Organisational Behaviour

and Effective Reward

Systems
Lecture 9
Learning Objectives
Define the use of performance
measurement systems within
organisations
Identify deficiencies in conventional
performance measurement and look
at contemporary efforts
Identify characteristics of good
performance measurement systems
Performance Measurement
Systems
Measure performance of areas of the
business and individuals by comparing
performance with a target

Essential part of the planning and
control process

Go beyond the measurement of
financial performance
Purposes of Performance
Measurement
To communicate the strategy and plans
of the business and align employees
goals
To track performance against targets
To identify problem areas
To evaluate emplyees performance and
as a basis for rewards
To guide managers in developing future
strategies and operations
Conventional Performance
Measurement
Corporate
Divisions
Divisions
Plants
Departments
Productions processes
Work teams
Responsibility Centre
Investment Centre
Profit Centre
Revenue Centre
Cost Centre
Performance Measure
Return on Investment (ROI)
ROI is a financial measure of the performance
of an investment centre
Considers both the profit and the capital
invested
Measure of how effectively each investment
centre used its invested capital (average
operating assets) to earn a profit
ROI = profit .
avg op. assets

Return on Investment
Improving ROI
Increase either or both components of ROI
Increase return on sales by increasing
selling price or sales revenue, or decreasing
expenses
Increase investment turnover by increasing
sales revenue or reducing invested capital

Advantages of ROI
Encourages managers to focus on both profit
and the capital invested to earn that profit

Can be used to evaluate the relative
performance of investment centres
Limitations of ROI
Can encourage managers to focus on short-
term financial performance, at the expense of
the long-term
Can encourage managers to defer asset
replacement
May discourage managers from investing in
projects which are acceptable from the
organisations point of view, but decrease the
investment centres ROI
Residual Income
RI is the amount of profit remaining after
subtracting the imputed interest charge
Promotes goal congruence
Takes account of the organisations
required rate of return in measuring
performance
Encourages investment in projects which
yield a positive residual income

Limitations of Residual Income
RI is a dollar measure and thus cannot be
used to assess relative performance of
different-sized businesses
Can encourage short-term orientation
The measure for profit and invested capital
(asset base) chosen may affect behaviour
Need to be clearly defined and consistent across an
organisation
Use the profit margin attributable to the
investment centre (to evaluate the viability of the
centre)
Consider responsibility and controllability of
manager when determining the asset base
(average assets)


Measures of Shareholder Value
Improving the worth of the
business from the shareholders
perspective
Value-based management - using
shareholder value analysis to
manage a business
Need to understand the value drivers
(activities or actions that create
value)
Need to consider strategy, finance
and corporate governance
Measures of Shareholder Value
Several measures can be used
Economic Value Added (EVA)
EVA = NOPAT (avg. op. assets x WACC)

Market Value Added (MVA)
MVA = MV of company BV of company

Shareholder Value Added (SVA)
SVA = Corporate value MV of debt
Conventional Performance
Measurement
Measures focus on profit and its
components (revenue and costs)
Profit important for owners,
financial markets, and creditors
and therefore important to
managers
Problems with Conventional
Performance Measures
They are not actionable
Describe consequences, not causes
Emphasise only one perspective of
performance
Do not allow assessment of performance
across all strategically important areas
Provide limited guidance for future
actions
Report only on the immediate financial
outcomes of actions and decisions
May encourage actions that decrease
both customer and shareholder value
Contemporary Performance
Measurement Systems
Non-financial and financial measures
Non-financial measures have not always
been part of the formal performance
measurement system.
Strategic orientation
Selected to directly measure areas that
provide a competitive advantage and
increase value.
External benchmarks
Continuous improvement
Advantages of
Non-Financial Measures
Examples




Reflect the drivers of future financial
performance
More actionable
More understandable, easier to relate
to

Problems with
Non-Financial Measures
Wide choice of non-financial measures
available
Development can be ad-hoc and
undirected
Trade-offs must be made
May lack integrity
May not easily translate into financial
outcomes

Warning Signs of an Inadequate
Performance Measurement
System
Performance is acceptable on all
dimensions, except profit
Customers do not buy, even when prices
are competitive
No one notices when performance reports
are not supplied
Significant time is spent debating the
meanings of measures
The measures have not changed for some
time
The business strategy has changed
Characteristics of Good
Performance Measurement Systems
Link to strategy and goals of the
organisation
Be simple
Recognise controllability
Emphasise the positive
Be timely
Include benchmarking
Embrace participation and empowerment
Include only a few performance measures
Link to rewards
Designing Measures for
Continuous Improvement
Selecting relevant performance
measures
Performance measures should be changed
to reflect changes in the business
Defining and redefining the measure
Development of new measures
Making the performance target more
challenging
Increase difficulty over time
Behavioural Implications of
Changing Performance Measures
Performance measurement undertaken
to encourage goal-congruent behaviour
Resistance to change
Rewards linked to achievable targets
Support across the entire organisation
Bottom-up approach used to identify
measures
Treated as part of a comprehensive
system, not an add-on
Behaviour Implications
Main objectives of a reward system
include:
To attract qualified employees
To motivate employees to achieve high
level of performance
To create an enjoyable workplace that
will ensure employees return
Intrinsic and Extrinsic Rewards
Intrinsic

Extrinsic



Reward Preferences
Below are a list of rewards:
Pay, bonuses and other pay incentives, Time off,
Flexible working hours, Advancement and promotion
opportunities, Recognition from supervisor, peers, etc,
Ownership or profit-sharing, Autonomy, Personal
challenge and growth, Enjoyment at work, Social
support and friends, Job security, Interesting and
challenging work


References
Ivancevich, J.M., Konopaske, R.,
Matteson, M.T. (2011). Evaluation,
Feedback and Rewards.
Organisational Behaviour and
Management (9 ed.)
Langfield-Smith, Thorne & Hilton.
(2010). Management Accounting:
Information for Creating and
Managing Value. Australia: McGraw
Hill.