Performance Measurement and Incentive Systems · INSTITUTE OFUses ACCOUNTING AND CONTROL Prof. Dr....

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

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Introduction Assessment



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 [email protected] Office hours by appointment



Time frame

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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



Lecture Schedule I

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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


BSZ Chapter 10, 11, 15 D Chapter 13

3 23/04 Analysis of Incentives in a Principal-Agent-Framework – Part 1


BSZ Chapter 15, AG Chapter 12

4 05/05 Analysis of Incentives in a Principal-Agent-Framework – Part 2


BSZ Chapter 15, AG Chapter 12



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


BSZ Chapter 15 D Chapter 15

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Lecture Schedule III

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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



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



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!

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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



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

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Incentive and control problems in corporations



Motivation

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Incentive and control problems in corporations

From Steven D. Levitt and Stephen J. Dubner

• Sumo wrestlers

• Teachers

• Realtors



Outline

1. Incentive- and control problems in corporations

1.1 Uses of accounting information 1.2 Reasons for the use of incentive systems




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Incentive and control problems in corporations Uses of accounting information



Uses of accounting information

Schweitzer/Küpper [1998]

Feltham/Demski [1970]

Documentation Planning Monitoring Behavioral control

Decision-facilitating Decision-influencing

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Decision-facilitating vs. decision-influencing information

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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



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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Target compensation from Johnson & Johnson Medical (1999)

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Fixed compensation Percentage of

compensation at risk

$64.000 - $88.999 $89.000 - $112.999 $113.000 - $156.999

10% 15% 20%



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

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Outline


1.1 Uses of accounting information

1.2 Reasons for the use of incentive systems 1.3 Reporting system and reports



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Incentive and control problems in corporations Reasons for the use of 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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Regarding c) Divergent Risk Preferences

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Relevance of market and firm-specific risk

Firm Performance

Market risk

Firm-specific risk

Controllability Diversification

Firm owners Management



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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→ Present value of the bonus is negative. → The manager will not carry out the restructuring

project.



Outline




1.3 Reporting system and reports 1.4 Efficient risk sharing


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Incentive and control problems in corporations Reporting system and reports



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



Outline





1.4 Efficient risk sharing 1.5 Analysis of incentive problems

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Incentive and control problems in corporations Efficient risk sharing



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



Outline







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Incentive and control problems in corporations Analysis of incentive problems



Agency Theory

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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



Coordination of the relation between principal and agent

Contracts:

• Performance measurement

• Performance evaluation

• Allocation of decision rights

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Management control systems [Merchant 1998]

• Personell controls

• Action controls

• Result controls

• Avoidance controls

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Performance Measurement and Incentive Systems · INSTITUTE OFUses ACCOUNTING AND CONTROL Prof. Dr....

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