Kungliga Tekniska Högskolan
KTH Industrial Engineering and Management
Håkan Kullven
ME 2028
BEHAVIOURAL MANAGEMENT
CONTROL
AUTUMN TERM 2008
HOMEWORK ASSIGNMENT
CHRISTIAN STÄCKER
STOCKHOLM, 2008.12.02
Contents
Question 1:
How could Leo’s Four-Plex Theater avoid control problems? ------------------------------------------- 1
Question 2:
Discuss the ability to measure controllable results effectively in Armco’s new system. -------- 3
Question 3:
What is controllability? --------------------------------------------------------------------------------------------- 6
Question 4:
In what ways could personal controls be used in Alcon laboratories in order to create
an atmosphere of self-monitoring? ----------------------------------------------------------------------------- 6
Question 5:
Consider the impact on controls of gaming operations at Bellagio, if technology could
be applied to monitor dealers’ work as proposed in the case; what control systems
could be removed and why? What could the potential indirect costs be of such a
technology based systems? --------------------------------------------------------------------------------------- 8
Question 6:
AirTex does not really have a strategy. What if it was given a growth mission. What
would the desired behavior be at each department? What potential control
problems would be candidates for addressing with new control systems? ---------------------- 10
Question 7:
What are the positive and negative effects with Heidelberg’s use of transfer pricing? ------- 13
Question 8:
What kind of incentives, than stock options, can be used in order to create a similar
effect that stock options create? ------------------------------------------------------------------------------ 14
Question 9:
Give one suggestion on how Borealis could have designed their budgeting process
better, so to avoid some of the problems. ------------------------------------------------------------------ 15
Question 10:
In what way could the budget be causing a separation between thinkers and doers in
Borealis?--------------------------------------------------------------------------------------------------------------- 16
Question 11:
What problems is there with using a measure such as ROI? ------------------------------------------ 16
Question 12:
What do we mean when we say that financial measures can be seen as congruent? --------- 17
Question 13:
What are the critical success factors at Catalytic Solutions? ------------------------------------------ 18
Question 14:
How could pressure be reduced in Catalytic Solutions and how could that be a
remedy against myopia? ----------------------------------------------------------------------------------------- 19
Question 15:
How could we use a subjective performance evaluation in the case of Beifang Chuang
Ye Vehicle Group? -------------------------------------------------------------------------------------------------- 19
Question 16:
Discuss the role of controller in a company. --------------------------------------------------------------- 21
Question 17:
Discuss Learnout & Hauspie from a model for ethical discussions of your choice. ------------- 22
Question 18:
What is contingency theory? ------------------------------------------------------------------------------------ 24
Question 19:
If you should have to pick one single thing from the course that you believe is the
most important knowledge from it, what would it be and why? ------------------------------------ 25
Question 20:
What case did you learn the most from and why? ------------------------------------------------------- 26
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Case: Berkshire Industries --------------------------------------------------------------------------------------------------------------- 27
1.
Why did Berkshire implemented a new incentive system? -------------------------------------------- 27
2.
Compare the new system with the old one. Relate the two systems to the concepts
from the course. How would you describe the two systems and the differences
between them? ----------------------------------------------------------------------------------------------------- 28
3.
Should the company make special adjustments on economic profit for the Spirit
division? Give your arguments for both a positive and a negative answer for this and
also give your own suggestion. --------------------------------------------------------------------------------- 31
Bibliography:
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How could Leo’s Four-Plex Theater avoid
Question 1:
control problems?
To avoid control problems, you can consider the four strategies Elimination,
Automation, Centralization and Risk Sharing, as mentioned in our text book.1
Looking at the Four-Plex-Theater case with the identified problems and the
company’s circumstances, the Elimination of activities by outsourcing processes
appears not as a proper solution. The selling of tickets and refreshments has to
happen in the theater.
To implement automation, you have to consider the cost-factor, as well as the
possibility of implementation. To substitute a worker by a machine, the activity has to
be definable in algorithms. You have to know precisely what to do in that process,
just like the basis for using Action-Control. Then, to buy machines, robots or
computers and to implement them is a high cost factor. You have to compare the
long term costs of both processing ways, with human workers and with machines, to
see if automation is feasible.
There are three problematic processes mentioned in the
case: The selling of tickets, the selling of refreshments and
the collection of tickets by entering the screening rooms. To
analyze the processes, you have to consider that the selling
and
collecting
of
tickets
are
connected,
while
the
refreshment selling is separated. To avoid failures by
collecting the money or registering the selling you could
implement automats. It exist a lot of automats which sell
refreshments like drinks, chocolate and chips. The money
and the selling are counted automatically, it is not possible to
cheat and you just have to refill the automats. The ticket
Motivational Problem in
spite of Automation? –
The depressive Robot
Marvin
selling could be the same. But here you have to consider the collecting. To prevent
cheating, e.g. adults buy a child-ticket, you need a person at the collecting point to
check. Here automation cannot be a solution, at least not with a proper effort.
1
Kenneth A. (2007): P.12 -15
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Selling automats are common in use. You can find them anywhere in the streets. For
the selling tasks they are a cheap and safe solution in term of registration and
cheating. But in a theater they are quite unusual. It could be a new business idea to
open cinemas with automatic solutions everywhere, to lower the prices and have a
new cinema experience. But Leo’s theater is located in a small town in west Texas.
The costumers could be traditional thinking and expect the traditional way of
experiencing a theater so they want to buy their ticket and popcorn from a person,
not from an automat.
To improve the management control we
should look at the human behavioral level.
There is just one manager, so there is no
more centralization possible. But risk
sharing
2
could be very appropriate.
Involving the employees in the risk and
also
the
profit
will
enhance
their
motivation.
To transfer risk is one approach to deal
with motivational problems. Like Frederick
Taylor mentioned in his famous statement,
a worker tries to make the least effort. 3
But there are also self-interests in the
motivation of behavior. The young people
who should sell refreshments, but hand
them out for free to their friends, have an
Contract Theory and Moral Hazard
The Microeconomics theory shows in the
moral hazard problem, that the most efficient
solution for a contract between a principal (in
this case the theater manager) and an agent
(employee) is to hand over all the risk and the
profit to the agent and then get a fixed
payment.
By considering the risk aversion of people, the
agent would not agree to a contract where he
takes over all the risk. But by taking some of
the risk, he will be more motivated, because
first he can lose something, but second he
gets rewarded by his effort.
If you want someone to do something (work
more concentrated) it is better to reward him,
than to punish him. If you want someone not
to do something, punishment is to be
preferred.
interest to be nice to their friends in this
way. The risk-sharing, moral-hazard dealing contract between the manager and his
employees has to contain incentives which compensate these interests.
Next to dealing with the motivation, you always have to consider a possible lack of
direction and personal limitations. As a manager, you have to provide the
necessary information to do a good job. In case of the ticket-collecting, the employee
Moral Hazard and contract theory: Varian (1994),chapter 25; Bolton (2005), chapter 4 – I used the german
version of Varian. It is originally an US-book, so I also added the US-Version in the Bibliography, but without
the chapter I used.
3
Kenneth A. (2007), p.9
2
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is maybe not aware of the importance of separating the colors correctly. And all the
employees should be aware of the importance doing a good job with least mistakes
possible. A small Theater has not a big cash-flow. Even the selling of some
refreshments has to happen correctly, considering the theater’s profit. And due
to ”tone of the top”, as the top manager should live the philosophy, he should be
very carefully by handing out tickets for free. As the employers see this careless
behavior, they don’t see a reason to behave different.
Question 2:
Discuss the ability to measure controllable
results effectively in Armco’s new system.
The new system contains ten key performance measures:
1. Heats per week
2. Tons per man hour
3. Disabling Injury Index
4. Total Quality Index
5. Spending
6. Maintenance Performance
7. Cash Flow
8. Product Mix
9. Inventory days on hand
10. Sales price minus cost of net metal
Effective result measurement fulfills two aspects. First, you find congruence between
the company’s objectives and the measured results, second, the results measures
evoke the desired behavior.4 Furthermore, effective measure of controllable results
contains “precision”, “objectivity”, “timeliness” and “understandability”, like it is
explained in the text book.5
4
5
Kenneth A. (2007), p.33
Kenneth A. (2007), p34
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Often it is quite difficult to find
the right results measure which
really
leads
to
company’s
objective. A very good article
about this issue is “On the folly
Congruence of objectives
Using results control, it can be difficult to find the appropriate
incentives that align the employee’s effort with the company’s
objectives. You can discuss that mathematically in the principal agent
theory, where the principal is the boss and the agent is the employee:
Y = a1 *f1 + a2 *f2
Y: The agent’s contribute to
the company’s value, this is
not visible for the principal
ai : the agent’s effort
of rewarding A, while hoping
for B” 6 , where it is shown on
some
interesting
examples,
which behavior is evoked by
The agent’s contract:
S = α + bP
S: Salary
P: Agent’s measurable
contrabute
α: Fix payment
b: variable payment
P = a1 *g1 + a2 *g2
rewarding the wrong results. In
the frame on the right, you can
see a mathematically approach
The employee gets one b per P. So it is the result incentive. The f-vector
is the employee’s likely behavior, the g-vector presents the objective
leading behavior. You can show that:
about alignment of objectives.7
Looking at the ten performance
measures
of
Armco’s
new
Here, b* is the efficient variable payment and cos(θ) indicates the
alignment.
system, most of them can be
a2
measured effectively in the
f
explained way, but some are
θ
critical. The points 1, 2, 5, 7, 8,
9
and
10
can
easily
be
expressed in numbers and
factors.
The
company’s
objectives can be broken down
to these numbers and so it is a
precise way of measure results.
Timelines
to
measure
g
and
reflect these factors are also
a1
 If cos(θ) equals 1, you have perfect alignment of objectives and
the result payment b* is an efficient incentive.
 If cos(θ) is between 0 and 1, the incentive leads just partly to
the objectives.
 If cos(θ) equals 0, the incentive does not lead to the aimed
objective at all.
 If cos(θ) gets negative, the incentive is even contra productive
aiming a goal.
mentioned in the text and finally we can suppose that an Operations Manager
understand performance keys like heats peer week or tons per man hour, as it is his
profession and he knows how to focus on them.
6
7
Kerr S. (1975)
Baker, G. (2002), p.740-743
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But I see three problematic factors:

