ACC 531 Final Exam

What effects might the PPP have?

- As motivation increases, quantity should increase. - But quantity may not increase due to controllability issues and interdependency problems. - Quality may also be affected since it is not incentivized, technicians have an incentive to "rush." This creates an alignment problem.

What is the issue with not validating the links (i.e., mistake two)?

- Believing that linkages are "obvious" - Companies rely on preconceived beliefs - The idea is that we need to correct the issue with triangulation - We need to spend time finding multiple measures - We need to adopt the scientific method of trying to disprove it. - The importance is identifying independent and dependent variable, data gathering, and proving it.

What does Jensen's optimal compensation plan system look like?

A linear (sloping) compensation line. - No minimum safety net - No cap

What was the organizational architecture of Safelite prior to 1993? What were the consequences?

- Decentralized. - Individual shops were profit centers. - Stores were hard to find because incentives were only based on store number growth. - Some stores were maxed out with work, but others were idle. (Due to heavy decentralization, they had no incentive to cooperate).

How are standards selected for variances?

- History - Market trends - Benchmarking - Bottom-up (participative) budgeting - Negotiation - Goal setting

How could motivated reasoning affect performance evaluation?

- Ignore bad news - Overweight on good news - Stop information search when things look good... but keep searching when things look bad. - Interpret ambiguous news as good. *Very similar to confirmation bias*

How does the informativeness principle affect incentive systems?

- Incentive problem is an information problem. - Inefficiencies from incentive problems can be reduced by improvements in information. - Any informative indicator should be included in the contract.

How does multitasking affect incentive systems?

- Many jobs include multiple tasks. - Differences in measurability can distort incentives/allocation of effort. - You get what you measure... if X and Y are important, better measure BOTH.

How does the three-legged stool balance?

- Measure performance over areas where agent has decision rights. - Reward performance that is being measured. - Don't assign decision rights if the exercise of those rights cannot be measured and rewarded.

Why do we need balanced scorecards?

- Multiple measures are easy to manipulate, but most jobs are multidimensional and require multiple measures to summarize and review performance. - Even when you find one single measure it can be gamed and is usually a combination of multiple measures. - Balanced scorecards help us understand our objectives and find appropriate measures to proxy for these objectives and establish causal links.

What is the issue with measuring incorrectly (i.e., mistake four)?

- Need to have validity and reliability. - You are measuring the right thing, but using it wrong (capturing the wrong measure)

What are the optimal conditions for piece-rates?

- Output is easily measured in terms of value create (i.e., quantity AND quality). - The employee engages in few important tasks other than those that are easily measurable (as unmeasured duties may be neglected). - Interdependencies are not so high as to minimize the impact of individual effort. - Uncontrollable factors are not too influential.

What are the main assumptions Zimmerman makes?

- People try to maximize their utility (self-interested behavior) within constrained resources. - People create teams and work together to overcome constrained resources and increase their options. - Markets automatically (1) allocate decision rights, (2) measure performance, and (3) reward performance/incentives. - Firms need to create organizational architecture to mimic what the market automatically does. - Principals and agents have different underlying preferences and we use incentives to get agents to behave like their preferences align with the principal's (goal congruence). - Firms use culture or peer pressure to change behavior. - All economic resources or assets are bundles of decision rights with respect to how they can or cannot be used. - Firms use contracts to enforce the organizational architecture.

What is the issue with not linking measures to strategy (i.e., mistake one)?

- People use the BSC like a checklist without real thought. - Companies do not spend enough time thinking (making an effort-driven educated guess) and creating a causal model chain - If you cannot test it, then it isn't real - You require rigor in finding and mapping a real strategy and appropriate proxies.

What happens when balanced scorecards are used incorrectly?

- Scorecards are "templates" when done incorrectly - Benchmarking and using templates can lead to a "move to the mean." - Strategy is about doing different and NOT being average. - Many companies add scorecards just because they represent "best practices" but do not understand that they need their own scorecard unique to them.

Why was Mobil ripe for BSC implementation?

- They were highly centralized (only top management cared about strategy) and became decentralized. - They cut one leg of the stool and they needed to make people buy in and care about strategy via measurement and incentives.

What is the "litmus test" for a scorecard?

- You would never lose it because it is so deep, specific, and particular because it is your game plan. - Scorecards are NOT templates, they matter and relate to really understanding who you are and what you are going to become. - Real strategy is like revelation; it is personal.

