Week 3 slides

Question 1

Why are NFPM used?

Answer 1

They are often used to address the shortcoming (backward looking nature) of APM.

Question 2

What 2 particular items does NFPM help address where APM lacks.

Answer 2

• Informative for those actions that do not show up in FPM
• Provides guidance to employees to focus on actions that should be associated with future performance.

Question 3

What is the biggest weakness of APM?

Answer 3

Congruence, they are not good at capturing what value you add to the firm.

Question 4

What are the 4 downsides/concers of NFPM?

Answer 4

1. Easier to manipulate
2. Ambiguity in measurement (different underlying distributions)
3. Inconsistency in units and time, makes it harder to make meaningful comparison
4. Complexity in linking performance levels, difficult to find relationships in KPI’s

Question 5

What 5 items describe the ambiguous relationship between nonfinancial and future financial performance

Answer 5

• Purchasing threshold
• Diminishing returns
• Quality NFPM & warranty expense moderated by customer expectations
• Reduced variability from management interventions
• Asymmetry: negative outweighs positive.

Question 6

What is the evaluation of NFPM?

Answer 6

• Quite sensitive for certain employees
• Limited susceptibility to noise
• Less congruence when used alone
• Susceptible to manipulation?

Question 7

What is the key take away of NFPM?

Answer 7

NFPM are important, but also come with an array of problems. The hardest is how to measure and if it really has an impact on financial perofrmance.

Question 8

What are the 3 objective PM?

Answer 8

Market measures (financial summary measures)
Aggregate accounting measures (financial summary measures)
NFPM

Question 9

Where does the value of NFPM lie?

Answer 9

NFPM are important as supplementation to APM, never only use NFPM for manager. Only maximize NFPM until it gives financial benefit. Valuable in addition to APM to compensate for shortcomings of APM

Question 10

What describes subjective performance measurement?

Answer 10

• Judgment based on personal impressions, feelings, and opinions rather than external facts
• Non-verifiable
• Can be numerical (performance review)

Question 11

What are the 3 types of subjectivity (3 ways subjectivity can be introduced)

Answer 11

• Subjective measures of performance (some things can only be measured with subjectivity)
• Subjective weighing of OPM (opposed to formula-based incentive plan)
• Ex-post subjectivity (discretion to alter bonus in the future based on other measures).

Question 12

What are 4 reasons to use subjectivity?

Answer 12

• Some actions can’t be measured objectively (leadership, innovation, relationship management), failure to incentive could lead to agent failing to allocate effort
• Mitigating incongruence (objective doesn’t describe how)
• Risk reduction
• Reduction of perceived unfairness

Question 13

What uncertainty about fairness exists with subjectivty?

Answer 13

Managers tend to avoid extremes, so many scores fall in narrow range, but this range contains large differences. Can solve this with forced distributions

Question 14

What are the 4 costs of subjectivity?

Answer 14

• Inaccurate assessment by supervisors (leniency, centrality bias, favoritism)
• Supervisor may renege on his pledges
• Influence activities (rent seeking, more focus on relations)
• Uncertainty about measurement criteria

Question 15

What describes a performance measurement system?

Answer 15

Typically comprised of a combination of FPM and NFPM
- Related to firm’s strategy and business model
- Embedded are implicit or explicit relationships between different performance measures

Question 16

What is meant with Don’t let metrics undermine your business?

Answer 16

Measurement system is never a perfect representation of you business model or strategy. people focus on those targets, you must keep considering if the targets are increasing the value of the firm. Measures are a means, not an end goal

Question 17

What problem does FPM and delegation create in a situation with BSUs?

Answer 17

Transfer pricing issues. At what price should goods be transferred?

Question 18

Why is transfer pricing relevant?

Answer 18

Transfer pricing method may incentivise managers to make decisions that are suboptimal from firm-level perspective.

Question 19

What are the 3 transfer pricing methods?

Answer 19

• Market-based
• Cost-based (variable & full (absorption))
• Negotiated transfer prices

Question 20

What describes market-based transfer prices?

Answer 20

• Useful when highly competitive market is available (liquidity)
• Deviations from market price incentivizes to trade externally
• Faciliaties evaluation of economic performance of units (every unit must be economically viable)
• Can lead to suboptimal decision if A has idle capacity, but refuses less than market price.

Question 21

What describes variable-cost transfer pricing and what specific issue does it have?

Answer 21

Price at marginal cost
If seller close to capacity, additional investments cannot be transferred to buyer in short-term
Sometimes supplemented with flat fee

Question 22

What is the minimum transfer price if the seller has excess capacity (after taking into account sales made to both market and buyer)

Answer 22

Minimum transfer price = variable costs
Any additional sales help to cover the contribution margin

Question 23

What is the transfer price if seller is at capacity, but must sell to buyer instead of for a higher price to the market? Assuming he could sell all output to the market

Answer 23

Seller requires opportunity costs
These are equal to: Margin if sold to external + VC

Question 24

What is the minimum transfer price if the seller must sell to buyer instead of the market, but only for a part. He is at capacity

Answer 24

Seller requires contribution margin for units that were not sold externally because he had to sell to the buyer.

Question 25

What is the minimum transfer price always equal to?

Answer 25

The variable costs
And if there is no excess capacity, a compensation for the contribution margin.

Question 26

If there is no overcapacity, what do you need to consider with transfer prices?

Answer 26

You need to consider the contribution margin of goods you can’t sell on the external market.

Question 27

What are the issues with full cost-based transfer pricing?

Answer 27

• Overstates firm’s opportunity costs of producing and transferring one more unit internally (especially if selling division has excess capacity) –> too few units traded internally
• Susceptible to manipulation by selling division (over-allocation of FOH)
• No incentive for selling division to control costs