Disabling injury index: A company’s first aim always has to be avoiding injuries. But
how will it be measured? There are no hints in the text, but I see a problem in
precision and objectivity. What is a bad injury and what not? Can you make up
different categories of injuries and measure the occurrence? The injury index is
obviously an outstanding factor. Safety is of high importance and has to be controlled
frequently (Timeliness) and every employee has to be trained due to safe behavior
(Understandability).

Maintenance performance is based on costs. This can be dangerous concerning the
congruence of objectives. If the emphasize on low cost maintenance is too high,
machines and inventory may not be repaired due to achieving goals in the
maintenance factor. Due to the introduced theory, cos(θ) gets negative and shows
contra productivity in the alignment of objectives. If problems with too high
maintenance costs appear, you should look behind the border: “Why do we have that
much maintenance?” Maybe the machines are old. Then you have to consider if a
new investment is a better solution in the long term.

The most difficult factor in the new system is the Total Quality index. The first level of
measurement contains: “Meeting product specifications”, “Yield” and “Shipped on
time”. These are competing goals.8 Mostly you can just focus on one of them. If you
have e.g. a fixed time to deliver, quality sometimes suffers. The three result
dimensions are not congruent. But the total quality approach is very common and
important to analyze the operations situation on the whole. It is important to explain
the goals
and the management
of
the three
dimensions
very carefully
(Understandability). The operations managers have to know how to deal with
struggles concerning the achievement of the three dimensions. Maybe Armco could
implement a weighting of the dimensions, or any guideline that says which dimension
is to prefer.
If Armco wants to implement a real total quality management approach, a lot more
has to happen, than explained in the case. Armco’s total quality index already
cascades down to the lowest level. But there is much more needed than a few
indexes. Every employee has to be trained in order to adapt the philosophy of total
8
In the theory of congruence of objective you now have three dimensions. The angles between them are 90°.
You have three alignment factors, due to the angles, and all are 1. I don’t explain this extensively in the text,
even though it is interesting, because of the few space for this report.
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quality. One statement about this issue: “Total Quality is not a `state, but a `journey´,
a process”9.
Anyway the ten performance keys in Armco’s news system are a good approach, but
due to “Understandability”, training is needed how the operations manager should
work with it and especially how the different keys should be linked.
Question 3:
What is controllability?
``Controllability is an important property of a system to be controlled. A linear
controllable system may be defined as a system which can be steered to any state
from the zero initial state´´10
This definition from Hongxing Xia is originally related to automation control of timesystems. But it fits to company systems as well. To use Results control as a
management control system, you first have to define result goals and to
communicate them to the employees. But then it is important that those who are
responsible for reaching the results, are able to influence and steer the processes
and activities which lead to them. Without the ability to control processes, you cannot
make anyone responsible for the results.11
Question 4:
In what ways could personal controls be
used in Alcon laboratories in order to create
an atmosphere of self-monitoring?
Self-monitoring, as a part of Personnel Controls, is the “naturally present force that
pushes most employees to want to do a good job.”12
Looking at control systems of Alcon Laboratories, the circumstances of a R&D
department have to be considered. In the case, researcher are described as “unique”
in terms of intelligent and creativity, but they can also be “lazy” if they don’t like a
9
Conti, T. (1993), p.231
Hongxing Xia,
11
Compare: Kenneth A. (2007), p.33
12
Kenneth A. (2007), p.83
10
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project and “their feelings can be hurt” if their ideas are killed.13 Furthermore, they are
not businessmen. What also should be considered is the fact that creativity is
something you cannot produce by algorithms, you can just enhance the probability of
success.
Three methods can be considered in using personnel control:14
1. Selection and placement of employees
2. Training
3. Job Design and provision of necessary resources
The R&D department needs excellent researches in the first place. Creativity and
intelligence is needed to develop new products. In the case of Alcon, it seems that
they have a good selection process to hire good researchers. These employees also
have appropriate resources to do a good job. But they are not good businessmen
and don’t like paperwork. In terms of long time projects, it is especially difficult to
measure productivity. To reach higher business awareness in the R&D department,
three approaches can be considered.
 First, concentrate in the selection process already on the applicants’
understanding of business. Nowadays, even from very specialist researches
you can expect some business understanding in terms of costs, timeline and
productivity.
 Second, you can look at the team recruitment on the whole. In the selection of
team members, you can make up teams consisting of more research
orientated on the one hand and more business orientated members on the
other hand. Of course, the business orientated employees have to have a
huge technology background to provide efficient communication. Especially for
these cases, the study programs like “Industrial Engineering and Business
Management” are made for.
 Third, implement training programs for the researchers. Of course, they should
not run the business. Like they want it, their task is to develop and work on
new ideas. But they should have an understanding and awareness of the
importance of business issues concerning their field of work. As being part of
13
14
Kenneth A. (2007), p.101
Kenneth A. (2007), p.83-85
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the whole company, the R&D has to concentrate on objectives, costs and
timeline as well. Even if the R&D department has a special standing
concerning costs, they still have to be efficient and effective to ensure the
company’s success.
Enhancing scientist’s interest in business is a well known problem. In the article
“Making scientists into leaders at Park-Davis research”15 an approach is described
focusing on this problem. A training program has been developed, based on
workshops in which scientist learn about “creating value for the organization” and
“understanding personal responsibilities”. Participants of the workshops reported,
that the experience was very “worthwhile”, so with some effort, it should not be that
problem to excite someone for something he may not like.
Question 5:
Consider the impact on controls of gaming
operations at Bellagio, if technology could be
applied to monitor dealers’ work as proposed
in the case; what control systems could be
removed and why? What could the potential
indirect costs be of such a technology based
systems?
The new technology mentioned in the case are RFID chips in the gaming chips to
control each single chip. As you can identify each single chip and locate it
everywhere all the time, there would be huge improvement in some control areas.
The transfer process would not have to be under that strong control as well as the
chip handling on the table. It is always controllable how many chips are on the table
and which player has how many chips. You could also reconstruct the games exactly.
If someone steals chips, goes out of the casino and tries to change them anywhere
else, it could be detected and the chip could registered as stolen.
15
Pollitt D. (2001), p.371-373
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So the strong action control conditions for the dealers could be weakened. You
don’t need the drop boxes and the complex transfer process anymore. When a chip
is detected as out of the game, it’s worthless. So the dressing conditions for dealers
and the special movements are not necessary. Just by detecting the chips which
