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ACCT2522

12. PERFORMANCE EVALUATION &

MANAGEMENT CONTROL
12.1 ROLE OF ACCOUNTING INFORMATION IN ORGANIZATIONAL CONTROL

Control System Design

Motivation to exert effort

Individual Performance

Organisational Performance
•ability, uncertainty, effort,
resources...

Organizational Performance
•Efficient and Effective us of
organisational resources

Create and Sustain Value

MANAGEMENT CONTROL SYSTEM DESIGN

Management Control System (MCS): systems & procedure that provide regular information to assist in
control

Should motivate individuals to take actions and make decisions consistent with the organisation’s goals

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- Goal congruent behaviour

Performance evaluation and reward systems play a critical role

1. How comprehensively is employee performance measured?

2. How well is the reward tied to measured performance?
o Inventive systems (also known as reward systems/compensation schemes/plans)
o Set of procedures and standards for awarding compensation and other benefits to employees

MANAGEMENT ACCOUNTING SYSTEMS (MAS)

A system that produces the information required by managers to create value and manage resources

- an integral part of the organization’s MCS.

Roles of management accounting:

- Decision-facilitating information (planning info)

o Information that help managers make better decisions
- Decision-influencing information (control info)

o Information about performance, for evaluation purposes.
o This information will affect how employees behave...
 Motivate effort
 Direct attention


 Extract private information


 Attract employees with appropriate skills/knowledge

12.2 MOTIVATION THEORIES AND IMPLICATIONS FOR MAX

Motivation: is the driving force that causes humans to exert effort for their goals

Factors affecting motivation:

- Situation specific
- Individual characteristics: interests, attitudes & needs that people bring to the work place
- Job-related characteristics: content & context of task environment  autonomy, variety, difficulty
- Work situation characteristics: immediate work environment  politics and culture

SOURCES OF MOTIVATION

Intrinsic motivation: drive that comes from within individuals – self-efficacy and self-awareness

- Employees work hard because of interest or enjoyment associate with work

- Intrinsic rewards - psychological well-being

o E.g. mastering a topic of skill, meeting difficult or interesting goals

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o Intrinsic rewards cannot be “given” to employees

- MCS implications:

- Hire intrinsically motivated employees

- Create conditions to encourage intrinsic motivation e.g. job design, culture

Extrinsic motivation: drive induced by extrinsic (external) rewards and tangible benefits

- Extrinsic rewards – promised tangible rewards or outcome

o e.g. bonus, promotion, or avoid punishment
- MCS implications:

o Reinforce or induce motivation by creating significant extrinsic rewards
- Caution: some extrinsic rewards can reduce intrinsic motivation

THEORIES OF MOTIVATION

There are many theories of understanding what determines motivation; we focus on three:

1. Agency Theory
2. Goal Setting Theory
3. Expectancy Theory

1. AGENCY THEORY

“Economic theory assumes that humans are rational, goal directed and self-interested...”

- An economic contract exists between principal & agent

- Agents have more information: “information asymmetry”
o Effort levels aren’t observed directly by the firm
- Agents are motivated by self-interest

o Need to align individual goals to organizational goals
o Goal incongruence can lead to dysfunctional behavior

A number of conditions that should be observed from decentralized and group decision making:

- Shirking: is avoiding individual effort, which is undetected in the group setting

- Freeloading: is benefiting from the efforts of others in the group (while shirking)
- Taking prerequisites: is benefiting from the conditions of the job (while shirking and freeloading)

MCS implication:


- Need to measure and monitor performance - MAS information

o Use multiple performance measures?

- Design incentives to align individual goal to organizational goals i.e. achieve goal congruency
- Organizations need to offer monetary rewards to overcome employee opportunity costs of their time
and efforts and aversion to taking risks

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- Alternative extrinsic rewards should be used such as no fixed salaries, risky cash bonuses that are
contingent on meeting goals (e.g. commission), contingent promotions (with higher salaries) and
when appropriate, contingent awards of shares or share options.

2. GOAL SETTING THEORY

“Goals give direction to people’s pursuits.”

Studies have shown that ‘goal setting’ and ‘goal difficulty’ affects performance, presumably by affecting
motivation.

