Strategy, Balanced Scorecards, and Incentive Systems

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• Strategy,Balanced Scorecards, andIncentive
  Systems

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Using Leading and Lagging Indicators in Balanced
Scorecards
Leading indicators are measures that identify
future nonfinancial and financial outcomes to
guide management decision making.
Organizationallearning andgrowth
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Using Leading and Lagging Indicators in Balanced
Scorecards
Lagging indicators are measures of the final
outcomes of earlier management plans and their
execution.
Organizationallearning andgrowth
Business andproductionprocessefficiency
Customervalue
Financialperformance
Lead
Lead
Lead
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Balanced Scorecard
Balanced scorecards are performance measurement
systems or business models that tie together
knowledge of strategy, processes, activities, and
operational and strategic performance measures.
An incentive system communicates strategy,
motivates employees, and reinforces achievement
of organizational goals.
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Communicating Strategy to Employees
Many employees do not understand the impacts of
their activities on customer value and
profitability because their jobs are narrow or
they do not interact directly with customers.
Communicating leading indicators in a balanced
scorecard can make the effects of employees more
visible.
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Motivating Employees and Evaluating Performance
Visible leading indicators can contribute to
employees improved motivation and commitment. At
a commercial bank the following sequence may be
effective.
Increasedemployeetraining
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A Balanced Scorecards Strategic Performance
Measures
Financial performanceHow should we appear toour
shareholders?
Vision and Strategy
Business and productionprocess performanceAt
what business practicesmust we excel?
Customer performanceHow should be appear toour
customers
Learning and growth performanceHow should we
sustain our abilityto change and improve?
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Implementation of a Balanced Scorecard

• Organizational Learning and Growth
• Employee Training and Education.
• Employee Satisfaction.

Organizationlearning and growth 1. Employee
training.2. Employee satisfaction.3. Employee
turnover.4. Innovativeness.5. Opportunities for
improvement.
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Evaluation of Measures of Organizational Learning
and Growth
Consider the information in this table
Incremental profit Total benefits Total
costsBreak-even profit 0 9X - 240,000 9X
240,000
Break-even benefit level, X 26,667 per year
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Evaluation of Measures of Organizational Learning
and Growth
Information in this table considers the time
value of money
Break-even profit .909X .826(2X) .751(3X)
.683(2X) .621(X) - 1.000(80,000) -
.909(80,000) - .826(80,000)Break-even benefit
level, X 32,170 per year rounded
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Business and Production Processes Efficiency
Organizationallearning andgrowth
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Customer Value
Organizationallearning andgrowth
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Evaluation of Measures of Customer Value
Customer satisfaction survey scale 1 to 5
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Financial Performance
Financial measures of performance tend to be the
most objective measures because most
organizations have dedicated significant
resources to ensure the validity of their
financial performance measures.
Organizationallearning andgrowth
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Benefits and Costs of a Balanced Scorecard

• Benefits of a balanced scorecard
• Encourages all employees to consider the impacts
  of their decisions on profitability.
• Appears to work in various types of organizations.

• Costs of a balanced scorecard
• Measurement costs.
• Education costs.
• Use costs.

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Fundamental Principles of Incentive Systems
Pay for performance means that at least some
portion of a managers income is not guaranteed
but depends on measure(s) of organizational
performance.
An effective incentive system should motivate
employees to achieve the organizations goals and
objectives and reward them if they do.
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A Role for Theories of Incentives and Behavior
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Features of Performance Based Incentive Systems
1. Absolute or relative performance?
3. Financial or nonfinancial performance?
5. Current or deferred rewards?
Performance-basedmanagement incentivesystem
2. Formula-based or subjective
performance?
4. Narrow or broad responsibility of
performance?
6. Salary or bonus rewards?
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Absolute or Relative Performance

• Absolute performance evaluation compares
  individual performance to set objectives or
  expectations.
• Relative performance evaluation compares an
  individuals performance to that of others.

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Formula-Based or Subjective Performance

• A performance evaluation formula computes rewards
  earned for specific achievements.
• Subjective performance evaluation uses
  non-quantified criteria not captured by formulas.

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Financial or Nonfinancial Performance

• Financial performance reflects the achievement of
  financial goals, such as . . .
• Cost control.
• Revenue growth.
• Earnings.
• Residual income.
• Adding nonfinancial measures to the incentive
  system,
• Gets managers to focus on the leading indicators
  of profit.
• Gives recognition of the time lags between
  nonfinancial and financial performance.

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Narrow or Broad Responsibility of Performance

• Incentives work best when individuals see a
  strong link between their actions and performance
  results. Many companies reward division managers
  for both business-unit and companywide
  performance.

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Salary, Bonus, or Stock Rewards

• Some companies stress salary while others stress
  performance-based compensation. Some common
  performance-based compensation plans include
• Cash bonuses.
• Stock awards.
• Stock appreciations rights confers a bonus to
  employees based on increases in stock price for a
  predetermined number of shares.
• Stock options gives an individual the right to
  purchase a number of shares at a specified price
  over a specified time period.

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Ethical Aspects of Incentives and Compensation
A mismatch of executive pay and firm performance
has been widely observed in many types of
organizations. In some cases, the mismatch is the
result of poorly designed incentive systems that
generate high rewards even when stockholders lose
money.
It is likely that regulatory actions will more
closely align executive pay and performance, but
it ultimately it is difficult to mandate
integrity or ethical behavior.
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Incentive Plans in Nonprofit Organizations
Despite differences between for-profit and
nonprofit organizations, nonprofit organizations
increasingly use features of executive incentive
plans developed in the private sector.
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End of Chapter 20