enters or leaves the casino in any way, you could implement a computer based
balance. You could then more concentrate on the players who try to trick.
Indirect costs occur, if the implementation of managing control systems evokes
behavioral displacement.
In that case, the control system evokes employee’s
behavior which is not aligned to company’s objectives. Such costs are difficult to see
and measure, but they can be significant.16 For the new technology at Bellagio, two
issues of indirect costs come to my mind.
 First, a new technology has always an amount of risk. You don’t know exactly
how good it is until you used it in praxis. There will always problems appear
which you could not calculate and foresee in advance. Especially new ways of
tricking could appear. Here the indirect costs could be tremendous, if a new
system turns out as a big failure because of unpredictable issues.
 Second, there is always a risk of customer’s rejection by implementing a new
technology. If people are used to something and suddenly it is substitute by
something else, which should be better, but is strange and different in use in
the first place, they could reject it. Especially, if customers do not see the use
in it. The human being is a “Creature of habits”. So with a new technology, the
gamer could lose the fun in the game, but actual, I don’t see that risk as too
significant, because the RFID technology will not change so much for the user
at it is unseeable.
16
Kenneth A. (2007), p.179, 180
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Question 6:
AirTex does not really have a strategy. What
if it was given a growth mission. What would
the desired behavior be at each department?
What potential control problems would be
candidates for addressing with new control
systems?
The desired behavior of the employees in each department should be aimed to the
company’s, respectively the departments, objectives and should be aligned with the
corporate strategy. To support the implementation of a management control system,
the identification of key recurring actions and/or the critical success factors is
recommended. Furthermore, likely behavior caused by the control problems lack of
direction, motivational problems and personnel limitations should be considered.17
AirTex new managers, Ted and Frank, implemented a lot of new management
control systems and changed many processes, especially those pertain to
accounting. Without going too much into details, we can summarize that the
departments are financial responsible for their results now, but they are also
activated to act free in a specific framework to achieve their goals. A basically new
structure is implemented, but without the airport sale, there is now future plan
mentioned. For a growth strategy, we can suggest critical success factors, desired
behavior and potential problems for each division.
1.
Starting with the fuel line division, we first have to consider the general
possibilities of growth. There are two possibilities: You increase the overall market
value or you gain market share from competitors. There is no clue about competitors
in the area of AirTex in the case, so what is left for the growth of the fuel line division
is a general growth of the airport.
Critical success factors of the division in this context could be: (1) Forecast airport
growth, (2) link capability to airport growth.
17
Kenneth A. (2007), p. 218-220
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These two points reflect the desired behavior of the division: Be aware of the change
and provide the needed resources efficiently. Maybe new investments are needed,
e.g. new storages and trucks. Control Problems in this case could be personnel
limitations, as far as the line manager Will Leonard has now education in business
management.18 He could be over challenged by forecasting growth and initiating and
leading structural changes, especially because financial knowledge is needed here to
invest successfully. As long as there is small growth, training as part of personnel
control would be appropriate to educate Will on the business level. If strong growing
is predictable, they should hire (Selection and Placement) a manager with the
specific knowledge.19
2.
The critical success factors of Service and Parts should be (1) Quality, (2) fast
services, (3) fair prices. In a growth strategy, you could separate the Parts service in
order to sell also to other customers. Then (4) on time delivery and (5) acquiring new
customers could be added. Again, desired is the behavior which leads to congruence
between results and objectives. As the division has very skilled and experienced
employees in the field of technique, control problems could appear by facing
business and change issues. Motivational Problems in the case of Carl Green
probably appear. He is “in his 60s”, has “a bit of retirement mentality” and is probably
not willing to make big steps in company change anymore. Let him do what he likes,
the technique, and put him business man aside (Selection and Placement). Also, if
larger sales activities are planned, more employees are needed.
3.
In the flight school the desired behavior should focus on the CSFs (1) High
quality education, (2) Acquire new customers, (3) Profit. The third point is very
general and every company has to make profit20, but in the text is an every year loss
situation mentioned without giving more explanation.21 So I cannot say if it is a lack of
customers or a waste of resources. Anyway, a flight school can be profitable and
should be if it won’t be closed. Like in the Service division, AirTex has again very
skilled and specialized employees in the flight school what can be used to
acquaintance new customer. But they also miss business knowledge and motivation.
The motivational factor is expressed very strongly, so problems and behavioral
18
Kenneth A (2007), p.10
Kenneth A (2007), p.84
20
As long as it is a profit organization
21
Kenneth A. (2007), p.242
19
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displacement could also appear by hiring managers and put them beside the flight
trainer, because they don’t like change. The new direction of the company has to be
explained very clearly and probably punishment by not following as well.
4.
There is few information on the Avionics department in the text. But obviously,
the one employee provides “work to rule”22, as he works not more than necessary.
The question is, if there is more work to do or not. In a growing company there would
be more work, so you can think of result control like an awarding system for fast and
quality repairs or always short “TO-DO” lists.
5.
There is a new franchise deal for the Aircraft Sales. It is a field of high potential
profits. The desired behavior is obvious a high number of sold airplanes for high
prices. So the salesmen should have a result orientated contract. This incentive
provides high efforts from salesmen. Referring to moral hazard theory again, the
contract should consist of fix and variable elements, to provide the right incentive
between risk and risk aversion.23
6. The accounting division on its own is not a department which provides growth,
but which grows with the company.
This should happen appropriate. Educated
manager and a clear communicated direction are needed to prevent a situation like
before in the company.
To dare an even farer look in a possible growth future, you could consider to divide
the departments and found sub-companies with own strategies and even more
separated responsibilities. Then, strategies for each sub-company with own
accounting departments and maybe complete different control systems have to be
implemented. You can see such a development e.g. at Lufthansa, which started as
one company and is now divided into many sub-companies with own responsibility
like Logistic, Passage, Technique, IT and even Catering and Call-Centers.24
22
Winch D. (1989), p.66
See Question 1, as well as Varian (1994),chapter 25; Bolton (2005), chapter 4
24
See: http://konzern.lufthansa.com/de/html/ueber_uns/geschaeftsfelder/finanz/index.html
23
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Question 7:
What are the positive and negative effects
with Heidelberg’s use of transfer pricing?
Transfer prices are prices for delivering products between company’s own
departments. As the departments have own economic responsibility, as a profit
center or a cost center, prices should cover all costs and a mark-up. But for strategic
reasons, prices can be set lower if you use Dual Costing or negotiated prices.25
The positive effects of transfer pricing are:

