Why are NFPM used?
They are often used to address the shortcoming (backward looking nature) of APM.
What 2 particular items does NFPM help address where APM lacks.
- Informative for those actions that do not show up in FPM
- Provides guidance to employees to focus on actions that should be associated with future performance.
What is the biggest weakness of APM?
Congruence, they are not good at capturing what value you add to the firm.
What are the 4 downsides/concers of NFPM?
- Easier to manipulate
- Ambiguity in measurement (different underlying distributions)
- Inconsistency in units and time, makes it harder to make meaningful comparison
- Complexity in linking performance levels, difficult to find relationships in KPI’s
What 5 items describe the ambiguous relationship between nonfinancial and future financial performance
- Purchasing threshold
- Diminishing returns
- Quality NFPM & warranty expense moderated by customer expectations
- Reduced variability from management interventions
- Asymmetry: negative outweighs positive.
What is the evaluation of NFPM?
- Quite sensitive for certain employees
- Limited susceptibility to noise
- Less congruence when used alone
- Susceptible to manipulation?
What is the key take away of NFPM?
NFPM are important, but also come with an array of problems. The hardest is how to measure and if it really has an impact on financial perofrmance.
What are the 3 objective PM?
Market measures (financial summary measures)
Aggregate accounting measures (financial summary measures)
NFPM
Where does the value of NFPM lie?
NFPM are important as supplementation to APM, never only use NFPM for manager. Only maximize NFPM until it gives financial benefit. Valuable in addition to APM to compensate for shortcomings of APM
What describes subjective performance measurement?
- Judgment based on personal impressions, feelings, and opinions rather than external facts
- Non-verifiable
- Can be numerical (performance review)
What are the 3 types of subjectivity (3 ways subjectivity can be introduced)
- Subjective measures of performance (some things can only be measured with subjectivity)
- Subjective weighing of OPM (opposed to formula-based incentive plan)
- Ex-post subjectivity (discretion to alter bonus in the future based on other measures).
What are 4 reasons to use subjectivity?
- Some actions can’t be measured objectively (leadership, innovation, relationship management), failure to incentive could lead to agent failing to allocate effort
- Mitigating incongruence (objective doesn’t describe how)
- Risk reduction
- Reduction of perceived unfairness
What uncertainty about fairness exists with subjectivty?
Managers tend to avoid extremes, so many scores fall in narrow range, but this range contains large differences. Can solve this with forced distributions
What are the 4 costs of subjectivity?
- Inaccurate assessment by supervisors (leniency, centrality bias, favoritism)
- Supervisor may renege on his pledges
- Influence activities (rent seeking, more focus on relations)
- Uncertainty about measurement criteria
What describes a performance measurement system?
Typically comprised of a combination of FPM and NFPM
- Related to firm’s strategy and business model
- Embedded are implicit or explicit relationships between different performance measures
What is meant with Don’t let metrics undermine your business?
Measurement system is never a perfect representation of you business model or strategy. people focus on those targets, you must keep considering if the targets are increasing the value of the firm. Measures are a means, not an end goal
What problem does FPM and delegation create in a situation with BSUs?
Transfer pricing issues. At what price should goods be transferred?
Why is transfer pricing relevant?
Transfer pricing method may incentivise managers to make decisions that are suboptimal from firm-level perspective.
What are the 3 transfer pricing methods?
- Market-based
- Cost-based (variable & full (absorption))
- Negotiated transfer prices
What describes market-based transfer prices?
- Useful when highly competitive market is available (liquidity)
- Deviations from market price incentivizes to trade externally
- Faciliaties evaluation of economic performance of units (every unit must be economically viable)
- Can lead to suboptimal decision if A has idle capacity, but refuses less than market price.
What describes variable-cost transfer pricing and what specific issue does it have?
Price at marginal cost
If seller close to capacity, additional investments cannot be transferred to buyer in short-term
Sometimes supplemented with flat fee
What is the minimum transfer price if the seller has excess capacity (after taking into account sales made to both market and buyer)
Minimum transfer price = variable costs
Any additional sales help to cover the contribution margin
What is the transfer price if seller is at capacity, but must sell to buyer instead of for a higher price to the market? Assuming he could sell all output to the market
Seller requires opportunity costs
These are equal to: Margin if sold to external + VC
What is the minimum transfer price if the seller must sell to buyer instead of the market, but only for a part. He is at capacity
Seller requires contribution margin for units that were not sold externally because he had to sell to the buyer.
