Post on 08-Sep-2019
Munich School of Management
Prof. Dr. Christian Hofmann
Institute of Accounting and Control www.iuc.bwl.lmu.de
Summer Term 2015
Performance Measurement and Incentive Systems Introduction
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Content
• Use of accounting information for performance evaluation and in the design of incentive systems (decision-influencing role of accounting information)
• Efficient risk sharing between shareholders of a firm
• Optimal incentive contracts with different information systems
→gain a better understanding of the incentive effects of accounting reports and their use as performance measures
1
Introduction Assessment
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Contact
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Introduction Contact
Lecturer Prof. Dr. Christian Hofmann Room Ludwigstraße 28 RG/ Room 501 Office hours by appointment
Assistant Viktoria Diser Room Ludwigstraße 28 RG/ Room 523 Email diser@bwl.lmu.de Office hours by appointment
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Time frame
3
Introduction Time frame
Lecture: Time slot Tuesdays or Thursdays, 10:00-12:00 c.t. Room Prof.-Huber-Platz 2, Lehrturm,
Room V 002
Tutorial: Time slot Tuesdays or Thursdays, 14:00-16:00 c.t. Room Prof.-Huber-Platz 2, Lehrturm,
Room V 002
Evaluation: Assignment
1) Due on 08.06.2015, 12:00 2) Due on 06.07.2015, 12:00
Exam
Date: 16.07.2014 Room: tba
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Lecture Schedule I
4
Introduction Lecture Schedule
No. Date Description Literature Additional Reading
Part 1: Foundations of Optimal Incentive Contracts
1 14/04 Fundamental Concepts in the Economic Analysis of Incentives
Lecture notes, pp. 1-10
BSZ Chapter 10
2 21/04 Introduction to Principal-Agent-Theory and Risk-Sharing in Partnerships
Lecture notes, pp. 13-32
BSZ Chapter 10, 11, 15 D Chapter 13
3 23/04 Analysis of Incentives in a Principal-Agent-Framework – Part 1
Lecture notes, pp. 36-56
BSZ Chapter 15, AG Chapter 12
4 05/05 Analysis of Incentives in a Principal-Agent-Framework – Part 2
Lecture notes, pp. 36-56
BSZ Chapter 15, AG Chapter 12
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Lecture Schedule II
Part 2: Design of Performance Measurement Systems
5 12/05 Multiple Performance Measures Lecture notes, pp. 66-75 BSZ Chapter 15 D Chapter 14
6 19/05 Controllability-Principle Lecture notes, pp. 83-98 BSZ Chapter 16 D Chapter 16
7 21/05 Relative Performance Evaluation Lecture notes, pp. 105-117
BSZ Chapter 16
8 02/06 Information Content and Recognition of Accruals
E-book, Chapters 15 & 16
9 09/06 Multiple Tasks and Congruency of Incentives
Lecture notes, pp. 123-129
BSZ Chapter 15 D Chapter 15
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Introduction Lecture Schedule
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Lecture Schedule III
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Introduction Lecture Schedule
No. Date Description Literature Additional Reading
Part 3: Performance Measurement in Hierarchies
10 11/06 Responsibility Accounting E-book, Chapter 18 Lecture notes, pp. 134-147
BSZ Chapter 12, 13, 17 AG Chapter 4, 5 D Chapter 16
Part 4: Performance Measurement in Dynamic Incentive Problems
11 16/06 Intertemporal Accruals E-book, Chapter 17
12 30/06 Q&A
Exam
16/07 Exam, Room: tba
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Class Material
• Lecture Notes (in German) • Available for purchase in the Institute’s administration office during the first two
weeks of the lectures (14. – 24.04.)
• Lecture Slides • Available for download on the Institute’s homepage: www.iuc.bwl.uni-muenchen.de
• Password: will be provided during the first lecture
• E-book • Available for purchase
• https://create.mcgraw-hill.com/shop/#/catalog/details/?isbn=9781308113593
• Additional Readings • Brickley, J. A./ Smith, C. W./ Zimmerman, J. L.: Managerial economics and
organizational architecture, 5th ed., Boston et al. 2008.
• Demski, J.S.: Managerial Uses of Accounting Information, 2nd ed., New York 2008.
• Anthony, R./ Govindarajan, V.: Management Control Systems, 12th ed., Boston et al. 2006.
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Introduction Class Material
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Assessment
Exam • 60 Minutes
• 50% of the final grade
Assignments • Two Assignments
• Each Assignment counts 25% of the final grade
• Time per assignment: 1 week
• Please submit a written version of the assignment in the administration office of the IUC during office hours!
