Performance Evaluation

The performance evaluation system in designed to measure three basic elements : personal
performance, attainment of operating goals, and return on investment. Subordinates are evaluated only
on the basis of their personal performance; segment managers are judged on all three criteria. The
relative weigh assigned to each performance criteria or key result area for all profit centers is 20-70-10.
At corporate headquarters, the breakdown is 40-40-20. The personal performance factor is highly
subyektive since it is guided by a results management system. This system rates individuals on their
accountabilities and compliance with written objectives and performance rules. The attainment of goal
and return on investment are accounting measures based on goals and standart set by the profit center
or corporate unit head.

Goal Setting

The following notes explain in more detail the various elements of the goal structure and performance
reporting.

1. Sales are and controlled by the profit center

2. Other income represents net estimated corporate income from sales of assets, interest income,
and the like, and is determined by corporate
3. Manufacturing costs are set and controlled by a standart cost system. Unusual costs, such as
major losses from insurance deductibles, are borne by corporate headquarters. The standards
for direct material, direct labor, and overhead are determined by the manufacturing plants.
Each plant managers’s rating and bonus is highly dependent on the capability of not execeeding
the standard allowances and the degree of cost absorption by the products
4. Selling and administrative expenses are determined by a rigit fixed formula and format, with half
of the elements zero-based budgeted. Item such as salary expenses are based on annualized
December salaries plus an average increase factor for the next year. However, Miller was
assurated by a manager that if one is careful, this rigid formula proves to be quite flexible.
5. Distribution center profits are duplicate credits for distribution center profits given to the
manufacturing divisions. Manufacturing division managers are there by induced to supply
products to internal users even at time when demand exceeds suplly and they could get higher
prices externally
6. Direct overhead-actual includes such items as bad debts and management incentive provisions,
which are determined by the profit center. For their computation, see the following section on
bonus computations
7. Corporate direct overhead-allocated includes items such as research and development,
advertising, and direct corporate service charges. They are set by corporate, but allocated on
the basis of a fixed formula to the profit centers and affect their operating profit.
8. Operating profit repsents the net of items 1 through 7 and is used as an incentive measurement
point for the profit centers (see the section on bonus computations for more detail)
 9. Corporate indirect overhead-allocated consists basically of current cost whose benefits are long-
term in nature. They include long-range advertising and research and delevopment, as well as
indirect corporate service charges set by corporate
10. Tax is determined on the basis of fixed formula, which uses the effective tax rate for the profit
center after considering all permanent tax benefits
11. Net earnings repsesent the basis for group and corporate incentive measurement
12. Capital employed is composed af actual current assets and fixed assets of the profit center, less
allocated current liabilities and deferred taxes. Profit centers that are legal subsidiaries use
actual book values for ratable items.
13. Return on capital employed is computed by dividing capital employed into net earnings. No
minimum required return level is yed established, since this measurement tool has been in use
for only a short period of time.
14. Receivable days outstanding are intended to monitor cash flow from receivables and to induce
minimization of capital employed.
15. Inventory turnover is used as in inventory control measure to prevent excessive inventory build-
up.

Bonus Computations

Segment manager’s bonuses are determined on the basis of the performance ratings achieved in each of
the three key result areas. Using the relative weights aoted earlier as base, a typical incentive payout for
a profit center manager would be computed as shown at the top of page 194.

Since performance rating for attainment of operating goals receives the highest weigh, it will
benefit or hurt the until by a factors of 2. There is an upper limit of 200 pecent bonus or 75 percent
attainment.

Subordinates are not entitled to bonuses; however, their personal performance appraisal results
are used by their superiours when deciding on raises and promotions.

Performance Reporting

Actual performance of the profit centers and corporate units is reported monthly in the form of
segmental statement of earnings and on the basis of various rations.

1. Statements of earnings. Such a statement is prepared each month on a cumulative basis with
variances from goals flagged. Return on capital employed is shown as afootnote to net earnings.
The segmental statements of earnings inform the managers simultaneously of their success or
failure in attaining their operational goals and of the return on investment accomplished during
the period.
2. Receivable days outstanding. This ratio is presented on a comparative two-years monthly trend
basis with the annual obyective shown. Actual current-years result are flagged when
performance in unfavorable, which permits a modified from of exceotion reporting.
3. Inventory turnover. This ratio is determined using the same format as for receivables.
Perceived Dilemma Areas.

During the course of his investigation, Miller discovered various contradictions, wich he perceived as
dilemma situations requiring diagnostic attention and possible remedial actions. A discussion of the
main areas of concern and the problems encountered follows.

