Slide 11.

Chapter 11:
Remedies to the Myopia
Problem

Sulthan Hakim/ 145020308121003

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.2

We seek
a measure,
or a combination of measures,

that leads managers and employees to take

the right actions or make the right decisions
in order to create long-term value

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.3

But
Financial measures of performance often are not, by themselves, sufficient
to motivate optimal management decisions

Worse, financial measures often create pressures for short-term

performance potentially at the expense of long-term value creation

The myopia problem

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.4

Overcoming
myopia
Reduce pressure for short-term profit
Reduce the weighting placed on the annual profit target
and emphasize other, longer-term performance
indicators, such as market share and technical break-
throughs
Use subjective performance evaluations?

Make the short-term profit targets easier to achieve

Some slack is created to fund longer-term projects
But, motivational effects of easy targets?

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.5

Overcoming myopia (continued)

Control investments with preaction reviews
Operating expenses Developmental expenses
Today businesses Tomorrow businesses

Combination of non-financial
Financial results controls
performance indicators
and action controls

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.6

Overcoming myopia (continued)

Extend the measurement horizon

Measurement congruence

The longer the period of measurement, the

higher the correlation between accounting
income and economic income

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.7

Overcoming myopia (continued)

Measure changes in shareholder value directly

Valuation difficulties
Measurement precision and objectivity of future cash
flows for non-publicly traded entities?

Cost
Expensive to do on a recurring, ongoing basis

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.8

Overcoming myopia (continued)

Improve accounting profit measures

Adjust depreciable lives of fixed assets, adopt

current-value depreciation, charge depreciation
for older assets
Capitalize expenditures related to long-term
investments
Recognize profits more quickly
Impute a cost of equity on income statement
Put leases on the balance sheet, etc.

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.9

Overcoming myopia (continued)

Measure a set of drivers of future financial
performance
Use non-financial performance measures

Balanced scorecard
The BSC includes financial measures that tell the
results of actions already taken
It complements the financial measures with operational
measures on customer satisfaction, internal processes,
and the firms innovation and improvement activities

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.10

Template Balanced Scorecard

Financial Perspective
How do we look to
our shareholders?

Customer Perspective Business Processes

How do we look to
Vision What business
our customers? Strategy processes are the
value drivers?
Learning and Growth
Are we able to sustain
innovation, change, and
improvement

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.11

A Balanced Scorecard
Tells the story of your strategy
Every measure is part of a chain of cause and effect
linkages

All measures eventually link to organizational outcomes

A balance exists between outcome measures (financial,

customer) and performance drivers (customer value,
internal processes, learning, and growth)

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.12

Why do Companies Need a BSC?

The source of value has shifted from tangible to intangible assets1

percentage of market value related to

Intangible 38% 62% 85%

Assets

Tangible
Assets 62% 38%

15%

1982 1992 2000

1 Slide adapted from Robert S. Kaplan

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.13

Creating value from intangible assets is different

Intangible assets do not have a direct impact on financial results

They have second- or third-order impacts1

Training

Service Customer Customer

Revenue
Quality Confidence Retention

Information
Technology

1 Slide adapted from Robert S. Kaplan

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.14

Evaluating the BSC-approach

Are BSCs balanced?

What is the proper weighting to achieve balance

Among the four perspectives?
Among the two dozen measures?

Average weights in a study of 60 BSC firms by Towers Perrin (1996):

Financial 56%
Customer 19%
Internal business 12%
Innovation and learning 5%
Other 8%

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.15

Evaluating the BSC-approach (continued)

We never figured out how to use the scorecard
to measure performance. We used it to transfer information, a lot of
information, from the divisions
to the senior management team. At the end of the day, however, your
performance depended on
your ability to meet your targets for contribution
to bottom-line profits.

Senior manager in a large financial institution.

Quoted in M.C. Jensen, Value maximization, Stakeholder Theory,
and the Corporate Objective Function, Journal of Applied Corporate
Finance (Fall 2001), p. 19.

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.16

Evaluating the BSC-approach (continued)

Do employees make the right tradeoffs?
For example, throughput and labor productivity are possible
measures in the internal business process perspective, and costs
and profits are common measures in the financial perspective

Throughput can be increased by forcing employees to work

more overtime, but as fatigue sets in, labor productivity will
decrease

The overtime is also costly, so there is a cross-dimension

tradeoff between throughput and many financial measures,
such as costs and profits

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.17

Evaluating the BSC-approach (continued)

How to tie BSC-performance to incentives?

In the short term, tying incentive compensation of

managers to a balanced set of scorecard measures will
foster commitment to overall organizational goals, rather
than suboptimization within functional departments

Whether such linkages should be explicit or applied

judgmentally will likely vary from company to company.

More knowledge will undoubtedly continue to be

accumulated in the years ahead

Kaplan and Norton, 1996

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.18

Evaluating the BSC-approach (continued)

How to measure important nonfinancial areas?1

Extremely High Quality

6 of Measurement
Important

5
Gap
4

2
Extremely
Not at all Poor Quality
Important 1 of Measurement

1 Slide adapted from David F. Larcker

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.19

Evaluating the BSC-approach (continued)

Establishing the chain of cause-and-effect linkages?

A Compelling Place to Work A Compelling Place to Shop A Compelling Place to Invest

Customer
Recommendations

Attitude Service
About the
Job Helpfulness

Return on Assets
Employee Customer
Operating Margin
Behavior Impression
Revenue Growth

Attitude Merchandise
About the
Company Value

Employee Customer
Retention Retention

5 unit increase in DRIVES

1.3 unit increase in DRIVES
0.5% increase in
employee attitude customer impression revenue growth
NOTE: The rectangles represent survey information; the ovals, hard data. Adapted from Harvard Business Review, JanuaryFebruary 1998.

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.20

Bottom-line measures
Are like a compass leading managers in the desired
direction
Allow managers greater autonomy
The managers can decide what intermediate measures to
focus on achieving the desired financial result

The managers can achieve the desired financial result by

putting different combinations of inputs and outputs
together

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.21

Baskets of measures
Are like a roadmap that provides guidance to
managers as to how to achieve the desired end

If done well, can provide a linked cascading of

measures from the top of the organization to the
bottom. They show everybody how their efforts
contribute to the overall goal.

Can be restrictive (managers have less autonomy in

making the tradeoffs)

Propensity to become obsolete as conditions change

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012
Slide 11.22

But
Complexity provides challenges:
Identifying right measures, measurement rules,
and importance weightings

Developing the measurement systems

Setting properly challenging performance targets

for many measures

Linking to incentive compensation

Keeping up-to-date (avoiding obsolescence)

Merchant, Management Control Systems PowerPoints on the Web, 3rd edition, Pearson Education Limited 2012