- Goal Setting: the act of setting performance targets

- Goal Difficulty: determines the effort and ability needed

Goals improve performance via effort

- Direct attention
- Stimulate effort
- Increase persistence

When setting goals, consider - Setting performance goals


- Goal specificity - Performance evaluation


- Goal difficulty/attainability - Standards for awarding compensation
- Participation and goal commitment
- Impact of feedback Links with prior topics?

Limitations - Standard setting


o perfection vs practical standards
- Ability and task complexity
o Participative standard setting
- Goal acceptance and commitment
- Target costing
- “Tunnel Vision” – too focused on the goal

MCS implications:

In summary: Individual performance by setting a specific, difficult yet attainable goal. Achieving difficult goals
increases the high level personal needs of self-efficacy and self-esteem, with or without monetary rewards.

3. EXPECTANCY THEORY

“The ultimate goal of action is hedonism or happiness, and is attained by maximising benefits and minimising
costs, or maximising the pleasure and minimising the pain related to any behaviour including decision making”

Individuals are motivated to act by the value (valence) of rewards from attaining a goal, expectation of
attaining that goal and the instrumentality of actually receiving the promised reward.’

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Based on a sequence of events:

- Effort: the level of effort the individual puts into the task
o i.e. how hard do they work?
- Performance: the achievement of the target/goal
o Consider – how is performance measured?
- Outcome: the reward

o Can be financial and non-financial
- Satisfaction: individual’s satisfaction with the outcome

Perceived high levels of all three predict high motivations, whereas low levels of any one breaks the chain of
interaction and predicts low motivation.

In addition, the theory implies that as long as at least two are of a minimal level, increasing the third will
increase motivation.

MCS Implications

1. Set realistic goals  improves expectancy

2. Use measures that accurately reflect employee performance  improves expectancy
PLUS: Employee must have an expectation that there is a high probability that they can perform well
3. Ensure employees obtain rewards if effort is exerted  improves instrumentality
4. Provide a desirable outcome  improves valence
PLUS: Employee must believe there is a high probability that these outcomes will be received if they
perform well

SUMMARY OF MOTIVATIONAL THEORIES

- Individuals are goal directed, whether they pursue goals rationally or not
- Goals may promise intrinsic or extrinsic rewards, which are complementary impacts on motivation if
incentive systems are designed properly for the decision context
- Higher monetary (extrinsic) rewards alone might not provide sustainable motivation

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- Specific, difficult, attainable goals provide the most motivation to succeed but the real costs of
striving for these goals must be considered
- Different casual attributions of outcomes, perceived unfairness in processes and rewards, or broken
links in the reward process can cause dissonance, which is unproductive and disruptive if not dealt
with openly and credibly

12.3 INCENTIVE SYSTE M DESIGN: PRINCIPLES AND CHOICES

Incentive/reward systems: processes, practices and systems used to provide levels of pay and benefits to
employees

- Motivate goal congruence - alignment of employee and organizational goals

- Encourage employees to strive for higher performance

Incentives may consist of:


- Base salary

- Performance based pay e.g. commissions or bonuses
- Promotion opportunities
- Non-financial rewards

INCENTIVES

Some general findings (based on research) on incentives and rewards:

- Extrinsic and intrinsic rewards: research has indicated that these compete, such that adding extrinsic
rewards diminished intrinsic rewards to the detriment of performance. More recent research
indicates that adding extrinsic rewards with other, properly matched, management controls can
enhance performance
- Rewards based on performance or decision making (capability process) pay-for-performance is a
widespread practice that is criticized for impeding intrinsic motivation and rewarding luck.
- Current or deferred rewards: current monetary rewards have been criticized for motivating short
term myopic decision making. Payouts are typically deferred to avoid short termism

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- Individual or group rewards: rewards for small group performance can result in higher performance
than individual rewards for group members. Small group incentives appear to work against
freeloading better than individual awards
- Performance sensitivity of rewards (floors, variability and caps) many performance based systems
are structured as a quota bonus plan with piecework type rewards between floor and ceiling quotas
which provide higher motivation and lower risk.

