5. Ongelmat performanssi managementissa

Question 1

Myopia problem

Answer 1

Nearsightedness (myopia) is a common vision condition in which near objects appear clear, but objects farther away look blurry.

• Myopia = short-term orientation in decision-making
• Financial results control systems tend to produce myopic behavior

Question 2

REMEDIES TO MYOPIA PROBLEM

Answer 2

Reducing pressure for short term profits
– Reduce relative weight of profits and increase weight of e.g. non-financial aspects
– Make targets easier to achieve

Using pre-action reviews

Lengthening the horizon
- Extend the measurement horizon (+ long term incentives)

Changing what is measured
a. Other proxies for shareholder value than accounting measures
b. Improving accounting measures (change how costs are treated as expenses or activated to BS; imputed costs - e.g. fully depreciated assets still in use; EVA)
c. Using non-financial measures/drivers

Control investments with pre-action reviews
* Use margins that do not reflect investments – would EBITDA do the job?
* Merchant & Van der Stede suggest distinction between operating expenses and developmental investments
* Investments then decided based on proposals
* Variations of this used in practice, e.g. certain development ideas funded at higher organizational levels

Question 3

EVALUATION IN THE PRESENCE OF UNCONTROLLABLE FACTORS

Answer 3

People are typically risk averse -> controllability principle

Firms that held people accountable for uncontrollable factors will bear some cost
– Higher expected value of compensation
– Adverse employee behaviors, e.g. not investing in R&D, game playing, etc.
– Excuses -> lost time + tension
– Lost motivation, sense of unfairness

Basic economic argument: owners should bear the risks, not employees

Question 4

Different types of uncontrollable factors

Answer 4

Different types of uncontrollable factors:

– Economic and competitive factors
– Force majeure
– Interdependencies (within firm)
* Pooled (different units rely on common resources)
* Sequential (outputs of one unit are inputs for another)
* Reciprocal(bi-directional sequential interdependencies)
* Interventions from above

Question 5

How to deal with uncontrollable factors?

Answer 5

Two approaches to deal with uncontrollable factors:

Before the measurement period
* Insurance
* Responsibility structures, i.e. hold employees accountable for the performance areas that management wants them to pay attention to -> design and use of financial performance measures

After the measurement period
* Variance analysis
* Flexible performance standards, such as use of flexible budgets
–> Budgets are modified to reflect actual conditions, not used often in practice
–> Scenario / what-if plans
–> Updating standards more frequently

Evaluators adjust uncontrollable factors normally only in favor to employees – they protect them from bad luck, but do not protect shareholders from good luck

Question 6

After the measurement period –> what are the 2 types of evaluations?

Answer 6

Relative performance evaluations (internal or external)
* For what type of organizations this works well?

Subjective performance evaluations
* Measures/indicators cannot capture all important aspects
* What are the potential problems of subjective evaluations?

Question 7

What are the ETHICAL ISSUES RELATED TO MCS?

Answer 7

• Managers have to control for unethical behaviors within organizations
• Some of pressures to behave unethically may be created by organizations performance management system
• Or, one may argue that good performance management system should encourage also for ethical behavior
• Issue: good (financial) performance and good ethics are not always the same – examples?
• Codes of professional conduct are common
• Note: unethical and illegal are not synonyms

Question 8

Merchant & Van der Stede discuss four ETHICAL MODELS:

Answer 8

VUJu Rieha

Utilitarianism
* “Greatest good for the greatest number of people”

Rights and duties
* Does a decision violate some of the rights people have? Does a decision or act allow one to escape from some duties?

Justice / fairness
* Treating the people same except when they are different in relevant ways
* Outcomes do not necessarily need to be fair as long as the process is

Virtues
* E.g. integrity, loyalty, courage

Question 9

HOW TO CREATE Framework for analyzing ethical issues?

Answer 9

– Clarify the facts (what, who, where, when and how) – Define the ethical issue
– Specify the alternatives
– Compare values and alternatives
– Assess the consequences
– Make a decision

Question 10

HOW TO CREATE Framework for analyzing ethical issues?

Answer 10

– Clarify the facts (what, who, where, when and how) – Define the ethical issue
– Specify the alternatives
– Compare values and alternatives
– Assess the consequences
– Make a decision

Question 11

WHY DO PEOPLE BEHAVE UNETHICALLY?

Answer 11

People are different:
* “Bad apples”, dishonest people
* Morally disengaged or ignorant * Rationalizers
* Lack of moral courage

Question 12

MANAGEMENT CONTROL / ACCOUNTING RELATED ISSUES

Answer 12

• Creating budget slack
• Managing earnings
• Responding to flawed performance indicators
• Using controls that are “too good”
• Any other examples?

Question 13

SUMMARY OF ETHICS DISCUSSION

Answer 13

• Employee ethics is an important component of personnel or cultural controls
• If good ethics can be encouraged, it can substitute for action or results controls
• It is important for you to be able to recognize when ethical issues arise (we discussed some typical MCS
  related issues) and have a framework to make a judgement in those situations

Question 14

Mitä on TRANSFER PRICING?

