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CHAPTER 7: ALIGNING PERFORMANCE GOALS AND INCENTIVES
-See the impact of measurement and control system on employees (they determine the success of a company).
THE NATURE OF PERFORMANCE GOALS -performance goals provide a guide to implement strategy. They communicate what managers expect and how to allocate their time.
GOAL,OBJECTIVES AND TARGETS Objectives and targets are more specific and incorporate measurement and standards. -how managers create and define goals. ( they calibrate, communicate, support those goals throw performance measures and incentives).
PURPOSE OF PERFORMANCE GOALS -financial goals= max profit, cash flow. They don’t say to employee how crate value, so without clarity they can choose different way ex cut cost, expense of services. With everyone pulling on different directions any strategy is bound to fail. Strategies are hypothesis so you need goal and communication to get it alive, since employees pay attention to what is measurable. So without goal and measures communication is not enough. Information are useful to improve decision making, to motivate and evaluate efforts, to signal preferences about activities and opportunities , to promote education, training and learning. Performance goals provide a disciplined approach and managers preferences. They are linked to bonuses and promotions, they are motivational. Goals can be also shared with stockholders and analysts.
CRITICAL PERFORMANCE VARIABLES How to select performance goals? A lot of goals can be chosen but only some are critical for strategy implementations – called critical performance variables. 2 steps to identify them: 1- influence the probability of success of the strategy ; provide largest potential for marginal gain. 2- identify the critical performance variables between the drivers – they need a future envision.
SELECTING PERFORMANCE MEASURES To achieve goals managers must design measures for desired outcomes. A measure is a quantitative value and can be either financial or nonfinancial.
3 TEST to determine if a measure is suitable to support a performance goal:
1- DOES IT ALIGN WITH STRATEGY? Measures tell people what is important. If you are measure on customer satisfaction, so customers are important. Ex goal cost/unit – the set is ex quality failure. So measures tell priorities, goals and ultimately business strategy.
2- CAN IT BE MEASURED EFFICTIVELY? Ideally measures should be objective, complete and responsive.
NATURE OF MEASURES An objective measure can be independently measured and verified. They derive from formulas. By contrast, subjective measures cannot be independently measured and verified. Measures vary according their degree of completeness and responsiveness. A complete measure captures all the relevant attributes of achievement; a responsive measure reflects actions that a manger can directly
influence ( they get people responsible). It has to be find the balance between objectivity, completeness and responsiveness.
3- IS THE MEASURE LINKED TO VALUE? In business managers can measure both leading variables (anteriori) ex training and lagging variables (posteriori) ex profit and customer satisfaction. It is difficult to prove that leading variables create value for the company. Input process measures (leading variables) are valid only if managers are able to understand cause and effect relationships.
-how many measures for each employee? To implement strategy effectively the focus must be on a small number of variables. Measure to be effective as communication devices must focus attention. Number seven is used a lot since it is difficult to memorize more than 7 information.
SETTING PERFORMANCE BAR Managers have to choose the target or desired level of achievement.
• Benchmark comparison They set the standards for the most effective utilization of resources.
MOTIVATING EFFORT Performance goals have to motivate individual so we have to understand how people respond to goals. Another important thing is decide who has to set the performance bar – top managers or also the subordinates?
• LEVEL OF DIFFICULTY Individual creativity and initiative can be maximized when people have a reasonable pressure.
-DECIDE WHO SHOULD PARTECIPATE IN SETTING GOALS Some firms encourage low level manager to take part to the process because to face an uncertain environment is fundamental a bottom up approach to exchange more information. In a stable organization an exchange is not needed and top managers held information. So the decision about who should participate in setting performance goals depends of the type of organization and who has the information. There are so two views : 1- principals evaluate efforts and dispense rewards – top-down contracts solve the agency problem. Subordinates don’t participate to goal setting procedure. 2: if people participate in goal setting they get more motivate. In this case subordinates participate in the goal setting procedure. Both have some rights so the decision depends on who has the information.
MULTIPLE PURPOSES OF PERFORMANCE GOALS Goal setting process is complicate since goals are used simultaneously for a variety of purposes: communicating strategy and motivation, for planning and coordination and ex post evaluation managers and business. Performance goals are important for planning and coordinate the level of resources and the work workflow coordination among interdependent units. Performance goals are also important for ex post evaluation of accomplishment. Managers have to find the right balance between information accuracy and motivational impact.