Advantage against competitors: By using transfer prices which are lower than full cost
covering prices, e.g. just covering the marginal costs, the transfer price can be much
lower than the market price. In the Zümwald case, Display tech won’t sell his product
to Heidelberg and loses market share. In case of big companies, which are probably
monopolist in some market areas and have competitors in other areas, they can use
marginal cost prices even to squeeze competitors out of the market. Because of big
fix costs, regarded as sunk cost for the monopolistic area, they don’t count them to
the competitive market area and offer the product to marginal costs. The competitor
might have to regard full cost and will leave the market in the long run.26

Negotiated transfer prices imply excellence managers on the department leading
level. If those managers have negotiated a transfer price, which is lower than their
initial price, it implies that these managers have awareness of the whole company’s
situation as well as for their department and they have the ability to find a solution in a
very difficult situation. In this case, the CEO can be sure to have hired the right
people.

If transfer prices which are lower than market prices are needed, it implies that the
departments are not working efficient. They have an incentive for lowering costs in
order to be competitive.
The negative effects are:

On the long run, you have to consider the fix costs as well. If there is no opportunity to
lower the costs, maybe because there have been too high investments, prices which
don’t cover fix costs can ruin the department.
25
A mathematically approach to compare negotiated and cost based transfer pricing can be seen in the article:
“Negotaited versus cost-based transfer pricing” by Baldenius, Reichelstein, Sahay.
26
Weimann (2003), chapter 7
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
If the departments are forced to skip the mark-up and sell their product for lower
prices than they can make profit, the employees will lose motivation if the situation
will not change after some time.
Question 8:
What kind of incentives, than stock options,
can be used in order to create a similar effect
that stock options create?
The benefits of stock options are:27

Large potential gains for the employee

Motivation of the employees to increase the company’s value and growing

Tying the employees to the company (if stock options are seen as longtime
incentives)
There are plenty variations of stock shares next to stock options, for example
Restricted Stocks as explained in the text book. The differences lay in the amount of
risk you have of increasing or decreasing stock prices as well as the restrictions and
conditions included. In general you can say, the more potential risk, the more
potential gain, or loss.
To motivate the employees to participate on the company’s value increasing, you can
consider profit sharing as an alternative to stock plans. The advantage of profit
sharing plans is, that the employee’s net profit is not linked to unforeseeable issues
on the stock market. It is aligned to the company’s real performance. To ensure that
employees stay in the company for a longer time, you can implement a bonus bank,
where the bonuses are paid on and from which the employee gets his bonus after
some time.
Kraizberg, Tziner and Weisberg add Merit Pay and Gain Sharing to stock options and
profit share and compare those incentive systems with the focus on enhancing work
27
Kenneth A. (2007), p.398
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performance and motivation. With different approaches they could not clearly
conclude which system is to prefer and referred to empirical studys.28
Another alternative, especially to tie employees for a long time, are pension plans. A
company pension, linked to the time someone has been in the company, is a strong
incentive, especially in times of declining government pensions.29
Question 9:
Give one suggestion on how Borealis could
have designed their budgeting process better,
so to avoid some of the problems.
The problems with the budgeting process mentioned in the case were the fast
changing circumstances on the market. The philosophy of a “plan-make-sell” strategy,
in which targets and resources were negotiated once a year, has not been
practicable due to weekly changing products and supplier markets. Furthermore a
lack of costumer’s needs consideration is mentioned and the budgeting process is
described as protracted, tedious and complex. 30 The process also bounded a lot of
resources for some time.
To avoid these problems, Borealis could have implemented a different budgeting
process. Instead of a complete budgeting process once a year, different planning
levels should have been considered:31

Strategic planning to define the company’s principal objectives and performance
framework for a definite period.