What are types of bias?

1. Availability heurisitc - People base their predictions, assess probabilities, and judge causality based on how easily an example can be brought to mind - E.g., what kills more people each year, sharks or lawn mowers? Most people think sharks due to the news, but in reality it is lawn mowers killing kids. 2. Motivated reasoning - People tend to evaluate evidence in ways consistent with their preferences.

What are the four types of control systems?

1. Belief System - E.g., mission statement - Necessarily vague, so as not to restrict opportunity-seeking - Used to communicate and reinforce core values (ethical and strategic) 2. Boundary System - E.g., code of conduct, strategy constraints - Specific guidelines that bound strategy and behavior - Design and use follows from analysis of strategic behavior and risks to be avoided. 3. Diagnostic Systems - E.g., variance analysis, budgeting - 99% of traditional management control systems - Focus on information feedback and corrective action - Measurement of critical performance variables associated with intended business strategy 4. Interactive Systems - E.g., monthly meetings with executive team, weekly reports on trends - Top management's "hot button" - Intended to generate organizational learning and shape emerging strategy

What are the benefits of decentralization?

1. Creates greater responsiveness to needs of a subunit's customers, suppliers, and employees - Good decisions cannot be made without good information. - Subunit managers typically have better information than top management regarding local issues, reducing costs, improving quality, and local performance. - Kodak uses decentralization and suggests they are benefited by an "increase in the company's knowledge of the marketplace and improved service to customers." 2. Leads to gains from faster decision making by subunit managers - Faster decision making creates a competitive advantage over centralized organizations. - E.g., Delegating decision making to the sales force may allow a firm to respond faster to changing customer requirements. 3. Increases motivation of subunit managers -Decentralization = Creativity = Productivity -Managers are more motivated and committed when they can exercise initiative. 4. Assists management development and learning - By giving managers more responsibility, this helps develop an experienced pool of management talent to fill higher-level positions in the company. 5. Sharpens the focus of subunits managers, broaden the reach of top management - Subunit managers can have a concentrated focus (e.g., their geographic area), allowing those above them to focus on strategic planning for the entire organization. - Allows for "Big Picture" vs. "Day to Day" guys.

What are the two roles of management accounting information?

1. Decision facilitating - How are we doing? - Do we need to re-evaluate our strategy? - Or do we need to change the tactics we use to achieve our goals? 2. Decision influencing - My employees are self-interested. So... - How can I influence them to do what I want?

Who are Mobil's customers?

1. Franchise dealers (gas stations with convenience stores 2. Direct to customer stations (end consumers at all Mobil stations)

What challenges exist for subjective performance evaluation?

1. Inaccurate evaluations - Reduced motivation, suboptimal behavior, poor information for decision-making 2. Bias 3. Supervisors don't like evaluating others - Information gathering - Psychological costs of giving low ratings, distinguishing among employees - Confrontation - Appeals - Influence activities 4. Uncertainty about criteria

What are the costs of decentralization?

1. Leads to suboptimal decision making - Because top management has given up control over decision making, it subunit managers do not have necessary expertise/talent to handle this responsibility, the company is worse off. - Suboptimal / incongruent / dysfunctional decision making occurs when a decision's benefit to one subunit is more than offset by the costs to the organization as a whole. 2. Manager's attention is on the subunit rather than the company as a whole - Individual subunit managers may regard themselves as competing with managers of other subunits in the same company as if they were external rivals. - They view relative performance as more important than firm performance. - "Rival" managers may not help other subunits during emergency situations. - E.g., Nintendo wants a rush order for unexpected Australian demand for the Wii, but Japanese Nintendo manufacturers don't want to alter their cost schedules to accommodate another subunit, although it would benefit the entire company (this is also an example of suboptimal decision making). 3. Results in duplication of output - If subunits provide similar products or services, their internal competition could lead to failure in the external markets. - By mimicking each other's successful products, rather than those from outside firms, they only re-divide the company's existing market share and confuse customers. - E.g., GM confused customers with its competing divisions: Oldsmobile, Pontiac, and Saturn. 4. Results in duplication of activities - Even if subunits operate in distinct markets, several individual subunits may undertake the same activity separately. - E.g., Human resources or information technology. - Centralizing these functions helps to streamline and use fewer resources for these activities, ending wasteful duplication.

What are the benefits of subjective performance evaluation?

