ELEMENTS

Defining performance dimensions

Defining the right performance dimensions involves balancing an organizations’ responsibilities to all of
their stakeholders, including owners (equity holders), debt holders, employees, suppliers, customers,
and the society at large. Should a firm’s sole aim be to maximize shareholder returns, or should it also,
or even primarily, be customer- or employee-focused? Are these performance foci mutually exclusive, or
are they rather mutually reinforcing? Where do performance dimensions such as innovation and
sustainability belong? And so on.

As challenging as defining the desired performance dimensions may be, it is equally critical to choose
performance measures that are congruent or aligned with the chosen performance dimensions because
the goals that are set and the measurements that are made will shape employees’ views of what is
important. Phrased differently, what you measure is what you get. For example, firms may define one of
their desired performance dimensions to be shareholder value creation, and yet measure performance
in terms of accounting profits. This implies that employees are likely to try to improve the measured
performance (in this example, accounting profits) regardless of whether or not it contributes to the
desired performance (in this example, shareholder value). We discuss this problem, and the difficulties
related to this particular example, further in Chapters 5, 10, and 11.

Similarly, firms may aim to pursue innovation, yet they end up measuring patents filed. Anxious to
promote innovation, many companies offer incentives to their employees to develop patentable ideas,
and such incentives are likely to produce results in the form of an increase in the number of patents
filed. But as Tony Chen, a patent attorney with Jones Day in Shanghai, notes, “patents are easy to file,
but gems [can be] hard to find in a mountain of junk.

Measuring performance

measurement is a critical element of a results-control system. The object of the measurement is typically
the performance of an organizational entity or an employee during a specific time period. Many
objective financial measures, such as net income, earnings per share, and return on assets, are in
common use. So, too, are many objective nonfinancial measures, such as market share, customer
satisfaction, and the timely accomplishment of certain tasks. Some other measurements involve
subjective judgments involving assessments of qualities; for example, “being a team player” or
“developing employees effectively.”

Performance measures typically vary across organizational levels. At higher organizational levels, most
of the key results are defined in either stock market terms (such as share price) and/or financial or
accounting terms (such as a return on equity). Lower-level managers, on the other hand, are typically
evaluated in terms of operational measures that are more controllable at the local level. The key result
areas for a manager in charge of a manufacturing site, for example, might be a combination of measures
focused on production efficiency, inventory control, product quality, and delivery time. The variation in
the use of financial and operational performance measures between higher- and lower-level
management creates a hinge in the management hierarchy. That is, at some critical middle
organizational level, often a profit center level (see Chapter 7), managers must translate financial goals
into operational goals. These managers’ goals are defined primarily by financial measures, so their
communications with their superiors are primarily in financial terms. But because their subordinates’
measures are primarily operational, their downward communications are primarily in operational terms.

Setting performance targets

Performance targets are another important results-control element because they affect behavior in two
ways. First, they improve motivation by providing clear goals for employees to strive for. Most people
prefer to be given a specific target to shoot for, rather than merely being given vague statements like
“do your best” or “work at a reasonable pace.” Second, performance targets allow employees to assess
their performance. People do not respond to feedback unless they are able to interpret it, and a key part
of interpretation involves comparing actual performance relative to target. The targets distinguish
strong from poor performance. Failure to achieve the target signals a need for improvement.

Providing rewards

Rewards or incentives are the final element of a results-control system. The rewards included in
incentive contracts can come in the form of anything employees value, such as salary increases,
bonuses, promotions, job security, job assignments, training opportunities, freedom, recognition, and
power. Punishments are the opposite of rewards. They are things employees dislike, such as demotions,
supervisor disapproval, failure to earn rewards that colleagues earn, or, at worst, dismissal.

Organizations can elicit motivational effects from linking the prospect of rewards (or punishment) to
results that employees can influence. For example, organizations can use any of a number of extrinsic
rewards. They can grant additional monetary rewards, such as in the form of cash or stock. They can use
non-monetary rewards, such as by granting high performing employees public recognition and more
decision authority. Alternatively, in entities where performance is mediocre or poor, they can threaten
to reduce the decision authority and power that managers derive from managing their entities or
decline to fund proposed projects.