Capital budgeting to define activities and resources for business units in order to
fulfill the strategy.

Operational budgeting to consider the short time needs and circumstances on the
market.
The three levels are in different detail and time validation. To react on the weekly or
monthly market changes you have to adapt the planning periods to this circumstance.
28
Kraizberg, Tziner and Weisberg (2002), p383-390
Devinatz V. G. (2007),
30
Kenneth A. (2007), p.369
31
Kenneth A. (2007), p.331-333
29
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But it is of course not feasible to prepare complete budget plans in those short terms.
So prepare a framework, which leads to objectives on the one hand, but which is
flexible enough to react appropriate. This also won’t bound as much resources every
year for a long planning process. If the framework is once set, the departments can
plan separated and there are not that detailed planning needed every year.
In order to meet the market’s needs more appropriate, the budgeting process should
have included more external targets instead of internal targets.32
Question 10: In what way could the budget be causing a
separation between thinkers and doers in
Borealis?
The budgeting was aligned to the company’s strategy, which was defined by the top
management of Borealis, but not communicated well to the plant workers. The
problem is mentioned in the case as that the CEO came to the plants and talked to
the workers about targets and innovative technology, but “could not translate these
into terms that made sense to the workers”.33
To solve this problem, they successfully implemented the balanced score card.
Question 11: What problems is there with using a measure
such as ROI?
The problems with using measures as ROI are the production of management
myopia, a tendency of sub-optimization and misleading performance signals by
measuring the denominator.34
Myopia means the short-term view on investments. Using financial measures such as
ROI lead to investment decisions with short-term profit returns. Long-term
investments are disregarded, because of the manager’s pressure of immediate
success.
Sub-optimization occurs by decision making of new investments due to the ROIindex. Division managers tend to decide for or against investments just because of
32
Kenneth A. (2007), p.334
Kenneth A. (2007), p.371
34
Explanations as to compare from Kenneth A (2007), p.443-450
33
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the ROI but not of best interest of the corporation. Investments with a lower ROI as
the current ROI of a division will be neglected by this division, but maybe assumed by
a division with very low current ROI. Such a division would probably assume an
investment which has an even lower ROI as the capital cost in order to increase their
own ROI. The result is that the company’s capital slowly moves to the least
successful division.
Furthermore, ROI can suggest misleading performance signals, because of
depreciation and inflation. Divisions with depreciated assets show higher values for
ROI. This is just because of the artificial low assets’ value, but not because of better
performance. If an investment was done some years ago, inflation increases the
profit value compared to the investment, even there is no higher performance. The
fact that low asset values increases the ROI index also leads to leasing decisions of
assets instead of investments, because leased assets don’t appear on the balance
sheet.
Considering these problems of finance measures, there are a lot of gaming
possibilities. Behavioral displacement of managers occur by focusing on having “nice
numbers to show the boss” instead of focusing on creating values for the company.
Question 12: What do we mean when we say that financial
measures can be seen as congruent?
Financial measures are congruent means that they are aligned with the main
company’s objective, profit maximization. 35 The increasing of financial indices like
ROI leads to increasing of profit and firm value, so there is a correlation of accounting
profits and firm value.36
Important to mention in this case is also the factor of the timeline. The congruence
between profits and firm value increases in the long term. Start-up firms for example
have probably no profit, because of the investments or the beginning of selling. Also
long R&D efforts are not countable directly in the conservative accounting systems.
35
36
This is the main objective if we are talking about profit organizations.
Kenneth A. (2007), p. 442
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So in these cases you should not trust financial indices to measure the company’s
value.37
We can adapt the congruency theory of question 2 here. If the profit maximization is
“g” and “f” shows what the financial measures induces, cos(θ) is the alignment factor.
To show the timeline, we can expand the factor with the timefactor and get cos(θ[t]).
Starting a business, the financial measure vector is about rectangular to the profit
vector and cos(θ[t1])
is about 0. But with
t increases
time increasing, the
alignment
effect
f
f
increases as well
and
we
get
cos(θ[t*>t1]) nearer
g
g
Θ[t1]
Θ[t*>t1]
to 1.
Question 13: What are the critical success factors at
Catalytic Solutions?
To identify the critical success factors at Catalytic Solutions, I first give a definition of
critical success factors:
“A critical success factor (CSF) is one of between four and eight factors
that is MOST critical of any given mission, project or goal. It is what you
MUST be or have.”38
For the Catalytic Solutions Company, the SCF can be identified as:




37
38



Number of patents
Perfect Quality
On-time-delivery
Low costs
Close Customer Relation
Production Capability
Efficiency, Productivity
Kenneth A. (2007), p. 441
Justice T, Jamieson D (2006) p.361
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Question 14: How could pressure be reduced in Catalytic
Solutions and how could that be a remedy
against myopia?
Pressure against employees is set by high emphasize on short term profits in the
bonus system. This can be reduced in two ways:39

Design the financial aspect of the bonus system due to more long term profits than
short term profits,