Answer 14

Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control.

Question 15

TRANSFER PRICING AND PERFORMANCE MANAGEMENT

Answer 15

• In an international setting, questions regarding transfer pricing refer typically to tax issues
• Arm’s length pricing required by OECD and local tax authorities
• There are also other problems than taxation related to transfer pricing

Question 16

THE PURPOSES OF TRANSFER PRICES FROM MANAGEMENT CONTROL PERSPECTIVE:

Answer 16

1) To motivate divisional managers to make optimal economic decisions from the viewpoint of a whole company

2) To determine the profit/loss of a division based on which the managerial and economic performance of the division can be evaluated (objectives and allocation of resources)

3) To ensure that divisional autonomy is not undermined
Note! No single transfer price is likely to meet all of the set objectives

Question 17

What are the 4 TRANSFER PRICING METHODS?

Answer 17

TRANSFER PRICING METHODS:

• Market-based transfer price
• Cost-based transfer price
• Negotiated transfer price
• Transfer price set by headquarters

Question 18

MARKET PRICE as a transfer price

Answer 18

Theoretically superior, if perfectly competitive market exists

However:
- market is seldom perfectly competitiveàmarket price is appropriate, if quality, delivery, discounts and back-up services are identical to other products in the market
- marketimperfectionscausedbydistressedcompanies
-> if market is not perfect, then the use of market prices may lead to incorrect decisions
- marketingcostsofsupplierarenotincurred

Question 19

COST- BASED TRANSFER PRICE

Answer 19

• Marginal costs, full costs or full cost plus a mark-up
• According to economic theory, the optimal transfer price is the marginal cost of the supplying division, if market price cannot be applied
• Seldom used in practice

Question 20

MARGINAL COSTS: POSSIBLE PROBLEMS

Answer 20

• Supplier does not receive profits and has no incentives to control overheads
• Maximum overall company profits are not guaranteed, if supplier’s capacity is constrained and it is forced to sell internally
• Supplier will sell externally, if it is able to receive a higher price from external sales
• Receiving division may under-price the final products/services sold to end customers

Question 21

Advantages and disadvantages of FULL COSTS?

Answer 21

FULL COSTS

• ADVANTAGES:
  – Supplier recovers its costs
  – Receiving division emphasize cost efficiency
  – Receiving division has a picture of supplier’s full costs
• DISADVANTAGES:
  – Supplier does not make any profit
  – Supplier may refuse to sell internally, if it can add a mark-up to external sales

Question 22

Advantages and disadvantages of FULL COSTS PLUS A MARK-UP?

Answer 22

FULL COST PLUS A MARK-UP

ADVANTAGES:
– Supplier obtains profit

DISADVANTAGES:
– Receiving division may pay more than what the actual value of product is, if it has no right to refuse and buy outside
– In a long supply chain, the price paid by the end customer includes excess internal mark-up -> threat to competitiveness

Question 23

Advantages and disadvantages of NEGOTIATED TRANSFER PRICES?

Answer 23

ADVANTAGES:
– Often considered to be relatively fair

DISADVANTAGES:
– Time consuming
– Negotiating skills decisive, may lead to decisions less than optimal from the viewpoint of a company as a whole
– In order to work, divisions should have equal bargaining power

Question 24

Explain TRANSFER PRICING IN PRACTICE?

Answer 24

Similar results are reported all over the world:
- 35-40 % of firms use market price/adjusted market price - 15-20 % of firms use negotiated price
- 40-50 % of firms use cost-based transfer price
- 5-10 % of firms use marginal costs as a transfer price

• There are differences in how domestic and international transfer prices are set. Domestic transfer prices are more commonly based on costs, whereas international transfer prices are market based due to more and more stringent tax regulation.

Question 25

TRANSFER PRICES SET BY HEADQUARTERS

Answer 25

• E.g. market price –10% or full cost +5%
• Neither based on economic logic as market- and cost- based transfer prices, nor on responsibility logic as negotiated transfer prices
• The aim is to simplify the situation
• Sometimes, the aim might be to reach a fair distribution. E.g. if each division would have been able to acquire certain service at a certain price, but if the acquisition is centralized, the service is received at a lower price => the received benefit is shared fairly between divisions

Question 26

HOW TO SOLVE TRANSFER PRICING CONFLICTS IN PRACTICE?

Answer 26

If no capacity constraints:
a) Supplier’s marginal/variable cost + a fixed lump-sum charged from the receiving division

b) Dual-rate transfer pricing system
- supplier’s marginal/variable cost is charged from the
receiving division, the supplier receives marginal cost + a mark-up, in other words, two transfer prices in practice

Question 27

Mikä on Arm’s length price?ä

Answer 27

Arm’s length price:

The price at which a willing buyer and a willing unrelated seller would freely agree to transact or a trade between related parties that is conducted as if they were unrelated, so that there is no conflict of interest in the transaction.