ALIGNING INCENTIVES 2 ways of motivating people: 1- people believe in organization goals so are willing to achieve then – INTRINSIC MOTIVATION – it comes from within. It occurs when people voluntarily join the organization. Managers can enhance intrinsic
motivation: emphasizing the positive ideals and beliefs of the business (make people proud of their work); involving subordinates in goal setting so they see the goals as legitimate.
2. giving formal incentive –reward/payment. Financial incentives are essential designing a performance measurement system – EXTRINSIC MOTIVATION. It comes from outside. Ex % on sales. Financial and nonfinancial benefit must be balanced when consist multiple products and goals. Bonus are paid if a key target is hit. There are 3 major design decision designing contingent incentives : 1- the bonus pool 2- the allocation formula and 3- the type and mix of incentives.
THE BONUS POOL Incentive means that people are paid more when performance exceeds some base. Higher performance implies an higher pay. A bonus pool is a pot of money reserved for the payment of incentive and recognition awards.
THE ALLOCATION FORMULA After having decide the pool, they have to be allocated to individuals. There are 3 categories of performance: individual performance; business performance and corporate performance. The decision consists in how to allocate the weight across these three performance variables. More is the control of f a manager in a single business higher is the weight given to business performance and individual performance. More business interacts with other business units higher weight is given to corporate performance. How to calculate the amount of payment? 1- by a formula : x=profit ; y= bonus x<profit<10% bonus=y+10000 The advantages are: no ambiguity in measurement and so it is clear for what employees are rewarded for and it is not required a lot of attention by managers since it is set usually once a year. 2- by subjective judgment – managers use they knowledge, experience and judge the contribution of subordinates. It is required an high degree of trust and a huge investment of time to gather information.
TYPE AND MIX OF INCENTIVES The last decision concerns what types of incentives to provide to employees. In addition to cash we can have: - gifts and prizes – deferred cash payments –awards of company stocks – grants of options for the future purchase of company stock. It the same of a balance sheet: starting from the more liquid. Public recognition is a powerful motivator. Longer term payout like deferred cash force managers to balance the trade offs between long and short term. Offering stock or stock option we incentive managers to increase share price
CHAPTER 8 : MARKET, BUREASUCRACIES AND CLANS
Evaluating organization according to efficiency it is possible to predict the organization form. Combination of goal incongruence and performance ambiguity distinguish 3 mechanism of mediation of control: -mkt efficient when performance ambiguity is low and goal incongruence is high -bureaucracies are efficient both goal incongruence and performance ambiguity are moderately - clans when goal incongruence is low and performance ambiguity is high.
THE NATURE OF ORGANIZATIONS What is an organization and why exists?
-it, complexity and cooperation, give contributions, mediate economic transactions.
MARKETS,BUREASUCERACIES, AND CLANS Transaction costs are a solution to the problem of cooperation. Without objects people effort are uncoordinated. – attention between individual autonomy and collective interest with must attend cooperative action. Our interest is in efficiency with which are carried out between individuals who are engaged in cooperation. Cooperative action involves interdependence between individuals, they gives value and receives a different value in return. In mkt relationship and transactions take place between 2 parties and it is mediated between by a price mechanism. In bureaucratic relationship each party contributes labor to a corporate body which mediates the relationship by placing a value on each contribution and then compensating it fairly. Transactions are equitable (standard of reciprocity). The demand for equity brings on transactions costs. It the company is unique there is a difficulty determining prices so It can be called a third part that assist them in evaluating the value of the company. It is costly. The same problem arises for transactions of services : it is difficult to value labor.
2 mechanism f mediating these transactions: market and bureaucracy. There is also a third mechanism (clan) if the objectives of individual are congruent the condition of reciprocity and equity can be met quite differently. The problem is that there is a problem in operating since members don’t share a selfless devotion to the same objectives. There is reciprocity between employee if they socialize, so it is useless measure performance or control them directly since they socialize naturally. There is non -performance related criteria of rewards. They can be very efficient in mediating transactions between interdependent individuals.
The three forms under which form is most efficiently satisfied?
