F 09420010120134023 PP T 10

Course : F0942 Management Control System
Year
: 2013-2014
Combination of Measures and Other

Remedies to the Myopia Problem
Slide 11.3
Chapter 11:
Combinations of Measures and
Other Remedies to the Myopia Problem
Kenneth A. Merchant and Wim A. Van der Stede, Management Control Systems, 2nd Edition Pearson Education Limited 2007
Slide 11.4
We seek
a measure,
or a combination of measures,
that leads managers and employees to take
the right actions or make the right decisions
in order to create long-term value.
Slide 11.5
But
Financial measures of performance often are not, by
themselves, sufficient to motivate optimal management
decisions.
Worse, financial measures often create pressures for
short-term performance potentially at the expense of
long-term value creation.
The myopia problem
Slide 11.6
Overcoming myopia
Measure changes in shareholder value directly

Measurement precision and objectivity of future cash flows?
Control investments with preaction reviews

Operating expenses
Today businesses
Financial results controls
Developmental expenses
Tomorrow businesses
Combination of nonfinancial
performance indicators
and action controls
Slide 11.7
Overcoming myopia (Continued)
Improve accounting profit measures

Adjust depreciable lives of fixed assets, adopt
current value depreciation, charge depreciation
for older assets
Capitalize expenditures related to long term
investments
Recognize profits more quickly
Impute a cost of equity on income statement
Put leases on the balance sheet, etc.
Cost of developing performance reports for

control purposes?
Slide 11.8
Extend the measurement horizon

Measurement congruence
The longer the period of measurement, the

higher the correlation between accounting
income and economic income.
Use long-term incentive plans?
Slide 11.9
Reduce pressure for short-term profit

Reduce the weighting placed on the annual profit
target and emphasize other, longer-term performance
indicators, such as market share and technical breakthroughs.
Use subjective performance evaluations?
Make the short-term profit targets easier to achieve
Some slack is created to fund longer-term projects
But, motivational effects of easy targets?
Slide 11.10
Measure a set of drivers of future financial

performance
Use nonfinancial performance measures
Balanced scorecard
The BSC includes financial measures that tell the
results of actions already taken.
It complements the financial measures with operational
measures on customer satisfaction, internal processes,
and the firms innovation and improvement activities.
Slide 11.11
The Balanced Scorecard

Financial Perspective
How do we look to
our shareholders?
Customer Perspective
How do we look to
our customers?
Vision
Strategy
Business Processes
What business
processes are the
value drivers?
Learning and Growth

Are we able to sustain
innovation, change and
improvement?
Slide 11.12
A Good Balanced Scorecard

Tells the Story of Your Strategy
Every measure is part of a chain of cause-andeffect linkages.
All measures eventually link to organizational

outcomes.
A balance exists between outcome measures

(financial, customer) and performance drivers
(customer value, internal processes, learning
and growth).
Slide 11.13
Why do Companies Need a BSC?

The source of value has shifted from tangible to intangible assets
percentage of market value related to

Intangible
Assets
38%
62%
Tangible
Assets
62%
38%
85%
15%
1982
19922
20003
Slide adapted from Robert S. Kaplan, Balanced Scorecard Collaborative, A Palladium company: reprinted with permission
Slide 11.14
Creating value from intangible assets

is different
Intangible assets do not have a direct impact on financial
results They have second- or third-order impacts
1
Training
Service
Quality
Customer
Confidence
Customer
Retention
Revenue
Information
Technology
Slide adapted from Robert S. Kaplan, Balanced Scorecard Collaborative, A Palladium company: reprinted with permission
Slide 11.15
Evaluating the BSC-approach