1. Mitigating incentive distortions - Capture value-enhancing efforts that are not easily quantified - Reduce excessive short-term focus 2. Reducing risk - Filter out uncontrollable events - Adjust performance targets 3. Limiting vulnerability to manipulation - Reduction in manipulation when objective measures can be improved through dysfunctional behavior 4. Reducing perceptions of unfairness - Restore perceptions of effort/compensation alignment.

What are the problems with a linear compensation plan?

1. No minimum safety net - You have risk averse employees 2. No cap - Employers are very uncomfortable with his idea. - Managers could see employees making more money than them.

What are the major components of the balanced scorecard?

1. Scorecard Perspectives: Categories of performance the organization cares about. (Not set in stone) 2. Strategic Objectives: Statements that define the purpose of actions taken in the organization. Usually action oriented ("Become X," "Increase Y," etc.). 3. Scorecard Measures: One or more measures represent (proxy for) the more abstract strategic objectives. 4. Targets: Levels of performance, or rates of improvement, that need to be achieved on the designated measures. 5. Strategic Initiatives: Actionable plans intended to affect performance in targeted objectives. 6. Strategy Map: A collection of predicted causal connections between strategic objectives. 7. Strategic Learning: We can test these predictions using data from our measure proxies and statistical tools to control for exogenous factors that might also influence the measures.

What should a transfer price do? What are the criteria for evaluating a transfer price?

1. Transfer prices should promote goal congruence 2. Transfer prices should induce managers to exert a high level of effort - E.g., subunits should be focused on keeping down costs and acquiring and using inputs efficiently. 3. Transfer prices should help top management evaluate the performance of individual subunits 4. Transfer prices should preserve a high degree of subunit autonomy in decision making - This criterion assumes a high degree of decentralization in the company.

What makes a variance favorable or unfavorable?

A favorable variance is one which, when considered by itself increases profit relative to the budgeted amount. An unfavorable variance is one which, when considered by itself, decreases profit relative to the budgeted amoung.

What is adverse selection?

Adverse selection deals with "hidden information." For example, when one party has more information than the other. An example is life insurance, where the insured has more information (especially about their individual health) than the insurance company. It also is reflected in lemons in the used car market. The solution to adverse selection is information gathering. For example, when buying a car you use CARFAX or get your own mechanic to check out the car. In hiring, we use job interviews and letters of recommendation.

How do agents view incentives?

Agents prefer to be paid based on EFFORT. If not possible, at least get some fixed amount so risk is minimized. Outcome = f(Effort, other factors) Agents focus on the "other factors" as an uncontrollable part of the outcome and their compensation. All else equal, individuals tend to prefer less volatile income streams (i.e., they are risk averse). Uncertainty creates risk, for which the agent must be compensated.

Why are most performance measures imperfect?

Alignment problem - It's common to care about dimensions of effort that are difficult to quantify - When a job requires multiple tasks, it is typically the case that performance regarding some tasks is easy to measure (e.g., on-time deliveries) relative to other tasks (e.g., courteous deliveries). - Individual performance measures (e.g., on-time deliveries) are incomplete ("distorted") and therefore not perfectly aligned with value creation. Controllability problem - Objectively measured performance is often influenced by factors beyond the agent's control Interdependency problem - Objectively measured performance is often the result of the efforts of multiple agents

What is a control?

Any mechanism imposed by management to encourage (or discourage) a specific behavior. Controls (extrinsic) increase effort but do so at the expense of trust, which can also motivate behavior (intrinsic). The issue is finding the right balance between trust and controls to get the level of effort desired.

Is the Church centralized or decentralized?

Both. If everything is run by the spirit's influence, then we are perfectly centralized. The Church, however, has a very structured form of decentralization. - Administration is centralized - Ministering is decentralized

How does the breadth of a measurement affect incentive systems?

Broader 1. Controllability problem is larger - Measure not "responsive" - Noisier representation of individual performance 2. Alignment problem is smaller - Less likely to distort behavior 3. Interdependency problem - Incentive to cooperate is strong - Potential for free-riding is significant Narrower 1. Controllability problem is smaller - Measures are "responsive" - Less noisy representation of individual performance 2. Alignment problem bigger - More likely to distort behavior 3. Interdependency problem - Incentive to cooperate is weak - Potential for free-riding is minimized

What are examples of formal (traditional) control mechanisms?