1. Sales
2. Manufacturing Costs
3. Selling and administrative expenses
4. Direct overhead – actual
5. Corporate direct and indirect overhead-allocated
6. Return on capital employed
7. Accounts receivable and inventories

Definition and Purpose of Performance Evaluation

Performance evaluation in the periodic assessment of the operating effectiveness of an organization, is

subunits, and its personnel in light of predetermined goals, standards, and criteria. Since organizations
are run by people, performance evaluation is in reality the evaluation of people’s behavior in the roles
assigned to them in organization.

The primary purpose of performance evaluation is to motivate employees to attain

organizational goals and to comply with predetermined behavior standards to produce desired actions
and outcomes. The behavior standards could be prescribed managerial policies or formal plants for
desired integrated actions.

Another aspect of performance evaluation is the discouragement of dysfungsional behavior and

the encouragement and reinforcement of desired, or functional, behavior through timely feedback of
performance results and intrinsic or extrinsic rewards.

Uses of performance evaluation

The greatest benfits are realized when they are used for the following purpose :

1. To mange the operations of the organization effectively and efficiently by maximizing employee
motivation;
2. To assist in personal decisions such as promotations, transfer, and termination;
3. To identify specific training and development needs and to provide criteria for selection and
evaluation of training programs;
4. To provide feedback to employees about how superiors perceive their performance; and
5. To provide a basis for reward allocations

Motivation as a tool for promoting operating efficiency

Motivation is concerned with wahat induces people to behave in particular ways. Motivations
researchers have delineated hierarchies of needs, types of motivators (extrinsic versus intrinsic ones),
and motivation hygiene factors. They have developed several motivation theories, including equity
theory goal-setting theory, reinforcement theory, and expectancy theory.

According to this theory, behavior is influenced by the probabilities people assign to the following
relationships:

1. The effort necessary to achieve the goal

2. Performance and reward
3. Reward satisfying personal goals.

Effect of rewards on behavior

There are three ways toshape the behavior of the people who work in organizations :

1. The response to desirable behavior can be made something pleasant. This behavior influence is
called positive reinforcement.
2. Desirable behavior can be induced by the elimination of something unpleasant. This is called
negative reinforcement. For example, the supervisor wil stop watching an employee if he or she
seems busy.
3. Punishment is a common remedy for undesirable behavior. For example, ballplayers may
suspended without pay for a certain length of time or fined because of gross infringement of
game rules.

Types of rewards and their benefits in functional behavior inducement anf reinforcement.

Rewards can be grouped into intrinsic and extrinsic categories. Intrinsic reward are personally satisfying
feeling that people experience for jobs well done and for goals attained. Intrinsic rewards can be
enchanced by techniques such as job enrichment, increased responsibility, participation in decision
making, and other efforts that lead to increases in people’s self-worth and drive to excel.

Extrinsic rewards include direct, indirect, and non financial compensation given employee.
Direct compensations are payments for basic wages or salaries, overtime and holiday pay, profit sharing,
stock options, and other types of performance-based bonuses. Indirect compensations provides
employee with fringe benefit such as insurance, vacation pay, sick leave, pensions plants, and other
benefits.

Behavior aspects by performance evaluation steps

Each step has behavior implications.

Preliminary steps:

1. Define the segmen and activities to be controlled and the individuals associated with them
 2. Set performance criteria (policies, goals, and standards) for each organizational segment and
activity.
3. Measure actual performance

Performance evaluation step

4. Compare actual performance with predetermined goals. Promptly report result to individuals
responsible for segments and activity.
5. Determine operational and behavioral causes of unfavorable variances.
6. Reinforce desired behavior and act to prevent recurrence of undesired behavior.

Set performance criteria :

1. Measurability of criteria
2. Time span on resources and expenses
3. Weights assigned to criteria
4. Performance indices versus performance criteria
5. Behavior aspects of usage
a. Single criterion measures (indices)
b. Multiple criteria measures (indices)
c. Composite criteria techniques.
d. Rate of return investment.
e. Residual income
f. Other indices

Measurement of actual performance:

1. Smoothing
2. Biasing
3. Gaming
4. Focusing and illegal acts

Behavioral aspects of performance evaluating using accounting information.

Firms use accounting information alone or in conjuction with other irformation as the basis for
evaluating segment and subordinate performance. The reasons for this are that accounting date are
“hard” or objective rather than “soft” or subjective. They are one of the few objective measures of
performance available. People may react unfavorably to the performance data supplied by the
accounting system for a number of reason. The following sections outline such reasons

1. The relationship of the organization structure to the financial reporting structure.

2. Degree of participation in standard setting
3. Level of understanding of the accounting system.