 above) rises the interesting
point of target setting: if James’ branch is the toughest in the division, maybe a
better target setting process would take care of the problems with the customer
satisfaction measure.
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
“How are targets decided?”
The process begins when Frits Seegers and area managers negotiate targets for
the division as a whole and for each area in particular. Control and customer
satisfaction are common to all areas and branches, while financial and strategy
implementation goals are specific to each branch. Next, each area manager
establishes the financial and strategy implementation goals for each branch
making sure that they add up to the area targets.
Some students may argue: “the customer satisfaction target is common to
everybody and it should not be so.” Others will counter: “Why should James
get a lower customer satisfaction target? Every branch manager could give an
argument for the uniqueness of his branch and why he should get a lower
target.”
Therefore, it seems that changing targets is not a good idea.
The Design of the Performance Scorecard
The primary purpose of a performance scorecard is to communicate a particular
strategy down the organization and establish a basis for evaluation based on
this strategy.
Therefore, defining a specific performance scorecard and linking rewards to the
accomplishment of the specified measures (diagnostic system) is appropriate
when top managers are aware and clear about the strategy they want to pursue
and they have the appropriate measures. In contrast, it can have undesirable
consequences if the model is incomplete and leaves out significant variables. In
this case, organizational effort will be misdirected.
Building on the previous point, the instructor can go back to Exhibit TN-2 and
ask students to draw top managers’ cause-effect relationships implicit in the
design of the performance scorecard (Exhibit TN-4).
Linked to this process, there is a shift of decision rights from branch officers to
top managers. When the only performance indicators were financial measures,
branch managers could achieve financial performance in several different
ways. However, when performance includes financial as well as non-financial
measures, the branch manager has less alternatives to achieve performance
because he has to perform in certain dimensions as specified by top managers.
The instructor could reinforce this discussion with the following questions:
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Atkinson, Solutions Manual t/a Management Accounting, 6E
“What would happen if financials were good but non-financial measures (for
example standards) were bad?”, “would James be achieving Citibank’s goals?”
James’ performance evaluation
At this point in the class, the instructor may choose to take a vote. Usually, the
class is still strongly divided between students that see “par” as fair and those
that see “below par” as the appropriate evaluation.
What are the pros and cons of giving him either of these two ratings?:
“Par”
“Below Par”
*
Rewards James’ effort.
Allows him to receive maximum
bonus.
*
Gives credibility to new
system, otherwise it is
undermined.
*
It is what James would have
received in previous years.
*
Communicates the importance
of customer satisfaction to the
rest of the organization.
*
It is easier to communicate.
*
Systems should be flexible to
adapt to exceptions.
*
We keep James’s motivation
up. In the worst case, he may
resign if he feels that the new
system has penalized his best
efforts.
The problem facing Lisa and Frits is typical of a subjective performance
evaluation system. These systems have the advantage of being flexible to adapt
to special cases like James’ case and take into account information that
objective performance evaluation may not include. But, these systems have
limitations. First, they make hard decisions like this one even harder because
the decision is not “objective”: Lisa and Frits have the last word and there is a
personal component to it. In addition and to avoid the personal tension linked
to a negative evaluation, people using subjective evaluation tend to overstate
performance, there is “evaluation inflation.” Finally, subjective evaluation
encourages politics inside the organization in an effort to influence the decision
maker.
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
Conclusion
The above class outline is more than enough for a 75 minutes discussion and it
points out the most interesting learning points in the case. But the case is still
richer than what has been described up to now and the instructor can explore
two additional questions:
How would you communicate the decision to James?
Would you roll-out this performance scorecard to other regions at Citibank?
Students may want to know what happened: James got a “below par” rating on
customer satisfaction, but Frits chose to override the system and gave him an
overall “above par” rating for the year. To indicate the importance of customer
satisfaction, however, he awarded a 25% bonus in lieu of the maximum 30%.
But, as in all cases, the relevant issue is the learning points during the class
which can be summarized with the overheads in Exhibit TN-5.
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Exhibit TN-1: The Relevant Organizational Structure
Frits
FritsSeegers
Seegers
President
President
Citibank
CitibankCalifornia
California
Other Area managers
Other branch managers
Lisa
LisaJohnson
Johnson
Area
manager
Area manager
Los
LosAngeles
AngelesArea
Area
James
JamesMcGaran
McGaran
Branch
Branchmanager
manager
Financial
FinancialDistrict
District
350
––
Support functions
Other branch managers
Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
Exhibit TN-2: The Performance Scorecard
Variables
Standards
Standards
People
People
Control
Control
Measures
• Leadership
• Ethics / Integrity
• Customer interaction
• Community involvement
• Contribution to overall business
• Performance
• Teamwork
• Training and development
• Employee satisfaction
Measured subjectively
through Lisa’s assessment
• Audit
• Legal
• Regulatory
Measured subjectively
by auditors, but using
standardized procedures
Customer
Customer
satisfaction
satisfaction
Strategy
Strategy
implementation
implementation
Financial
Financial
Measured subjectively
through Lisa’s assessment
Measured through a survey by an
external company
• Households
• Cross-sell, splits, mergers
• Retail asset balances
• Market share
Measured objectively
• Revenue
• Expense
• Margin
Measured objectively
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Exhibit TN-3: James’ customer satisfaction ratings
Rating
Goal
80
72
66
63
54
First
quarter
Second
quarter
Third
quarter
Quarters
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Fourth
quarter
Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
Exhibit TN-4: Cause-effect relationships
Standards
Standards
People
People
Customer
Customer
satisfaction
satisfaction
Control
Control
Strategy
Strategy
implementation
implementation
Financial
Financial
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Atkinson, Solutions Manual t/a Management Accounting, 6E
Exhibit TN-5: Concluding overheads
Citibank: Performance Evaluation
•The performance scorecard should be based on a business model
with cause-effect relationships.
• To choose diagnostic measures, managers must evaluate
three criteria:
• Alignment with strategy: “Does it tell people what they
should be focusing on?”
•Measurability: “Can it be measured?”
Is it objective, complete, and responsive.
• Linked to value: “Are we confident that it creates
economic value?”
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Chapter 9: Behavioral and Organizational Issues in Management Accounting and Control Systems
Citibank: Performance Evaluation
• The performance scorecard can be used as a diagnostic
system to communicate strategy if:
• There are measures available to communicate strategy.
• Cause and effect model relating leading and lagging
indicators is reliable.
• If communication is the objective, choose impact over elegance
(i.e., keep it simple).
• Use formula-based incentives when you are confident that
measures are correlated with economic value creation.
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