Budgets, financial measurements, variances, targets, internal controls, etc. Traditional controls are "used to measure progress against plans in order to guarantee the predictable achievement of goals."

What are the forces that are moving the business world more toward decentralization?

COMMUNICATION Technology has made transferring information very easy. Communication was key to the evolution of society, and it is the key to the decentralization of businesses.

What are variances?

Comparisons of what actually happened with what we expected. - Based on standards - Based on expectations

What is contracting theory and how does it apply to tying incentives to measures?

Contracting theory suggests an ideal performance measure for incentive purposes would be a measure that reflects an employee's true contribution to firm value. This measure does not exist, it is like a magical unicorn.

How does the firm address the three legs of the organizational architecture?

Contracts 1. They allocate decision rights; i.e., centralized vs. decentralized decision-making. 2. They measure performance; i.e., input vs. output, measure characteristics. 3. They create an incentive structure; i.e., form/structure compensation and non-monetary rewards.

How do contracts balance principal and agent views on incentives?

Contracts include both fixed (risk reducing) and variable (effort inducing) components. Risk-incentive trade-off. Effort incentives are linked to performance-based pay. Fixed-pay helps reduce risk, but reduces effort incentives.

Which method of transfer price is most commonly used? Why?

Cost, because it is easy.

What does Jensen say about a curvilinear plan?

Curvilinear plans are a bad idea - they are a bad compromise, too. They encourage managers to increase the variability of year-to-year performance measures, as it reintroduces a strong incentive for gaming.

Jan van der Schmidt, founder of a successful chain of restaurants in Europe, has died unexpectedly. Jan was the sole owner of the company's stock and was known for being authoritarian. He personally made most of the company's personnel decisions. He also made the decisions on menus, suppliers, and marketing. Employees throughout the firm are paid fixed salaries and were closely monitored by van der Schmidt. Jan's son, Karl, spent his youth driving BMWs around Holland and Germany at high speeds. He spent little time working with his father in the restaurant business. Nonetheless, Karl is smart and just received his MBA degree from INSEAD. Karl has decided to follow his father as the COO of the restaurant chain. What advice about organizational architecture do you wish to give Karl?

Decentralize decision rights. Decision rights should be given to those who have the requisite knowledge to maximize value of the firm. Change the salary (incentive) to match Karl's new goals, allowing delegation of decision rights. Change the way performance is measured. (Remember the obvious solution is never seen until someone says it.)

What is a subjective measure?

Depends on opinion or preference; e.g., how much do you like someone.

What does Jensen say about goal setting as a motivator?

Jensen believes that simple single measures are best (NOT ratios). What is hard wrong about "perfectly aligned measures?" - You lose precision of individual performance and controllability.

What is good about the competitive performance model?

Employees will work harder. But it is also a problem in that it decreases the incentive to increase the business of other divisions.

Issues regarding responsibility centers?

Fairness - each responsibility center manager has reasonable control over the elements of the profit equation (price, payer mix, case mix, volume, variable cost per unit, and fixed costs) for which he/she is responsible. Goal Congruence - each manager, pursuing the best interests of his/her responsibility center, is simultaneously pursuing the best interests of the firm overall.

How does favorable/unfavorable work for FOH Volume variance?

Favorable is when we got more than expected out of our fixed capacity Unfavorable is when we get less than expected out of fixed capacity

What tensions exist in budgeting at HCC?

For planning, top management wants information from division managers and line workers (bottomup communication) But then top management will turn around and use that information to set goals and incentive schemes (control) Jensen's solution is for top management to promise not to use managers' information to determine incentive schemes - Very few companies are willing to do this!

What is the key takeway of the Celtax Case?

How quickly are you going to abandon decentralization when you encounter its costs. If you give it up, you give up all of decentralization's benefits.

What are the problems with kinks in traditional compensation plans?

If you cannot make the hurdle, then you are incentivized to "take a big bath." If you hit the cap, then you have incentive to do real earnings management. When performance approaches the hurdle target, a manager has a strong incentive to accelerate the realization of revenue and profit. When performance hits the cap, the manager has a strong incentive to push revenue and profit into the next year. If the manager concludes that she cannot make the minimum hurdle, her incentive is to move earnings from the present to the future

What does it mean to take a big bath?

If you're going to take a loss, take as big a loss as possible. If the manager concludes that she cannot make the minimum hurdle, her incentive is to move earnings from the present to the future. This is because her compensation remains unchanged if she does not reach the goal, but by shifting revenue and profits to the future period, she increases her chances of getting a large bonus the following year.