THE MARKET FAILURES FRAMEWORK Market transactions consist of contractual relationships, regulated by a contingent claims contract that is a document that specifies all the obligations. Complexity and uncertainty make impossible to specify such a contract completely and so leaving it incomplete and giving an alternative in which parts have to trust. Conditions that lead market failure are: bounded rationality and opportunism (human factor) and uncertainty/ complexity and small numbers (environmental factors). The idea of failure of the market permits to compare the strengths of markets as opposed to bureaucracies. Every bureaucratic organization constitutes an example of market failure. The bureaucratic organization has 2 principal advantages over the market relationship. 1 they us employment relation with is an incomplete contract, overcoming the problem of dealing with the future all at once, but direct employee activities day to day and monitor employees’ performance closely, minimizing the opportunism problem. Bureaucratic organization can create a trust atmosphere between employees, because employees have common purposes and they learn that long term relationships will reward good performance and punish poor performance. This reduces opportunistic tendencies and there is less need of monitoring their performance. Bureaucracies emphasis technical expertise providing skill training and specialization. Combining also with a career orientation solidarity and affiliation increase and goals incongruence decreases.
Market fails when costs of completing transactions become unbearable. So inefficiencies of bureaucratic organization will be preferred to the relatively greater costs of market organization. Bureaucracies are better when the contribution of a worker is highly ambiguous and transaction costs are too high.
EXTENDING THE MARKET FAILURES FRAMEWORK:CLANS
Bureaucracies can fail when the ambiguity of performance evaluation becomes greater that which brings about mkt failure. Bureaucratic organization operates according with an hierarchical system. Superior set standards to compare behavior. Standards indicate value of output approximately. When tasks get ambiguous bureaucratic mechanism fail, because it is not possible to evaluate externally an individual. Employee can deal with uncertainty if they give him an higher risk premium, but employer’s goals are no more efficient. If employees don’t trust and ask protection to union representation transactions costs will rise. Critical element in the efficiency market : ambiguity of measure individual performance and congruence of employees and employer goals. In order to mediate transactions efficiently , reducing ambiguity of evaluation. Mkt is efficient when there is little ambiguity over performance so parties can tolerate high level of opportunism or goal incongruence. Bureaucratic relations are efficient when both performance ambiguity and goal incongruence are moderately high. Clans are the form that succeed by minimizing goal incongruence and tolerating high levels of ambiguity in performance evaluation. It has a strong form of employment relation and risk premium is minimized. They are efficient with high performance ambiguity ad low opportunism. They have an organic solidarity : conflicts have to be equilibrate and social relations can’t assume a juridical form. Union of objectives between individuals between a labor union or a corporation may be a clan. A joint within profession is a clan, instead between professions is a bureaucracy. Goal congruity is a central mechanism of control. Solidarity, social integration is an intangible incentive. A clan provides great regularity of relations and may be more directive than the other. Individual interests are best served by a complete immersion of each individual in the interests of the whole. Introducing social mechanism there is a reduction of differences between individual and organizational goals and It produces a sense of community, in the way there is a reduction of transaction cost for opportunism behaviors. This is common is technological advanced organization, since that individual performance are highly ambiguous.
When a bureaucracy fail only clan can be implemented, so we have to create goal congruence. Clan can employ a system of legitimate authority and promote learning and effective production.
MARKETS, BUREAUCRACIES AND CLANS: AN OVERVIEW We distinguished 3 mechanism of intermediation and now se set general conditions in which they mediate transactions between individuals most efficiently.
MODEL OF CONTROL – NORMATIVE REQUIREMENTS – INFORMATION REQUIREMENTS MARKET - Reciprocity - prices BUREAUCRACY- reciprocity/legitimate authority - rules CLAN – reciprocity- legitimate authority- common values and beliefs
It has been used 2 dimensions: underlying normative (social agreements) and informational requirements. Prices are the highly sophisticated form of information for decision making but it is difficult to get the correct price. Rules are specific to problems and cover routine situations. Traditions are implicit and not easily accessible
SOME CONCLUDING THOUGHTS Conditions of uncertainty and opportunism make transaction cost increase. Conditions for a pure market, bureaucracy or clan are rare, so sometimes they have to be combined and when it is not enough organizations are institutionalized
Bureaucratic organizations exist because under certain conditions they are more efficient in mediation transaction between parties.