week 10 pp slides

8/2/2019 Week 10 Pp Slides

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AF201 Lecture - S2, 2011 1

WEEK 10

PERFORMANCE EVALUATION 1

FINANCIAL PERFORMANCE REPORTS PERFORMANCE MEASURES AND

REWARD SYSTEMS


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AF201 Lecture - S2, 2011 2

DECENTRALISATION

Decision rights

Need increases as the firm grows

Why?

information costly

individual capacity limited


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AF201 Lecture - S2, 2011 3

DECENTRALISATION

Definition - see text book

Costs and benefits of decentralisation -see text


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AF201 Lecture - S2, 2011 4

GOAL CONGRUENCE

Managers committed to goals of an

organisation - but still satisfying

personal goals. Problems?

Self-interests.

Preferences not easily altered


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AF201 Lecture - S2, 2011 5

GOAL CONGRUENCE

How do we achieve it?

Performance evaluation system

Reward system


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AF201 Lecture - S2, 2011 6

RESPONSIBILITY CENTRES

Sub-unit of an organisation

Investment centre Profit centre

Cost centre

Revenue centre


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AF201 Lecture - S2, 2011 7

New developments in organisational

structuring

Financial performance reports

Definition of terms


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AF201 Lecture - S2, 2011 8

Financial Performance Reports

Financial Performance Report

Responsibility centres

Segmented Profit Statements Contribution margin format

Performance of Sub-units versus sub-unit

managers (Exhibit 12.5) Cost allocations common costs


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AF201 Lecture - S2, 2011 9

FINANCIAL PERFORMANCE

MEASURES

Summary financial performance

measures

Return on investment (ROI)

Residual income (RI)

Economic value added (EVA

)


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AF201 Lecture - S2, 2011 10

RETURN ON INVESTMENT

Return on investment (ROI)

capitalinvested

profitinvestmentonReturn =


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AF201 Lecture - S2, 2011 11


turnoverinvestmentxsalesonreturn

capitalinvested

revenuesalesx

revenuesales

profit

capitalinvested

profitROI

=

=

=


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AF201 Lecture - S2, 2011 12


Examine the two components

Return on sales (or profit margin)

Investment (or asset) turnover


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AF201 Lecture - S2, 2011 13


Improving ROI

Increase profit margin

Increase investment turnover


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AF201 Lecture - S2, 2011 14


Advantages

Focus on the profits AND the assets

Relative performance measure


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AF201 Lecture - S2, 2011 15


Limitations

Focus on ST

Asset replacement

New projects


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AF201 Lecture - S2, 2011 16

RESIDUAL INCOME

Residual income

= profit - (invested capital x imputed

interest rate)

What is Imputed interest charge?


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AF201 Lecture - S2, 2011 17

RESIDUAL INCOME

Advantages

Goal congruence

Required rate of return

New projects


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AF201 Lecture - S2, 2011 18

RESIDUAL INCOME

Limitations

Different-sized businesses

Biased

Short-term focus


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AF201 Lecture - S2, 2011 19

ECONOMIC VALUE ADDED (EVA)

What is it?

EVA = Net operating profit after tax -

{ Wt. Av. Cost of cap. X (T.A. - CL)}

Stern Stewart

Advantages & limitations same as RI


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Reward systems

Processes, practices and systems which are used to provide

levels of pay and benefits to employees

Motivation

The processes that account for an individuals intensity,direction and persistence of effort towards attaining goals

Intrinsic motivation

Derives from the interest and enjoyment of the work

Extrinsic motivation

Derives from sources outside the individual

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Theories of motivation

Herzbergs theory of work motivation

Hygiene factors

Provide the setting for encouraging employee motivation, but

do not themselves motivate employees Working conditions, wage levels, rules and regulations,

relationships with colleagues, job security

Motivators

Factors that relate to job content and which provide

employee motivation Achievement, recognition, the nature of the work,

responsibility, opportunities for personal growth

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Theories of motivation

(cont.)

Expectancy theory

Employee motivation is a result of the strength of the

relationships between expectancy, instrumentality and

valence

Expectancy: perception that effort will lead to a certain

performance

Instrumentality: perception that performance will lead to

desired outcome

Valence: the attractiveness of the reward Motivational theories need to be considered by managers

when they are designing performance evaluation and reward

systems

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Performance-related

reward systems

Performance-related pay systems (incentive compensation

schemes)

Link employee rewards for achieving or exceeding some

performance target

Individual incentive plans

Individuals are rewarded for achieving individual

performance targets

Subjective criteria may also be used

Common at the senior levels of the organisation

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Performance-related

reward systems (cont.)

Profit-sharing plans

Cash bonuses are paid to each employee, based on a

specified percentage of the companys profit

Does not tie individual effort to individual rewards Employee share plans (share option plans)

Provide employees with the right to purchase shares in

their company, at a specified price at some specified future

time

Commonly used for senior managers, and sometimes morejunior managers and employees

Considered to encourage goal congruence

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Performance-related

reward systems (cont.)

Gainsharing

Cash bonuses are distributed to employees when the

performance of the company, or their segment of the

company, exceeds some performance target

Team-based incentive schemes

Individuals are rewarded based on their work team

exceeding certain performance targets

Intended to encourage teamwork and cooperation between

employees Does not tie individual effort to individual rewards

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Group versus individual

performance

Consider the following issues

Identification with the group

Equity among employees

Competitiveness between employees Relating individual effort to reward

Rewarding only good performers

The timing of incentive payments can be crucial to achieving

desired outcomes

More frequent rewards may help ensure continual

motivation

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