Set financial targets which are achievable for the employees, so that the pressure is
just on a motivational level and not a “fear” level. Too high targets could also let
managers create slacks.
The bonus system of Catalytic Solutions includes a financial target with a 60%
weighting. The target consists of annual increasing revenue and reducing operating
costs. To achieve this target and get the high bonus, the employees could just
concentrate on short term solutions which lead to higher revenues and lower cost in
the bonus period, but which are not congruent with long term improvement. To
reduce costs, they could for example decrease quality. The effect, e.g. losing
customers or losing the high-quality-image, probably appears not in the actual bonus
period. Furthermore, the quality factor has a lower weighting in the bonus system.
The myopia issue as described above could be reduced or prevented by changing
the weighting of long term profits in the bonus system or by including long term profit
bonuses. Although, the stock options present a long term bonus, they could not
compensate the short term incentive, because they are not understood well. So
either more explanation is needed or another long-term profit incentive as direct
bonuses could be implemented to remedy myopia.
Question 15: How could we use a subjective performance
evaluation in the case of Beifang Chuang Ye
Vehicle Group?
A subjective performance evaluation should be used on the one hand in addition to
objective measures, to correct their flaws or to put the results in the right light, and on
39
Kenneth A. (2007), p.484
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the other hand to evaluate on the foundation of manager’s experience and
knowledge. Anyway, subject evaluations include risks of being biased, not
understandable and support Excuse Culture 40 and therefore have to be used
carefully.
In the case of Beifang, the question is
how
to
evaluate
the
managers’
behavior in not having reacted on the
foreseeable law release. As even the
top management has not believed in
the
release,
employees
can
you
responsible
make
the
for
their
behavior? Due to the controllable
41
principle
,
you
should
they can control or influence. A law
cannot
be
influenced
by
employees of a single company, as
long as we let lobbying out of this
focus. But could they be judged for not
reacting on the announced law?
Considering the responsibility of each
employee to be part of creating the
company’s
value,
the
I discussed the Beifang case with my stepmother, who is
from China and lives in Germany now for 15years. Based on
her experience with managers she suggested that another
manager in Ming Zhou’s situation would probably not
consider so much the well being of his employees but focus
more on the best for his company. He probably would have
not so much doubt by firing employees as long as he sees
the possibility of hiring new ones when the business is back
on track.
make
employees responsible just for issues
release
A glance at the side (to read after the general answer):
managers
should have reacted. As long as they
are in a position of decision making
and development forecasting, they
should not excuse on top down
Regarding old Chinese culture and current behavior, there
are two things to mention: For Chinese people it is very
important “Not to lose ones face”. It is difficult to admit
mistakes. Fail behavior is a big shame. Furthermore, Chinese,
as well as Asian people in general, are very proud. Feats are
very respected and honored. On the other hand, a lack of
mercy can be seen in acknowledging mistakes of other
people. What also everybody can see by watching the news
is that the single human being does not count that much in
China.
But this is a difficult field about psychology and culture
differences. Due to time, I could not research a lot about
investigations which deals with that issue. I guess the
Chinese course attendants can tell more about it. In the
case, Ming Zhou is very concerned about his employees. But
it could be interesting to examine the risks of subjective
evaluation like mentioned in the book in the frame of
Chinese culture.
decisions. These decisions can be wrong, as seen in the case, and therefore they
should have been scrutinized in advance.
In this way, a subjective evaluation can lead to loss sharing for all the managers as
they are responsible, but this should happen appropriate. Ming Zhou should not fire
40
41
Kenneth A. (2007), p.543, 544
Kenneth A. (2007), p.534
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them or cut the salary too much in order they search a new job to earn more money,
because his company has big perspectives. As soon as the new cars arrive for
selling, the company is back on track and earns revenues with growth perspective.
As the general manager Ming Zhou has done the same mistake as his subordinates,
he cannot just blame them, but should work with them together to get out of the
situation the best possible. Considering the grow perspective, managers are maybe
willing to take unpaid vacation in order to come back when business is running again
and then probably get compensated for the loss with higher salary.
Question 16: Discuss the role of controller in a company.
In a company, controllers face a “conflict of interests”. As being financial
measurement experts, they are part of the key management team and highly
involved in business decisions. But they are also responsible for correct and accurate
reporting from their unit to higher business levels. They have “fiduciary” and
“oversight” responsibility
42
and they should be “independent, impartial and
unbiased”.43 These duties can be incongruent objectives, especially if something is
not going correct and the controller is a highly integrated team member.
To support the independency and responsibilities of controller, the text book offers
four suggestions:44

Use audit committees and internal auditors to oversee the controller’s actions.

Use personnel and cultural control to select proper characters for this job and train
them to keep focused on their duties.
 Create incentive systems, which provides duty fulfillment and prevents behavioral
displacement.
 Implement solid vs. dotted line reporting. The solid line presents the primary reporting
relation and the dotted line the secondary. If the solid line leads to the corporate
controller, that is the person who defines the controllers task, duties and evaluates
him.
42
Kenneth A. (2007), p.633
Davis M., Stark A (2001), p.4
44
Kenneth A. (2007), p.633-634
43
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Question 17: Discuss Learnout & Hauspie from a model
for ethical discussions of your choice.
First, to begin the discussion, I would like to summarize the plenty of unethical
actions in the L&H Company in one major behavior displacement: Producing fake
revenue. This had an internal and an external effect:


Internal, the subordinates showed their superiors high revenues in
order to earn bonuses
External, the company showed their stakeholders high revenues and
profits to increase the company’s value.
To complete the focus, you can put the cost-situation of the R&D sub-company to the
faked increased value. I will discuss the case from a social view and use the
Bernoulli-Nash model, a variation of the Utilitarianism theory.
Some Theory:45
The social welfare function can be seen as a function that combines the utilities of
all individuals in a specific way to show the overall welfare. The social welfare has to
be maximized by choosing between different action possibilities.
xi : consumption of individual i
ui(xi) : Utility of i out of xi
W(): Social Welfare Function SWF
One way to build the SWF is to sum up all individual utilities. That is the utilitarianism
function. The problem there is that the allocation of the utilities does not count for the
evaluation of the welfare, just the sum of it. Concentrating the whole welfare at one
person, leads to the same result as equal sharing of the same welfare value.
The Bernoulli-Nash SWF considers the allocation. In that SWF, the increase of utility
for a person with low welfare is weighted more than the same increase for a person
with high welfare.
45
Acocella N (2000), p. 53-56
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Utilitarianism SWF:
Bernoulli-Nash SWF:
Figure 2: Bernoulli-Nash SWF
Figure 1: Utilitarianism SWF
Back to the case
We have two groups U1 and U2, which can be seen as two people or two groups of
the same size. U1 is poorer than U2, so U2 are the managers and owners of L&H and
U1 are usual shareholders.
1
to
2:
L&H
starts
operating.
The
company’s
increases
U2
value
by
SWF 2 › SWF 1› SWF 3
showing
2
faked value. U2 earns
bonuses and stock value,
U1
just
earns
from
1
3
SWF 1
increasing stock prices.
SWF 3
Even though we use the
Bernoulli-Nash
model,
the increase from U2 is
SWF 2
0
U1
Figure 3: L&H in the Bernoulli-Nash model
larger than from U1. This happens, because I suggest higher stock value for the
owners and managers plus high bonuses compared to small stock shares of the
other shareholders.
2 to 3: The truth about L&H’s operations turned out. The company went bankrupt
and loses all the stock value. Responsible persons were judged, managers went to
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jail and probably have to pay fines. They lose more than they owned in state 1 as
well as the other shareholders because they lose the whole investment. The loss of
the originally invested capital weighs even more for group 1, than the loss of the
earning before, because they are not that wealthy at all. If you consider reality with a
huge group of small shareholder, who invested their small savings in the stock
market and lose it all, it is even worse for the social welfare.
In state 3 you are on a level of social welfare even lower than the beginning. Value
was destroyed. Banks didn’t get their invested money, as well as shareholders,
managers were judged and costs were not cleared. We can see the same at the
moment with the international finance crises.
Why not to stay in state 2?
Why can’t we just stay in state 2 or proceed to even higher welfare by just showing
increased profits? Well, first of course are there violations of law which have to be
judged. But next to it, there was unethical behavior which causes a feeling to judge it.
First, there is the Inequality aversion, 46 represented in the concavity of the SWF.
There is a general tension and resentment, if there is a big gap between wealthiness.
If the richer people got this wealth even by unfair means, the society won’t accept it.
People desire fair situations. This is shown in Rawl’s theory of justice,47 where all
individuals find themselves in an original state of being. Nobody knows anything
about their social position and possibilities as well as the circumstances. From this
state, they could form a social contract which everybody accepts completely.
Question 18: What is contingency theory?
Contingency Theory claims that there is not “one best way” to organize, lead and
manage an organization. It has to be matched with the used technology and the
surrounded environment.48 A strategy that is the best for a specific situation has not
to fit in all other situations.
46
Fehr, E. (1999)
Acocella (2000), p.62-64
48
BusinessNET dictionary
47
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The most appropriate style depends on various internal and external factors or
constraints such as organizational size, technology, environment, strategies,
operations activities, etc. 49 The contingency theory can also be broke down to
aspects like the contingency theory of organization and contingency theory of
leadership.
The text book mentions contingency theory in terms of choosing the appropriate
management control system. The MCS should be aligned with the competitive
strategy and so, the competitive strategy “drives” the MCS design.50
Question 19: If you should have to pick one single thing
from the course that you believe is the most
important knowledge from it, what would it
be and why?
I think the most important thing to learn here is not a single tool or a strategy helping
you in a situation. It is the ability to analyze a very complex situation and then to
apply appropriate solutions. But it is important to be aware of that there is not one
correct solution and the difficulty lies just in finding it. The subject is about dealing
with people. Leading them and align their behavior to specific objectives. It is not a
mechanical problem, where you have to define the correct algorithm and then just to
run it. Where people are involved, there are so many possibilities and variations, you
can never be aware of everything.
The theory shows a lot of “helpers” to break down the complexity to small parts and
provides solutions to the different issues. This is very useful and often leads to good
performance. But especially the Aexon case shows, that where different people and
different interest have to fit together, theory cannot solve the problem solely.
49
50
12MANAGE
Kenneth A. (2007), p.728
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Question 20: What case did you learn the most from and
why?
The AirTex-case showed on a tremendous way, how misleading or just inactiveness
can lead to catastrophic structures. Like mentioned in the question above, the human
factor with self-interests and motivational issues has to be leaded at least in any way,
in order to keep the business on track.
Furthermore, reading the case, I thought the two managers who bought the company
were swamped by the many issues. In advanced they were very confident because
of their good education, but actually lacking experience. I would like to know if they
were really successful, because it occurred to me that the problems in AirTax were
too large and the old structures too old-established to change everything just in time
before bankruptcy. Especially with mostly theory knowledge.
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Case: Berkshire Industries
1. Why did Berkshire implemented a new incentive system?
Berkshire changed the incentive system form an “accounting earnings” measure,
corporate earnings per share (EPS), to an “economic profit” measure. Two reasons
are mentioned in the text which has driven this decision:51
First, the board of directors felt a too small congruence of objectives by using the old
system. While the incentives leaded to high earning growth each year, like aimed, the
shareowner’s value has not increased as strong as wanted. But the “maximization of
shareowner value” has become one of the main objectives.
As I explained the
alignment effect mathematically, you can say that the alignment factor cos(θ) is not
large enough.
Second, the board recognized a too large amount of subjectivity by evaluating
managers. The objectives were not strong enough linked to objective performance
measures, so bonuses seemed to be paid always. Furthermore was an excuse
culture recognized, as the managers spent a lot of time with explaining that they have
performed well.
51
Kenneth, A. (2007), p.465
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2. Compare the new system with the old one. Relate the two systems to the
concepts from the course. How would you describe the two systems and
the differences between them?
Old System:
The new System:
“Corporate earnings per share
“Economic profit”
Incentives
Planning + Target Setting
(EPS)”
Bottom-up planning process: Operating
divisions explain their annual earnings targets
and their means. Then it was compared with
Berkshire’s corporate earnings targets and the
remaining gap was negotiated, usually the
division’s targets were increased.
Annual Target automatically linked and
ratched to the prior year.
Corporate earnings growth target
approximately 8%
New target 75% up in case of growth, or
75% down in case of loss
To be sure to meet analyst’s EPSexpectations, a 10% profit reserve was
added.
Mathematically adjustments to relate to
shareholder value
Bonuses were in first place linked to the
divisions or corporate achieved earning targets
(depending where the manager belongs to).
Bonuses of 20-90%. Subjective evaluation
could be added in order to level uncontrollable
factors in the manager’s work (This was
usually the case)
Manager’s bonuses correlated with
divisions targets. The correlation was fixed
(no negotiating) but higher than in the old
system. There were no caps on bonuses
anymore.
Bonus bank. One fourth of bonuses were
paid on top in a bonus bank account.
Amount forfeited by leaving the company.
Missing the targets means negative amount
on bonus bank.
To compare the two systems, I pointed out the main factors and listed them in the
tablature above. The related elements are facing each other in the tablature. We see