8
Introduction Assessment
Munich School of Management
Prof. Dr. Christian Hofmann
Institute of Accounting and Control www.iuc.bwl.lmu.de
Summer Term 2015
Performance measurement and incentive systems Part 1: Foundations of Optimal Incentive Contracts
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Outline
1. Incentive and control problems in corporations 1.1 Uses of accounting information
1.2 Reasons for the use of incentive systems
1.3 Reporting system and reports
1.4 Efficient risk sharing
1.5 Analysis of incentive problems
10
Incentive and control problems in corporations
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Motivation
11
Incentive and control problems in corporations
From Steven D. Levitt and Stephen J. Dubner
• Sumo wrestlers
• Teachers
• Realtors
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Outline
1. Incentive- and control problems in corporations
1.1 Uses of accounting information 1.2 Reasons for the use of incentive systems
1.3 Reporting system and reports
1.4 Efficient risk sharing
1.5 Analysis of incentive problems
12
Incentive and control problems in corporations Uses of accounting information
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Uses of accounting information
Schweitzer/Küpper [1998]
Feltham/Demski [1970]
Documentation Planning Monitoring Behavioral control
Decision-facilitating Decision-influencing
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Incentive and control problems in corporations Uses of accounting information
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Decision-facilitating vs. decision-influencing information
14
Incentive and control problems in corporations Uses of accounting information
decision-facilitating: • Provision of
information for decision-making
• Documentation of results
decision-influencing: • Provision of
performance measures • Appropriate design of
incentive systems
t Decision-facilitating
information
t + 1 Decision-influencing
information
Decision
time
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Decision-influencing information
Example of a compensation plan
Variable compensation
=
Fixed compensation
x Percentage of compensation at risk
x actual performancetarget performance
= Incentive weight x
Performance measure
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Incentive and control problems in corporations Uses of accounting information
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Target compensation from Johnson & Johnson Medical (1999)
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Incentive and control problems in corporations Uses of accounting information
Fixed compensation Percentage of
compensation at risk
$64.000 - $88.999 $89.000 - $112.999 $113.000 - $156.999
10% 15% 20%
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Causes of control problems
• Insufficient information regarding corporate objectives
• Incentive problems (individual goals deviate from corporate goals)
• Limited abilities and skills of employees
• Poor coordination within the management team
17
Incentive and control problems in corporations Uses of accounting information
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Causes of control problems
18
Incentive and control problems in corporations Uses of accounting information
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Causes of control problems
19
Incentive and control problems in corporations Uses of accounting information
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Outline
1. Incentive- and control problems in corporations
1.1 Uses of accounting information
1.2 Reasons for the use of incentive systems 1.3 Reporting system and reports
1.4 Efficient risk sharing
1.5 Analysis of incentive problems
20
Incentive and control problems in corporations Reasons for the use of incentive systems
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Reasons for the use of incentive systems
a) Effort disutility b) Consumption on the job c) Divergent risk preferences d) Divergent time preferences
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Incentive and control problems in corporations Reasons for the use of incentive systems
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Regarding c) Divergent Risk Preferences
22
Incentive and control problems in corporations Reasons for the use of incentive systems
Relevance of market and firm-specific risk
Firm Performance
Market risk
Firm-specific risk
Controllability Diversification
Firm owners Management
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Year Expenses Cost savings Bonus
1 80.000 € - - 4.000 €
2 75.000 € - - 3.750 €
3 - 50.000 € + 2.500 €
4 - 120.000 € -
5 - 150.000 € -
6 - 110.000 € -
Regarding d) Divergent time preferences
Example: Investment in restructuring of corporate processes
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Incentive and control problems in corporations Reasons for the use of incentive systems
→ Present value of the bonus is negative. → The manager will not carry out the restructuring
project.
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Outline
1. Incentive- and control problems in corporations
1.1 Uses of accounting information
1.2 Reasons for the use of incentive systems
1.3 Reporting system and reports 1.4 Efficient risk sharing
1.5 Analysis of incentive problems
24
Incentive and control problems in corporations Reporting system and reports
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Decisions about availability of reports
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Incentive and control problems in corporations Reporting system and reports
• Reporting system vs. ex post available reports • Ex ante uncertainty about the reporting content
t Decision about the reporting system
t + 1 Report y(a, 𝜃)
Output x(a, 𝜃)
time Decision
𝒂
Environment
𝜃
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Outline
1. Incentive- and control problems in corporations
1.1 Uses of accounting information
1.2 Reasons for the use of incentive systems
1.3 Reporting system and reports
1.4 Efficient risk sharing 1.5 Analysis of incentive problems
26
Incentive and control problems in corporations Efficient risk sharing
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Efficient risk sharing and incentive problems
• Risk sharing is rational in case of ex ante uncertainty
• Efficient risk sharing: diversified (risk-neutral) investors bear the entire firm-specific risk
• Incentive problems impede efficient risk sharing
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Incentive and control problems in corporations Efficient risk sharing
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Outline
1. Incentive- and control problems in corporations
1.1 Uses of accounting information
1.2 Reasons for the use of incentive systems
1.3 Reporting system and reports
1.4 Efficient risk sharing
1.5 Analysis of incentive problems
28
Incentive and control problems in corporations Analysis of incentive problems
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Agency Theory
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Incentive and control problems in corporations Analysis of incentive problems
Principal-agent-relation
An individual (principal) delegates tasks to a second individual (agent).
Exemplary principal-agent-relations:
Principal Agent
Shareholders Board of directors Executive board Division manager Department manager
Board of directors Executive board
Division manager Department manager
Worker
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Coordination of the relation between principal and agent
Contracts:
• Performance measurement
• Performance evaluation
• Allocation of decision rights
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Incentive and control problems in corporations Analysis of incentive problems
INSTITUTE OF ACCOUNTING AND CONTROL
Prof. Dr. Christian Hofmann - Performance measurement and incentive systems Prof. Dr. Christian Hofmann - Performance measurement and incentive systems
Management control systems [Merchant 1998]
• Personell controls
• Action controls
• Result controls
• Avoidance controls
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Incentive and control problems in corporations Analysis of incentive problems