Chapter 11

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
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
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?
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
Slide 11.6
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?
Slide 11.7
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
Slide 11.8
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?
Slide 11.9
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
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
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)
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

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

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%
Slide 11.15
(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.
Slide 11.16
(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
Slide 11.17
(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
Slide 11.18
(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
En
lie
vi
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
Slide 11.19
(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.
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
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
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)

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Slide 11.

Reduce pressure for short-term profit

Overcoming myopia (continued)

Control investments with preaction reviews

Financial results controls

Overcoming myopia (continued)

Extend the measurement horizon

The longer the period of measurement, the

Use long-term incentives?

Overcoming myopia (continued)

Measure changes in shareholder value directly

Measurement precision and objectivity of future cash

Expensive to do on a recurring, ongoing basis

Overcoming myopia (continued)

Improve accounting profit measures

Cost of developing performance reports for control

Overcoming myopia (continued)

Measure a set of drivers of future financial

Template Balanced Scorecard

Learning and Growth

Every measure is part of a chain of cause and

All measures eventually link to organizational

A balance exists between outcome measures

Why do Companies Need a BSC?

percentage of market value related to

Slide adapted from Robert S. Kaplan

Creating value from intangible assets is different

Slide adapted from Robert S. Kaplan

Evaluating the BSC-approach

Evaluating the BSC-approach

We never figured out how to use the scorecard

Evaluating the BSC-approach

Do employees make the right tradeoffs?

Throughput can be increased by forcing employees to work

The overtime is also costly, so there is a cross-dimension

Evaluating the BSC-approach

How to tie BSC-performance to incentives?

managers to a balanced set of scorecard measures will

Evaluating the BSC-approach

How to measure important nonfinancial areas?

Slide adapted from David F. Larcker

Evaluating the BSC-approach

Establishing the chain of cause-and-effect linkages?

A Compelling Place to Shop

A Compelling Place to Invest

1.3 unit increase in

Complexity provides challenges:

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