CHOICES IN INCENTIVE SYSTEM DESIGN

Some of the choices regarding performance measures are:

- Controllable or uncontrollable performance

- Absolute or relative performance measures
- Numeric/formula based or subjective measures
- Financial or non-financial measures
- Quantitative measures or qualitative indicators
- Objective measures or subjective indicators
- Singular or multiple measures
- Absolute or relative performance measures

- Narrow or broad responsibility of performance
o Individual performance targets / team based targets / gainsharing / profit-sharing
- Current or deferred awards


o Salary, bonus or stock Consider risks, alignment of interests


PERFORMANCE RELATED PAY SYSTEMS

Performance-Related Pay Systems are systems that base rewards on achieving some performance target.

Under these systems employees are paid:

- A base salary (predetermined); and

- An additional pay awarded based on performance

Examples include:

- Individual incentive plans: reward individuals for achieving individual performance targets
o Advantages is that individual effort is clearly tied to outcomes and rewards
o Disadvantage: difficult to design measures that separate performance outcomes of an
individual from the performance of a team/department
o Reward may be a cash bonus, non-cash reward, certificates of achievements, gift vouchers etc.
- Profit-sharing plans: a plan where cash bonuses are paid to each employee, based on a specified
percentage of the company’s profit
o Reward individuals but are based on the overall performance of the organization
o Encourages employees to identify with the company and “think like the owners”

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- Employee Share (stock options) Plans: plans that provide employees with the right to purchase
shares in their company at a specified price at some specified future time
o Senior employees with high influence will affect the share price
o Junior employees’ efforts may not affect share prices as much
o Helps employees to identify with the fortunes of the company
- Gainsharing: a system where cash bonuses are distributed to employees when the performance of
the company, or of their segment of the company exceeds some performance targets.
o Based on achieving productivity gains that can be directly influenced by employees
o E.g. reducing labour cost, labour usage, and material usage
o A proportion of the performance gain will accrue to the employees based on some formula
o Employees’ share may go into a pool and then distributed
- Team-Based Incentive Schemes* are systems where individuals are rewarded when their work team
exceeds certain performance targets
o Designed to encourage teamwork and cooperation among employees
o Do not tie individual effort to rewards, however, within small teams this may not be as big of an
issue.
o May still result in ‘free riding’ and reward employees that do not contribute as much

*Comparing Individual versus Team-Based Incentive Schemes:

Identification with the group
Equity among employees
Competitiveness between
employees
Relating individual effort to
reward
Rewarding only good
performers
Individual
Goal Incongruent
Differentials are divisive
May cause dysfunctional behavior,
seeking to maximize individual
performance
More control over the rewards
received
Good performers are rewarded
while bad performers are not
Team
Goal Congruent
No differential between
employees
Employee actions will aim to
improve the entire team
Dilutes individual contributions
Although more equitable, may
result in ‘free loading’

PRINCIPLES OF INCENTIVE SYSTEM DESIGN

1. Use multiple measures

2. Employees must believe that performance is a result of something they can control
3. Measure output vs. input
o Avoid rewarding output if:

 Cannot measure output consistently / timely basis
 Output affected by uncontrollable factors
 Output is expensive to measure
4. Link to strategy/critical success factors
5. Clear standards that employees can accept (SMART)
o Specific
o Measurable (quantifiable)

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o Achievable

o Realistic

o Time bound
6. Measures must accurately assess performance 


Group performance vs. individual performance

SUMMARY

- Organisational goals matter and must be expressed clearly

- Extrinsic rewards, such as bonus pay, matter, are important motivators but they are not sufficient,
especially if one has regard for optimising overall pay levels
- Hiring individuals with compatible intrinsic motivations, and fostering the building of intrinsic
motivation are key complements to extrinsic rewards
- Specific, difficult but attainable goals and objectives are important targets
- Assisting cognitively limited individuals to use the right information and perhaps document its use,
can promotes good decision making
- Base rewards partly on performance, but not solely on performance. Quality decision making and
duration of performance are also important
- Incentive system design is not a completed science, and there are many paths that might lead to
success. Similarly what works in one context might not work well in another. Beware of anyone who
claims who have THE answer