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Accounting 304 > Midterm 2 > Flashcards

Midterm 2 Flashcards

1
Q

Contingent contracts create…

A

Value - align incentives and share risk

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2
Q

External negotiations are rough without…

A

Internal alignment - less time on strategy & more on interests

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3
Q

Owner-Manager incentive conflicts (5)

A
  1. Choice of effort
  2. Perquisite taking
  3. Differential risk exposure
  4. Differential horizons
  5. Over investment
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4
Q

Hierarchy in a firm

A 
Shareholder
CEO
Divisional manager
Plant manager
Workers
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5
Q

Sources of conflict

A
  1. Differences in preferences for perquisites and effort
  2. Differences in decision horizon
  3. Differences in risk preferences
  4. Differences in investment incentives
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6
Q

Elements of organizational architecture

A

Delegated decision authority
Performance measurement
Reward system

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7
Q

Contracts designate…

A

Actions, rules, payments, expectations

Can be explicit and implicit

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8
Q

Contract parties voluntarily agree to….

A

Modify behavior for mutual benefit.

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9
Q

Organizational architecture

A

Decision rights
Reward system
Performance measurement

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10
Q

Benefits of decentralization

A

Effective use of knowledge
Conservation of management time
Training and motivation for local managers

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11
Q

Costs of decentralization

A

Potential agency problems
Coordination costs and failures (duplicate efforts)
Less effective use of central information

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12
Q

Revenue center

A

PxQ
Take derivative
Solve for Q

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13
Q

Optimal level of decentralization

A

Solve for D

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14
Q

Assigning decision rights to teams

A

Benefits: better use of member knowledge, contribution by each member, increase employee support and involvement, enhance employee buy in

Costs: slower than individual decisions, collective action problem (politics), free riders (moral hazard)

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15
Q

Decision process

A

Initiation - generate proposals
Ratification - select initiatives to be implemented
Implementation- execution of decisions
Monitoring - measurement of performance of decision makers

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16
Q

Why do we measure performance?

A
  1. To provide feedback on employee activities

2. To determine rewards and compensation

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17
Q

What determines performance?

A

Ability
Effort
Noise (random stuff)

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18
Q

Agency cost =

A

Monitoring costs + bonding costs + residual loss

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19
Q

Who pays for monitoring costs?

A

Principal

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20
Q

Who spends bonding costs?

A

Agent

Ex: audit fee

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21
Q

Residual loss represents…

A

Opportunity loss remaining when contracts are imperfectly enforced

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22
Q

Incentive contracts can improve performance because they …

A

Motivate employees

Attract high performers

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23
Q

Stretch performance

A

Belief that aggressive targets will motivate managers to perform at their highest levels

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24
Q

Minimum performance standard (MPS)

A

To judge managers first on if they hit an MPS

MPS should be realistic and achievable

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25
Problem with MPS
It can be subjective
26
Owner incentives:
To maximize profits and have diligent employees
27
Employee incentives:
Maximize utility and take breaks from working
28
Incentive problems
Firm cannot observe employee performance costlessly | Output can be difficult to measure
29
If employee and owner interests align :
Incentive problem does not exist
30
Contracts can solve incentive problem if :
Workers actions and output are observable
31
Constraints for contracts
Contract must balance fixed income and performance incentives
32
Compensation contracts :
Motivate employees | Share risk more efficiently
33
Employer is risk ----
Neutral
34
Employee is risk ---
Averse
35
Fixed income does not
Motivate employees to perform better - incentive coefficients do
36
Incentive component of pay can be made stronger if:
Employee is less risk averse Variance of performance measurement is smaller Employee is less effort averse Marginal productivity of effort is higher
37
Ratchet effect:
Employees only have incentive to meet goal and not exceed it
38
Subjective performance evaluation
Can completely replace objective performance evaluation
39
Overcome problems with subjective performance evaluation
Forced distributions Rotate superiors and employees more frequently 360 degree performance reviews
40
Relative performance evaluation
Can be used in or across firms
41
Upside and downside of paying for human capital
Upside : More measurable than performance May be better sign of long term value added Downside: Ability does not equal performance Skills may erode
42
Upsides and downsides of seniority pay
Upside: Long term commitment/motivation effect Underpay in early career (firm) Security of rising income (employees) Downside: Weak performance incentives/ reward Inequity Overpay in later career (firm)/ pension
43
Upside and downside of paying market wage
Upside: Measure the market price Equity (fair and impartial) Downside: Determining appropriate labor market
44
Upside and downside of efficiency wage
Upside: Attract better workers Gain in motivation and productivity Low wages = high turnover Downside: More expensive to pay workers
45
Paying for individual performance
Reward for individual efforts
46
Pay for group performance
Team building system - tied to overall performance
47
Goals of the balanced scorecard
1. Translate strategy into action | 2. Communicating and linking
48
Decisions cannot be made based solely on...
Financial information Much info cannot be quantified
49
Balanced score card balances
Current performance and long term abilities Feedback and guidance Financial and non financial measures
50
4 aspects of balanced score card
Financial Customer Internal business process Innovation and learning
51
Financial perspective measures
Operating income Cash flow Revenue growth Stock price
52
Customer perspective measurements
Responsiveness to customer desires Market share Customer satisfaction and retention Customer perception of the company
53
Internal business perspective measures
``` Manufacturing or service excellence Backlogs Cycle time Quality New product introductions ```
54
Innovation and learning perspective measures
Technological leadership Research and development Employee training and satisfaction Invest in new technologies
55
Designing a balanced score card steps
1. develop company strategy 2. determine critical success factors and goals 3. determine activities that drive achievement 4. determine metrics to evaluate performance
56
With transfer pricing no:
Cash changes hands
57
Seller will sell to outside if transfer price is
Below market price
58
Buyer will buy from outside if transfer price
Is above market price
59
Transfer price is calculated as:
Marginal cost per unit + opportunity cost per unit
60
Profit is:
Historical, backward looking, does not consider investment required, might not be comparable
61
ROI is:
Intuitive, measures investment usage and levels, independent of scale, does not require a cost of capital estimate
62
Residual income is:
Incorporate investment base, lines goals, motivates revelation of private information, conservation principal
63
EVA equals
Adjusted after-tax income - cost of capital x adjusted total divisional asset
64
EVA adjustments:
Marketing and R&D expense, depreciation expense, goodwill, restructuring costs
65
Challenges of EVA
Some adjustments are difficult to justify, cost of capital is difficult to measure, ignores managerial risk aversion
66
Informativeness principal
Compensation based on all factors of employees performance
67
Internal labor market
Hiring from within the firm
68
Two reasons why KN introduce BSC
Transfer strategy to action in communication
69
Downside of controllability principal
Doesn't try to forecasting usual affects Doesn't cooperate with other managers Doesn't try to mitigate negative effects
70
How to determine transfer price
Market price, full cost, marginal costs, negotiation
71
Two types of agency problems
Adverse selection and moral hazard
72
ROI =
After-tax net income divided by divisional assets
73
Turnover ratio equals
Sales divided by divisional assets
74
Profit margin equals
After-tax net income divided by sales
75
Residual income equals
After-tax net income minus the cost of capital times total divisional assets
76
NPV is used for decisions… | RI is used for decisions....
Before projects | During projects for evaluation
77
EVA equals
Adjusted after-tax income minus the cost of capital times adjusted total divisional assets
78
Why are internal negotiations difficult?
1) sharing private info is uncomfortable 2) can appear as greedy - not a team player 3) info could be used against me

Accounting 304 (3 decks)

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