that for the bonus bank is no element existing in the old system. In general there are
two levels of elements in both systems. One is the planning and target setting level
and the other is the incentive level. In the following, I will refer those elements to the
text book.
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Planning and Target Setting52
In the old system, “operational budgeting” was used in order to define the annual
targets. There is no hint about “strategic planning” in the case, but the 8% earnings
growth over long time and then the board of director’s change intentions can be seen
as such long term strategic elements. The target setting process was a “bottom-up”
process leading to a mix of “historical” and “negotiated” targets. First the divisions
explained their expectations of earnings and means objectives, but then those were
negotiated to achieve the historical corporate growth rate. Negotiating was used in
order to take each divisional possibilities into account (due to information asymmetry).
Actually the targets should have been “fixed” in both systems, but in the old system
they turned out as more “flexible” because there were usually negotiations afterwards.
The new system consists of “model-based targets”, as there was a mathematically
implementation to set them. In that way, a planning process was not needed
anymore.
The target setting approaches were both “internally” focused in the first place,
because new targets were set according to prior development, but both had an
“externally” focus as well. The old system considered analysts’ expectations and the
new system tried to focus on shareholder value with adjusting elements.
Incentives
Both systems provide “risk-sharing-incentives”53 by paying bonuses correlated to the
level of objective achievement as it is derived from the moral hazard theory.54 So
“results control” is preliminary used on the management level.55 The “performance
dimension” is defined extensively in the NOPAT-system. The new system has higher
bonuses in order to increase acceptance for the new system, as well as no caps.
Therefore that the bonuses are absolutely fixed to the targets, an afterwards
negotiating is not possible anymore.
52
Refering to chapter 8 in Kenneth A. (2007)
Kenneth A. (2007), p.396
54
See Question 1, as well as Varian (1994),chapter 25; Bolton (2005), chapter 4
55
Kenneth A. (2007), p.29-32
53
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As a “long-term incentive”56 a bonus bank has been installed. This should reduce
myopia and short-term gaming and enhance the manager’s effort to work on the
company’s and his division’s long-term value. Furthermore the bank systems should
improve manager retention.
Discussion
The aim of the new system was aligning the management’s behavior with
shareholder interests and reducing the problems of subjective evaluation.
Furthermore it should be understandable and provides signals to increase long-term
value.
The new system is a very tight result control.57 Using model based targets, which are
recommended from the text book in use with “programmable activities”58 eliminates
the possibility of slack reserve building. Therefore the targets don’t have to be
negotiated anymore, the company safes money due to long target negotiating
processes. Furthermore, the subjective evaluation is not possible anymore.
Obviously at Berkshire existed an extensive excuse culture 59 , therefore most
bonuses were paid regardless of the result. In that case, the bonus loses his
incentive effect and motivation.
On the other hand, the tightness can affect problems as we can see in the case,
especially in the Spirit division. Without the target negotiation and discussion process,
you don’t take the divisional manager’s knowledge and experience into account. You
tie them down to numbers. Their motivation could suffer, because the change from
negotiating to straight model targets implies “no trust” form superiors in the skills of
subordinates. Furthermore, without the subjective evaluation, there is no tool left to
consider uncontrollable factors.
The new system has no bonus cap. In this case, it seems to be appropriate. What is
mentioned in the text book as disadvantages like high payments for lower managers
than for the superiors60 is wanted due to success.
56
Kenneth A. (2007), p.397, 398
Kenneth A. (2007), p.118-122
58
Kenneth A. (2007), p.333
59
Kenneth A. (2007), p.544
60
Kenneth A. (2007), p.402
57
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To reduce myopia and concentrate more on long-term perspective, the bonus bank
was implemented. The bonus bank system seems to be very appropriate to keep
employees longer in the firm. But the negative amount for failed results seems to me
as a demotivating punishment. As mentioned in question 1, if you want someone to
do something, rewarding is to prefer. If you want someone not to do something,
punishment can be appropriate.
The link to shareholder value seems not to work in the case. The alignment factor 61
cos(θ) seems to be around zero. As the stock price even decreased, you could guess
that there is a negative coalition between the objective shareholder value and the
adjusted measures. But I would say that the measure system in the whole is too
complex and the adjustments for shareholder value simply have no effect.
On the whole the new system misses major aims. The managers are confused and
motivation decreases. The intended effect in aligning manager’s behavior with
shareholder value is missing. The earnings and the economic profit is increasing, as
shown in Exhibit 362, but it seems that there is a lack of practical experience with the
NOPAT system, as far as the CLA has not concerned the various appearing
problems.
3. Should the company make special adjustments on economic profit for
the Spirit division? Give your arguments for both a positive and a
negative answer for this and also give your own suggestion.
The Spirit division faces recessionary times and the risks of the new system as
mentioned above turn out. The NOPAT system does not response on the changed
market conditions and the manager’s motivation decreases because of negative
bonus bank amounts. It turns out that the system does not consider the controllability
principal,63 as managers get punished for not controllable factors.
See the frame: “Congruence of objectives“ in Question 2, Baker, G (2002), p.740-743
Kenneth A. (2007), p.469
63
Kenneth A. (2007), p.534
61
62
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+
Arguing for special adjustments in the division, you can first mention the
motivation of the managers. The situation they are in is not caused by their
failures. They worked hard as it is mentioned in the case, but get punished
for uncontrollable factors. This is felt as not fair and leads to low motivation or even
the loss of skilled managers if they quit. Without changing this situation, the profit
development of the Spirit division could also pull the rest of the company down,
because of the impact on the stock market. Furthermore shows the situation in the
Spirit division the weakness of the new system to the other managers. This could
even lower the acceptance for it and makes the implementation even more difficult.
And it is also a question concerning “tone-of-the-top”. The division managers are
always demanded to solve problems, be flexible and focus on the success by using
knowledge, experience and also intuition and instinct. They are responsible for
achieving goals, now the top management, as the board of director’s, is demanded to
act in the same way. Otherwise they lose credibility.
-
Against special adjustments in the Spirit division I just can say one thing.
You should not change the system just in the Spirit division. The problem
there is nothing special about that department, it could happen in all the
others as well. It just shows the weakness of the new system in order to deal with
uncontrollable factors. Special adjustments just in that division would cause rumor.
The other managers would not understand why they are not part of changes and see
the Spirit department under special treatment.
Conclusion
In my opinion, there are some points to change, but that considers the whole system
and should be implemented throughout the company and not just in one division. The
pro and contra argumentation shows no reason to implement changes just in one
division, but really emphasizes the need of a general change.
Uncontrollable factors should be considered. This could happen by using objective
evaluations like more flexible goals, variances to consider changes in conditions, or
relative goals, to see the managers’ effort under special circumstances. Or they could
again implement subjective evaluations but considering the former problems. For
example they could use audit committees.
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The punishment system with negative amounts on the bonus bank should be erased
as mentioned before. The correlation of the system with shareholder value is also not
working but the biggest problem next to the controllability issue is the
understandability. The measure has to be simplified in order to improve its
implementation and application.
For me there is no doubt about the need of changes. But to decide whether Berkshire
should keep the NOPAT-system and improve it, or should return to the old system
and improve that, some information is missing in the case. It depends on the effort
needed for both opportunities. Changing a system completely causes again costs
and confusion in the operations. On the other hand, the NOPAT-system seems to be
too complicated as it can just be improved with some changes. So I mentioned where
in both systems improvements have to take place, but the decision needs analysis
which I cannot provide with the information of the case-text.
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