Are BSCs balanced?
What is the proper weighting to achieve balance
Among the four perspectives?
Among the two dozen measures?
Average weights in a study of 60 BSC firms by Towers Perrin
(1996):
Financial
56%
Customer
Internal business
Innovation and learning
Other
19%
12%
5%
8%
Slide 11.16
We never figured out how to use the scorecard

to measure performance. We used it to transfer
information, a lot of information, from the divisions
to the senior management team. At the end of the
day, however, your performance depended on
your ability to meet your targets for contribution
to bottom-line profits.
-- Senior manager in a large financial institution.
Quoted in M.C. Jensen, Value maximization, Stakeholder Theory,
and the Corporate Objective Function, Journal of Applied
Corporate Finance (Fall 2001), p. 19.
Slide 11.17
Evaluating the BSC-approach (Continued)

Do employees make the right tradeoffs?
For example, throughput and labor productivity are possible
measures in the internal business process perspective, and costs
and profits are common measures in the financial perspective.
- Throughput can be increased by forcing employees to work
more overtime, but as fatigue sets in, labor productivity will
decrease.
- The overtime is also costly, so there is a cross-dimension
tradeoff between throughput and many financial measures,
such as costs and profits.
Slide 11.18

How to tie BSC-performance to incentives?
In the short term, tying incentive compensation of
managers to a balanced set of scorecard measures will

foster commitment to overall organizational goals, rather
than suboptimization within functional departments
Whether such linkages should be explicit or applied
judgmentally will likely vary from company to company.
More knowledge will undoubtedly continue to be
accumulated in the years ahead
-- Kaplan and Norton, 1996
Slide 11.19

How to measure important nonfinancial areas?
Extremely
Important
High Quality
of Measurement
Gap
4
3
2
er
Em
pl
oy
O
ee
pe
ra
tio
na
l
Q
ua
lit
y
Al
lia
nc
es
Su
pp
En
lie
vi
rs
ro
nm
en
ta
In
l
no
va
ti o
Co
n
m
m
un
i ty
to
Cu
s
na
n
Fi
1
al
1
ci
Not at all
Important
Extremely
Poor Quality
of Measurement
Slide adapted from David F. Larcker
Slide 11.20
Bottom-line measures
Are like a compass leading managers in the
desired direction.
Allow managers greater autonomy
The managers can decide what intermediate measures
to focus on to achieve the desired financial result.
The managers can achieve the desired financial result
by putting different combinations of inputs and outputs
together.
Slide 11.21
Baskets of measures
Are like a roadmap that provides guidance to
managers as to how to achieve the desired end.
If done well, can provide a linked cascading of
measures from the top of the organization to the
bottom. They show everybody how their efforts
contribute to the overall goal.
Can be restrictive (managers have less autonomy
in making the tradeoffs).
Propensity to become obsolete as conditions
change.
Slide 11.22
But
Complexity provides challenges:

identifying right measures, measurement rules,
and importance weightings
developing the measurement systems
setting properly challenging performance targets
for many measures
linking to incentive compensation
Keeping up-to-date

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Course : F0942 Management Control System

Combination of Measures and Other

Measure changes in shareholder value directly

Control investments with preaction reviews

Financial results controls

Overcoming myopia (Continued)

Improve accounting profit measures

Cost of developing performance reports for

Overcoming myopia (Continued)

Extend the measurement horizon

The longer the period of measurement, the

Use long-term incentive plans?

Overcoming myopia (Continued)

Reduce pressure for short-term profit

Overcoming myopia (Continued)

Measure a set of drivers of future financial

The Balanced Scorecard

Learning and Growth

A Good Balanced Scorecard

Every measure is part of a chain of cause-andeffect linkages.

All measures eventually link to organizational

A balance exists between outcome measures

Why do Companies Need a BSC?

percentage of market value related to

Creating value from intangible assets

Evaluating the BSC-approach

We never figured out how to use the scorecard

Evaluating the BSC-approach (Continued)

Evaluating the BSC-approach (Continued)

managers to a balanced set of scorecard measures will

Evaluating the BSC-approach (Continued)

Slide adapted from David F. Larcker

Complexity provides challenges:

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