The following question-and-answer format summarizes the chapter’s learning objectives. Each decision presents a key question related to a learning objective. The guidelines are the answer to that question.
| Decision | Guidelines |
|---|---|
| Financial measures such as return on investment and residual income measure aspects of the performance of organizations and their subunits, managers, and employees. In many cases, financial measures are supplemented with nonfinancial measures of performance based on the customer, internal-business-process, and learning-and-growth perspectives of the balanced scorecard—for example, customer satisfaction, quality of products and services, employee satisfaction, and the achievement of environmental objectives. |
| Return on investment (ROI) is the product of two components: income divided by revenues (return on sales) and revenues divided by investment (investment turnover). Managers can increase ROI by increasing revenues, decreasing costs, and decreasing the investment. But ROI may induce the managers of highly profitable divisions to reject projects in the firm’s best interest because accepting the project reduces the ROI for their divisions. Residual income (RI) is income minus a dollar amount of required return on investment. RI is more likely than ROI to promote goal congruence. Evaluating managers on RI is also consistent with using the net present value method to choose long-term projects. Economic value added (EVA) is a variation of the RI calculation. It equals after-tax operating income minus the product of the (after-tax) weighted-average cost of capital and total assets minus current liabilities. |
| A multiyear measure gives managers the incentive to consider the long-term consequences of their actions and prevents a myopic focus on short-run profits. When constructing accounting-based performance measures, firms must first define what constitutes investment. They must also choose whether the assets included in the investment calculations are measured at historical cost or current cost and whether depreciable assets are calculated at gross or net book value. |
| Companies should tailor a budget to a particular subunit, a particular accounting system, and a particular performance measure. In general, asset valuation and income measurement problems can be overcome by emphasizing budgets and targets that stress continuous improvement. Timely feedback enables managers to implement actions that correct deviations from the target performance. |
| Comparing the performance of divisions operating in different countries is difficult because of legal, political, social, economic, and currency differences. ROI and RI calculations for subunits operating in different countries need to be adjusted for differences in inflation between the two countries and changes in exchange rates. |
| Companies create incentives by rewarding managers on the basis of performance. But managers face risk because factors beyond their control may also affect their performance. Owners choose a mix of salary and incentive compensation to trade off the incentive benefit against the cost of imposing risk. |
| The four levers of control are diagnostic control systems, boundary systems, belief systems, and interactive control systems. Implementing the four levers of control helps a company simultaneously strive for performance, behave ethically, inspire employees, and respond to strategic threats and opportunities. |