Results measures can provide a positive motivational impact even if no rewards are explicitly linked to
results measures. People often derive their own internally generated intrinsic rewards through a sense
of accomplishment for achieving the desired results.

Organizations should promise their employees the rewards that provide the most powerful motivational
effects in the most cost-effective way possible. But the motivational effects of the various forms of
reward can vary widely depending on an individual’s personal tastes and circumstances. Some people
are greatly interested in immediate cash awards, whereas others are more interested in increasing their
retirement benefits, increasing their autonomy, or improving their promotion prospects. Reward tastes
also vary across countries for a number of reasons, including differences in cultures and income tax laws.
Conditions determining the effectiveness of results controls

Although they are an important form of control in many organizations, results controls cannot always be
used effectively. They work best only when all of the following conditions are present:

1. Organizations can determine what results are desired in the areas being controlled;

2. The employees whose behaviors are being controlled have significant influence on the results for
which they are being held accountable; and,

3. Organizations can measure the results effectively.

Knowledge of desired results

For results controls to work, organizations must know what results are desired in the areas they wish to
control, and they must communicate the desired results effectively to the employees working in those
areas. Results desirability means that more of the quality represented by the results measure is
preferred to less, everything else being equal.

Ability to influence desired results (controllability)

A second condition that is necessary for results controls to be effective is that the employees whose
behaviors are being controlled must be able to affect the results in a material way in a given time period.
This controllability principle is one of the central tenets of responsibility accounting. Here are some
representative expressions that have stood the test of time of this perennial principle:

It is almost a self-evident proposition that, in appraising the performance of divisional management, no

A manager is not normally held accountable for unfavorable outcomes or credited with favorable ones if
they are clearly due to causes not under his control.

The main rationale behind the controllability principle is that results measures are useful only to the
extent that they provide information about the desirability of the actions or decisions that were taken. If
a results area is totally uncontrollable, the results measures reveal nothing about what actions or
decisions were taken. Partial controllability makes it difficult to infer from the results measures whether
or not good actions or decisions were taken.

Ability to measure controllable results effectively

Ability to measure the controllable results effectively is the final constraint limiting the feasibility of
results controls. Often the controllable results that the organization desires, and that the employees
involved can affect, cannot be measured effectively. In virtually all situations, something can be
measured; but often, however, the key results areas cannot be measured effectively.

The key criterion that should be used to judge the effectiveness of results measures is the ability to
evoke the desired behaviors. If a measure evokes the right behaviors in a given situation – that is, if the
measure can be said to be congruent with the desired results area – then it is a good control measure. If
it does not, it is a bad one, even if the measure accurately reflects the quantity it purports to represent;
that is, even if the measurement has little measurement error.

To evoke the right behaviors, in addition to being congruent and controllable, results measures should
be precise, objective, timely, and understandable. Even when a measure has all of the above qualities, it
should also be cost efficient; that is, the costs of developing and using the measure should be
considered.

Conclusion

This chapter described an important form of control, results control, which is used at many levels in
most organizations. Results controls are an indirect form of control because they do not focus explicitly
on the employees’ actions or decisions. However, this indirectness provides some important
advantages. Results controls can often be effective when it is not clear what behaviors are most
desirable. In addition, results controls can yield good control while allowing the employees whose
behaviors are being controlled high autonomy. Many people, particularly those higher in the
organizational hierarchy but also so-called knowledge workers, value high autonomy and respond well
to it, although they may not always respond well to the measures used, particularly when these suffer
from significant weaknesses in terms of the various measurement properties we discussed.

Results controls are therefore clearly not effective in every situation. Failure to satisfy all three
effectiveness conditions – knowledge of the desired results, ability to affect the desired results, and
ability to measure controllable results effectively – will impair the results controls’ effectiveness, if not
render them impotent. Worse, it could produce dysfunctional side effects, various forms of which we
discuss in later chapters.

That said, results controls usually are the major element of the management control system (MCS) used
in all but the smallest organizations. However, results controls often are supplemented by action and
personnel/cultural controls, which we discuss in the next chapter.