Slide 11.

Chapter 11:
Remedies to the Myopia
Problem

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 breakthroughs
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
Today businesses

Financial results controls

Developmental expenses
Tomorrow businesses

Combination of non-financial
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

Use long-term incentives?

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.

Cost of developing performance reports for control

purposes?
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
How do we look to
our customers?

Vision
Strategy

Business Processes
What business
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 assets

percentage of market value related to

Intangible
Assets

38%

62%

Tangible
Assets

62%

38%

85%

15%
1982

1992

2000

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 impacts
1

Training
Service
Quality

Customer
Confidence

Customer
Retention

Revenue

Information
Technology

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
Internal business
Innovation and learning
Other

19%
12%
5%
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?

Extremely
Important

High Quality
of Measurement

Gap
4
3
2

m
to

Cu
s

na
n
Fi
1

er
Em
pl
oy
O
ee
pe
ra
tio
na
l
Q
ua
lit
y
Al
lia
nc
es
Su
pp
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rs
ro
nm
en
ta
In
l
no
va
ti o
Co
n
m
m
un
i ty

al

1
ci

Not at all
Important

Extremely
Poor Quality
of Measurement

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
About the
Job

Service
Helpfulness
Return on Assets
Employee
Behavior

Customer
Impression

Operating Margin
Revenue Growth

Attitude
About the
Company

Merchandise
Value
Employee
Retention

5 unit increase in
employee attitude

Customer
Retention

DRIVES

1.3 unit increase in

customer impression

DRIVES

0.5% increase in
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