What are the effects of incentives on effort?

Incentives (extrinsic motivation) increase effort, but so does intrinsic motivation. However, extrinsic incentives can "crowd out" good or desirable behavior. Therefore, the behavioral impact is all about framing.

Who should hold decision rights?

Individual decision-making capacities are limited, due to limited capacity and cost to acquire, store, and process information. - For example, Steve Jobs was unable to make all the decisions at Apple. - Assigning decision rights should be driven by an effort to maximize decision-making capacities. However, the right to make a decision and the knowledge to make it usually reside within the same person. - If the knowledge is cheap to transfer, then the knowledge should be passed onto the decision-maker and that decision right does not have to be delegated. - If the knowledge is expensive to transfer (e.g., technical knowledge) or not useful after the passage of time, then the decision rights should be delegated to the person who has the appropriate knowledge. Ideally, knowledge and decision rights are linked, but they do not always reside within the same person. - Yet, if large agency costs arise if the person with the knowledge has the decision rights, then maybe a less knowledgeable manager out to make the decisions. - E.g., salespeople who definitely know their customers cannot change prices, only their managers, who know less about the customers, can. But that prevents abuse by salespeople.

What does Jensen say about the use of multiple measures?

Jensen says to be wary of establishing multiple measures of performance. He argues that although it can help managers to think more broadly about the operating and economic drivers of business success, it adds complexity to the system that can impede decision making. E.g., goal incongruence will eliminate a manager's ability to act purposefully. To have multiple measures you need a balanced scorecard.

What are the different types of transfer prices?

Market - Competitive market - Imperfect market Cost - Absorption - Cost-plus - Variable Hybrid - Negotiation

What is moral hazard?

Moral hazard deals with "hidden actions." Agents take actions that the principal cannot direct observe and that they would not like if they knew. For example, in the case of an auto accident, the insured would say that a pre-existing dent in the car was a result of the accident so that it too could be fixed. This lie is detrimental (cost-wise) to the insurance company who fixes a false claim. The solution to moral hazard is to monitor inputs and tie incentives to output; i.e., measure performance and have an incentive plan. Just remember that the more risk you ask the agent to take on, the more you have to pay.

How can subjectivity in performance evaluation help with the interdependency problem?

Peer evaluations - You need to be able to reduce noise and look for patterns -- You want to avoid forulaic measures - The biggest issue is bias

According to Ittner and Larcker, why are firms "coming up short" on nonfinancial performance measurement?

People are not using BSC correctly: Mistake One: Not Linking Measures to Strategy Mistake Two: Not Validating the Links Mistake Three: Not Setting the Right Performance Targets Mistake Four: Measuring Incorrectly

What role does framing play in incentives?

People will start to look at actions from an economic point of view. Penalties for late pickups at a day care led to more occurrences, as parents stopped thinking about it as being rude to seeing it as an economic transaction. Controls can affect the behavior people believe is appropriate given the setting. A manufacturer could run costly "scrubbers" to reduce pollution. If the decision to run them or not was not monitored, then it is an "ethical" decision. With audits, however, this became a "business" decision and people chose whether or not to run them based on the cost and chances of getting caught.

What issues arise from transfer pricing?

Policy issues: E.g., should divisions be permitted to source externally when internal goods are available? Operational issues: E.g., at what price should a transfer be made between two internal subunits?

How does the market address the three legs of the organizational architecture?

Prices.

How do principals view incentives?

Principals prefer to observe output (well-aligned output) and link output to reward. Outcome = f(Effort, other factors) The outcome is observable, but the effort and other factors are not... So principals focus on what they can observe.

What are the typical types of responsibility centers?

Profit, investment, expense, revenue

Other (less-used) transfer pricing models

Prorated Difference - Without negotiations, a company could choose to set the price at the midway point between the seller's minimum acceptable price and the buyer's maximum acceptable price. Dual Prices - For managerial accounting purposes, we can use different prices for the buying and selling divisions.

What are examples of incentives?

Recognition (employee of the month), gratitude expressed by management, good work assignments, monetary compensation (bonus, salaries), relationships/autonomy, time-off

What is measure reliability

Reliability = the measure reveals actual performance changes without introducing errors (i.e., noise) of its own

Why was turnover of Safelite installers so high?

Seasonality, "buck and a truck", total transferability of skills to competitors.

