Incentive and Compensation Systems

Incentive and Compensation Systems - Transcript

Incentive and Compensation
Systems
The Expectancy View of Behavior
• People act in ways they expect will create
rewards they desire
• The role of compensation is to provide
individuals with rewards they value when their
behavior promotes the organisation’s objectives
• Measured results, the domain of management
accounting, provide critical linkage in motivation
process. The decision maker must clearly
understand the linkage between the results and
reward that they value
Intrinsic and Extrinsic Rewards
• Intrinsic reward comes from within an individual.
No intervention by another person is required for
someone to experience intrinsic reward.
Satisfaction fro a job well done. Inner values and
beliefs.
• Extrinsic rewards is the reward that one person
gives to another.
• Prizes, awards, pay based on performance.
Extrinsic Rewards
• The role of management accountants is to
develop the systems that identify the
organization's desired results and tie
results to manager’s and employees’
compensation.
Tying Rewards to Performance
1. Rewards based on financial performance
• Traditional measures from the financial
control system such as corporate and
divisional profits as the result of which
the individual results are tied.
• Alferd Sloan designed a bonus plan in
1918 for General Motors
• Annual bonuses were awarded on the basis of
each manager’s contribution to the overall
success of the organization
• Prior to the plan there was decentralization at
the expense of the corporation’s welfare
• After the plan managers were more sensitive as
to how their individual efforts affected the
welfare of the entire organisation
• This plan also took care of non financial
measures
Rewards based on Group behavior
• Rewards based on individual behavior do not
promote group behavior
• group behavior encourages free riding to on the
efforts of others
• One way to combine individual and group
rewards is to base the total group reward or
group performance , such as corporate profit,
but to base the individual shares of the group
reward or performance points that reflect the
individual’s ability to achieve individual
performance objectives
Rewards based on non financial
measures
• Balanced Score Card
• Rewards based on cost control can
ignore maintenance of a plant that will
affect in the long run
• Combination of short run and long term.
1. Stock options
2. Bank bonus and pay out the bonus in
several years
3. Balanced Score Card
Executive Compensation
1. Be competitive to attract and retain
employees
2. Communicate and reinforce the key
priorities of the firm by taking bonuses to
key indices of performance .
Incentive compensation and the
principal- agent relationship
• An agency relationship exists when one
party ( the principal) hires another party
(the agent) to perform a service that
requires the principal to delegate some
decision making authority to the agent.
• Agency Theory: Balancing return and cost
• Managers tend to renege on pledges.
• Principal’s inability to monitor
• Moral hazard problem
Agency Theory argues
• If straight salary compensates the top
executives then they will not be motivated
to take action that will maximize the value
of the firm. They will over consume non
pecuniary items such as leisure , attractive
working conditions and company perks
and will not invest sufficient time and effort
to increase shareholder wealth.
• How to know what actions are optimal for
the firm?
• Monitoring is costly
• Incentive schemes to align agent's interest
with the principal’s
• But because of differences in risk attitude,
managers knowing more about the
environment, there is some agency cost
inolved
• Audited Financial statement. But does it
provide entire summary of manager’s
decisions and actions?
• Managers at times avoid risk. Managers
can suffer a significant decline in human
capital as well as financial wealth
• Owners are less risk averse
• Problem of Executive stock ownership:
Economic scenario and market condition
Other Financial methods
• EVA
• EPS
• ROE
• Managers can increase reported
earnings by
1. Producing goods in excess of demand
2. Repurchasing debts
3. Switching to straight line depreciation