Behavioural Aspects of Performance Management

1 Introduction

This relates to the ‘management’ part of performance management. If one knows that one’s performance is being measured (and very often one’s rewards are tied into the performance measure) then it is human nature to concentrate on those aspects of the work that are being measured. Indeed many would claim that ‘what you measure you change’ with the implication that what you dIntroduction

It is important therefore that the performance measures encourage goal congruence (i.e. encourage working for the overall good of the company) and that they encourage long-term as opposed to short-term thinking.

2 Recap of earlier chapters

We have already discussed in earlier chapters the use of Return on Investment, Residual Income, and Economic Value Added, NPV and IRR as ways of measuring financial performance, and the effect of these on long-term and short-term thinking.

We have also discussed in earlier chapters the importance of having a range of performance measures, looking at non-financial as well as financial performance.

3 Reward Practices

Employees are a key resource for almost all organisations This resource is difficult to manage:

• Unlike buying more non-current assets which will generally be easily available, employee shortages can be slow to overcome as the recruitment and training steps are often time-consuming.
  

• How much should employees be paid and what should be the relationship between the remuneration for the various grades and skill?
  

• Employees’ performances vary depending on mood, motivation, health and fatigue. Consistency and levels of effort are needed.
  

• At the end of every working day, these valuable assets leave the organisations premises and there is no guarantee that they will appear again in the morning. Most other resources, such as non-current assets, are more permanent. Worse still, you can find that your human resource has decided to relocate to a competitor.
  

HR policies, such as working from home, can vary greatly from employer to employer but a key element of HR management is the reward system. How much should be paid? Can remuneration be used to encourage employees behave in ways that the employer requires?

Broadly, remuneration can be made up of three elements:

3.1 Basic pay

Generally this will be in line with what competitors offer though gaining insight into competitors’ remuneration policies can be difficult. Often basic pay falls into bands for each grade or skill level so that modest pay increases can be awarded even if an employee’s grade has not increased.

3.2 Performance related rewards

This sounds great in theory (pay more for better performance) but it is not easy to achieve in practice. The easiest implementation is seen in sales commissions awarded to sales representatives based on their volume or value of sales. Sales are easy to measure and can often be traced to a given salesperson and their customers. Performance related pay for other jobs is usually more difficult:

For example:

• What type of areas of performance does the organisation want to encourage?
  

• Can those be measured?
  

• To what extend is the individual’s own efforts responsible for good performance? Good performance often depends on a number of people acting together successfully.
  

• How should measured performance be translated in increased remuneration?
  

The performance related rewards will often simply be money, for example, a bonus at the end of the year. However, in listed companies it is quite popular to offer employees, particularly senior employees share options. For example, say the current share price is $2. Options could be awarded allowing employees to buy shares after three years’ time at $3, provided they were still employed by the business. If after three years the shares are trading at $4, then exercising the options, paying $3/share will produce a profit of $1/share when the shares are sold. If the share price were only $2.50, the options would not be exercised (there is no point buying at the option exercise price if shares can be bought and sold on the market at $2.50.

This arrangement focusses managers’s attention on the share price - which is what most shareholders will be interested in maximising.

3.3 Benefits

For example:

• Medical insurance
  

• Pension contributions
  

• Provision of a car
  

• Holiday entitlements
  

• Child care
  

• Subsidised canteen
  

• Flexible working arrangements
  

Once again the benefits on offer usually have to be in line with what competitors offer. Often an employer can offer a ‘menu’ of benefits so that each employee could, for example, choose three or four benefits from a list.

3.4 How performance-related pay can be calculated

The calculation of the reward amounts can be based on:

An individual’s performance (eg a sales representative).

A team’s performance (eg the development and launch of a new product)

Divisional or group performance (eg divisional profit).

Whatever the level of the calculation, performance targets should be congruent with organisational objectives and set so that the correct performances are encouraged. Communication with employees is essential so that they know what they must achieve to earn their rewards. The rewards should be worth working for and the required performance should be perceived to be achievable otherwise the system is not likely to have much effect. In addition, the performances required to earn the additional rewards should not be trivial or too easy. For example, there have been cases where directors devised share option schemes for themselves where shares could be bought in a year for $5, but the current share price was $6! Not much encouragement there to drive the share price higher.

The reward system for many employees will be based on their behaviour across a number of desirable achievements as it is unusual for only one performance area to be dominant.

Whatever else, the performance-related reward system should be both transparent, fair and a clear link between the rewards and the achievement of the desired performances.

4 Potential benefits of reward schemes

Management encourage employees to achieve goals by having rewards linked to their success of failure in achieving desired levels of performance.

4.1 Potential benefits of implementing a reward scheme include:

• Rewards and incentives shape the behaviour of employees – a well-designed scheme will be consistent with the organisational objectives
  

• A reward scheme provides an incentive to achieve good performance.
  

• Key incentives can be emphasised in the reward scheme – it is a way of communicating the goals of the company to the employee.
  

• An effective scheme will create an environment in which all employees are focussed on continuous improvement.
  

• Schemes that incorporate share ownership can encourage behaviour that in the longer-term increases the market value of the business.

5 Potential behavioural problems

Reward systems inevitably alter employees’ behaviour and, as noted above, this can lead to better organisational performance. However, there can be adverse consequences arising from reward systems. For example, some reward systems can affect the risk appetite of employees so that they are encouraged to take greater risks with their employer’s resources in the hope of earning a large bonus.

In one of his articles for Student Accountant, the previous examiner highlighted the following specific problems that can occur with performance measurement schemes:

• Tunnel vision
  

Undue focus on performance measures to the detriment of other areas (‘What you measure you change’)

• Sub-optimisation
  

Ceasing effort when acceptable performance is achieved (eg when budgeted sales have been achieved), even though better performance might be achievable.

• Myopia
  

Focussing on the short-term resulting in the ignoring of the long-term

• Measure fixation
  

Behaviour and activities in order to achieve specific performance measure that may not be effective. For example, measuring behavior or results that are not important

• Misrepresentation
  

Using creative reporting to suggest that performance measures have been achieved

• Gaming
  

Behaviour designed to achieve some strategic advantage. For example, not passing on sales leads to a colleague so that your sales are comparatively higher.

• Ossification
  

The unwillingness to change a performance measure scheme once it has been set up.

6 Suggested ways of addressing the problems

• Involve staff at all levels in the development and implementation of the scheme
  

• Be flexible in the use of performance measures
  

• Keep the performance measurement system under constant review