What is an objective measure?

Something definable; e.g., score of a multiple quiz.

What is the real culprit of all the problems at Berkshire Toy Company?

The Incentive System! 1. Failure to recognize interdependencies: - Marketing hurt production, its sales were outside the relevant range in which production standards were developed - Marketing hurt purchasing via stockouts, rush orders, & expensive accessories - Purchasing hurt production via inferior materials - Production & Purchasing hurt marketing via lower quality materials and output 2. Rewarding marketing manager for all sales, regardless of contribution to profit - Increased sales volume by decreasing price - Increased sales volume by giving customer higher value (e.g., more accessories) - Increased sales volume without regard to current production capacity 3. Rewarding purchasing manager for low costs, regardless of quality

What is a decision right?

The ability to make a decision. Decision rights are broken down into four steps: (1) Initiation (management) E.g., the request to hire a new employee (2) Ratification (control) E.g., the approval of the request (3) Implementation (management) E.g., hiring the employee (4) Monitoring (control) E.g., assessing employee performance, reflecting on the person who hires the employee.

What is the horizon problem?

The agent is going to leave or end employment sooner than the principal. The agent will, therefore, make choices to benefit the short-term at the cost of the long-term (i.e., the principal is hurt due to short-term thinking). E.g., a soon to be retiring manager may forego a long-term profitable engagement that would negatively affect his compensation in the short-term but greatly benefit the company and his replacement's compensation in the long-term.

What are agency costs?

The cost of aligning preferences or leaving them unaligned. This is the cost of the principal-agent relationship. An example is when an airline had to leave a broken plane idle at an airport because a manager's self-interest is to not break budget by sending a mechanic over ASAP, which would require the manager paying for a hotel room. Instead the manager choose to save $100 and retain his bonus, but realistically cost the company $1000 in lost income.

What is responsibility accounting?

The firm is divided into segments, creating responsibility centers. Accounting system traces costs and revenues to specific responsibility centers or units within the firm.

What is a transfer price?

The price one subunit charges another for a product/input. In decentralized organizations, transfer prices are used by the management control system to coordinate the actions of the subunits and to evaluate their performance. Transfer prices are great if they help with goal congruence, manage effort, assist in subunit performance evaluation, or subunit autonomy. Transfer price may be market-based (price), cost-based, or hybrid.

What is the agency problem?

The principal agent problem is due to information asymmetry. Two forms of the agency problem are adverse selection (hidden information) and moral hazard (hidden actions).

How does Zimmerman suggest addressing goal incongruence?

The problem is that self-interested employees cannot easily have their goals altered, thus changing the underlying preferences of all employees' utility functions to mirror the principal's is unrealistic. The common solution is to structure agents' incentives so that when agents maximize their utility (e.g., compensation) that principals' utility (e.g., wealth) is also maximized. Thus incentive schemes - not changing underlying preferences - is what overcomes goal incongruence.

How does moving Jensen's line to the right or left, or changing the slope, affect compensation?

The slope and position of the line deal with risk aversion of employees and expectations (e.g., budgets).

Why are ratios bad performance measures?

The use of ratios induces gaming the system because managers can reach targets by increasing the numerator or decreasing the denominator.

What is Zimmerman's formula for "balancing" the three legs of the organizational architecture of the firm?

There is no formula or perfect solution to balancing the stool.

Why did Mobil use sub-teams?

These different teams are split into the different BSC perspectives and then segments within each perspective/

Why do formal controls deteriorate trust?

They signal management's level of trust (or lack thereof). They affect how employees see the situation; e.g., "if controls are needed at the Testing Center, then cheating must be an option." They affect the factors to which good behavior is attributed.

What is wrong with the cost accounting at Darby & Larkin?

They use the wrong driver for allocating costs. Bankruptcy uses almost no administrative resources but has tons of billable hours, so lots of administrative expenses have been allocated to this division.

What is the issue with not setting the right performance targets (i.e., mistake three)?

Think about this example. Is every customer worth the same? - Should you try to delight every customer 100%? No! - You need to understand what is the actual benefit. - You should change your behavior based on actual value-added - Going overboard is wasteful - Having top quality, for example, only gives you benefit to a point.

Does decentralization mean companies will get smaller?

