copyright © 2003 pearson education canada inc. slide 24-232 chapter 24 performance measurement,...

Copyright © 2003 Pearson Education Canada Inc. Slide 24-1

Chapter 24

Performance Measurement, Compensation, and Multinational Considerations


Accounting-Based Performance Measurement

Steps to Take in Designing a System

1. Choose variable(s) that represent top management’s financial goal(s)

2. Choose the time horizon for performance measures

3. Choose definitions of the items included in the variables in Step 1

4. Choose measures for the items included in the variables in Step 1

5. Choose a target against which to gauge performance

6. Choose the timing of feedback

Pages 877 - 878


Return on Investment (ROI)

Return on Investment =

• Popular approach to incorporate the investment base into the performance measure

• Includes all the major ingredients of profitability (revenues, costs and investment)

Pages 879 - 880

Income Investment

Return on Investment =

Revenues Investment x

Income Revenues

ProfitabilityTurnover

• Can break out the basic formula as follows (sometimes called the DuPont formula) to measure investment turnover and profitability


Residual Income (RI)

ResidualIncome

Pages 880 - 881

• Required rate of return is also called the imputed cost of capital

• Residual income yields an absolute number

Residual income

= $240,000 – (12% x $1,000,000)

= $120,000

Required rate of return

x Investment= Income -


Problems with Residual Income (RI)

• RI is favoured by some firms as managers will focus on maximizing an absolute dollar amount (dollars of residual income) rather than a percentage (ROI)

• Maximizing a % may result in suboptimal performance• managers earning high ROI%s may reject

projects that earn more than the company’s required rate of return

• managers earning low ROI% may accept projects that earn less than the company’s required rate of return

Pages 880 - 881


Economic Value Added (EVA®)

• EVA uses the weighted-average cost of capital (WACC) as the minimum required rate of return

• WACC represents the after-tax cost of capital from all debt and equity sources

• Many companies also make adjustments to the accounting definition of operating income such as capitalizing (and amortizing) R&D, restructuring costs, and leases

Pages 829 - 831

Economic Value Added

=After- taxOperatingIncome

-Weightedaverage

cost of capitalx

Totalassets -

Currentliabilities


Alternative Measures of Performance

• When calculating ROI and RI, can consider investment as being:• Total assets available• Total assets employed• Working capital plus long-term assets• Stockholders’ equity

• When considering long-term assets, value based on• Current cost• Gross book value (historical cost)• Net book value (historical cost - accumulated

amortization)• Replacement cost (replace productive capacity)

Pages 886 - 889


Distinction Between Managers and Units

• Must distinguish between the performance of the manager and the performance of the organizational sub-unit or division

• Company may put the strongest manager in the weakest division to change its fortunes

• Recognize the role of salaries and incentives in compensation arrangements

• Recognize situations where an employee might less effort than desired because the employee’s efforts cannot be accurately measured and monitored

• Benchmarking or “relative performance evaluation” may be used to filter out the effect of common uncontrollable factors

Pages 891 - 894


Performance Measures

• Providing incentives at the individual activity level may be difficult if employees are performing multiple tasks as part of their job• Must measure and compensate performance on all

aspects of the job and ensure that all aspects are properly emphasized

• In many cases, employees are grouped together in teams to perform certain tasks• May reward individuals on the basis of team

performance• The success of team-based compensation

arrangements depends on the culture and management style of the organization

Pages 894 - 895


Executive Compensation

• Most executive compensation plans are based on a blend of financial and non-financial performance measures including:

• base salary• annual incentives (often based on net income)• long-term incentives (including stock options)• fringe benefits

• Successful combinations emphasize

• achievement of goals• administrative ease• acceptance of the overall package as being fair

Page 895

copyright © 2003 pearson education canada inc. slide 24-232 chapter 24 performance measurement,...

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