Thomas Malone argues that decentralization will decrease the size of companies. He argues that large organizations fragment into smaller ones and company hierarchies become looser to gain certain desirable characteristics of decentralized organizations. His research suggests that decentralization creates smaller companies and increases their market value. However, decentralization does not necessarily have to mean companies get smaller. Some very successful large companies are run in a decentralized manner, especially because communication makes it possible.

How can subjectivity be used to make measurements better?

Three ways: 1. The use of subjective performance measures. 2. Ex post flexibility in the weighting of objective performance measures - Clearly laid out measures lead to objectivity and may constrain creativity - Management may not know what they want - Management may need to respond to the unexpected - Ambiguity can be helpful in avoiding conformity 3. Ex post discretionary adjustments (to objective measure, or to formulaic bonuses) based on factors other than the objective performance measure. - HCC changed the actual target for one division.

What is measure validity?

Validity = the measure captures what it is supposed to capture.

What are two of the key takeaways from the Domestic Auto Parts BSC activity?

Value-added relationships are only sustainable if both sides get value from the other: a two-way street. When you make your strategy map, it is top down. - Find the causal links - The meaning of the objectives is often in the measures.

What errors did Wells Fargo make in its most recent fraudulent activity?

Wells Fargo had to change their incentives because they have the wrong measure. It encouraged the wrong thing, which led to fraud. Wells Fargo experienced Mistake 1 and Mistake 2: Mistake One: Not Linking Measures to Strategy Mistake Two: Not Validating the Links

Interactive Control Systems What are they? How do they differ from diagnostic controls?

What are they? - Interactive control systems are the formal information systems that managers use to involve themselves regularly and personally in the decisions of subordinates. - They can turn a diagnostic control into a venue for communication and participation between managers and senior management. How do they differ from diagnostic controls? (1) They focus on constantly changing information that top-level managers have identified as potentially strategic. (2) The information is significant enough to demand frequent and regular attention from operating managers at all levels of the organization. (3) The data generated by the interactive system are best interpreted and discussed in face-to-face meetings of supervisors, subordinates, and peers. (4) The interactive control system is a catalyst for an ongoing debate about underlying data, assumptions, and action plans.

Diagnostic Controls: What are they? What are they good for? What happens if these are your only controls?

What do they look like? - Budgets, financial measurements, variances, targets, etc. What are they good for? - Having objective data What happens if these are your only controls? - The risk is that people will do anything to reach those goals; e.g., gaming the system.

Belief Systems What are they? What are they good for?

What do they look like? - Mission statements, creeds, tone-at-the-top, etc. What are they good for? -They are good for helping (positively) influence intrinsic motivation. This helps employees have positive vision and allows for decentralization. Just remember that senior management must believe and act in accordance. An example is the Honor Code; i.e., it is a focus on integrity.

Boundary Systems What are they? What are they good for? What are the consequences for passing these boundaries?

What do they look like? - These control systems explain what NOT to do. What are they good for? - Boundary systems are the foil to belief systems. They help focus employees on accomplishing goals within predetermined limits - Boundaries allow innovation when tied to a belief system by focusing their ability toward company goals. What are the consequences for crossing a boundary? - Severe; e.g., usually termination.

What is a static budget?

What you expected before the period began.

What is a flexible budget?

What you would have expected had you known actual output/sales quantity (i.e., what should it have cost to do what was actually done).

What is channel stuffing?

When managers ship loads of products to distributors to meet immediate sales goals, even though they know many of the goods will soon come back as returns. When performance approaches the hurdle target, a manager has a strong incentive to accelerate the realization of revenue and profit. E.g., she has an incentive to move up revenue from the next period.

What is surrogation?

When you care more about the measure than the objective. E.g., Home Teaching - we care about the visit, not the substance of the visit, nor the purpose of being a home teacher (i.e., being a shepherd).

Why was the productivity of the Safelite installers so low? Is this agency problem a moral hazard or adverse selection problem?

Wrong parts, wrong address, customers not at site, low effort for technicians (no incentives) with guaranteed wages, demand is seasonal. This issue is a moral hazard problem (hidden action).

What is free riding?

Zimmerman assumes that we are all naturally lazy. When we work in groups, the individual inputs are hard to distinguish, therefore, we tend to only observe the output; i.e., group performance. People, knowing this problem, would rather shirk their responsibilities since it is hard to gauge that they were the issue. E.g., group work in school, where one person does little to no work, but the rest of the group, knowing that the outcome affects their grades, does the majority of the work. Yet everyone receives equal credit for the output.