MMFV TT
Lecture 1:
Principal: boss
Agent: employee
Agency problem:
Decision facilitating: guide decision making -> data, analytics, scientific experimentation
Decision influencing: attract talent, offer incentives -> variable segment in salary and perks
Incentives are aligned -> decision facilitating
- info such that people take better decisions
Incentives are not aligned -> decision influencing
- Adverse selection (agent has private information before a contract is written, agent
only signs if it is beneficial for him)
- Moral Hazard: hidden information, hidden action (agent can gather information after
contract is written/ has info that principal is not aware of at time contract is written)
Hidden action: principal can not perfectly control agents effort
Moral hazard: time theft
Management control system: everything a company can do to incentivize employees to act
in firms best interest
- Economics (hard)
- incentive-based compensation
- employee selection
- monitoring systems
- Behavioral (soft)
- leadership
- social norms
- honor codes
Home economicus: rational and focussed on incentives
Decrease moral hazard -> monitoring
- monitoring systems
- internal control procedures
- increased documentation
Moral hazard hidden action: slowing down
,Lecture 2:
The higher (lower) in the hierarchy the more likely that companies will use more aggregated
(more specific) measures of performance; Aggregated financial measures are more goal
congruent
The higher (lower) in the hierarchy the more likely one uses more aggregated measures;
The advantage is that they are more comprehensive leading to higher thinking in trade-offs
and less dysfunctional behavior.
Aggregated measures:
Sensitivity: Influence of action (effort) choices of the manager on outcome
Precision: difference between measurement and achieved performance
-> What is the effect of random variation, uncontrollable factors, noise (e.g. a high score on
financials due to luck?)
Verifiability: Is the measurement process done objectively or not?
-> The extent to which it is ex ante clear how the performance measure is calculated
Audited: e.g. profit before or after tax
Unaudited: pro-forma earnings, CSR emission rights
Typically, nonfinancial PMs are not very congruent as they mainly measure a subset of the
actions a manager can take
Financial PMs are typically quite congruent but sometimes lack sensitivity, precision and
verifiability
Quality of PM:
- Understandable and recognition (Specific)
- Should be easy to measure (Measurable)
- Should be achievable with appropriate effort (Attainable)
- Realistic but some challenge (Realistic)
- Should fit with current organizational culture/ goals (Timely)
Manipulation; Measures should not be able to be influenced by actions we do not want as a
firm (distortions)
Best is to have 1) high quality, and 2) “aggregate” measures
IF not better maybe to keep Decision rights at higher level
Extending employment horizon by offering promotion opportunities:
- Probability of promotion induces employees to work harder (reduce moral hazard)
- Firm also wants to promote most capable employees to higher hierarchy, matching
effect (reduce adverse selection)
Aggregate Financial PM -> determine how much decision rights are allocated to managers
Non Financial PM -> informative to make better promotion decisons
, Moers, F. 2006. Performance Measure Properties and Delegation. The Accounting Review
81(4): 897-924.
if financial performance measures are ‘‘good’’ (‘‘poor’’) incentive measures, i.e., high (low)
on sensitivity, precision, and verifiability, then using these measures for incentive purposes
increases (decreases) delegation
t the ability to resolve the incentive problem depends on the quality of contractible
performance measures and, more specifically, on the quality of performance measures that
aggregate information about all actions. An aggregate performance measure can
complement the delegation choice because it provides the agent with the required discretion
and the principal with an instrument to constrain the extraction of private benefits
(Prendergast 2002).
Comprehensive financial (accounting) measures are the most aggregate performance
measures because they ultimately reflect the consequences of all decisions. However, the
degree to which this aggregation feature can be exploited depends on the costs of
contracting on financial measures. The more sensitive, precise, and verifiable financial
measures are relative to other (nonfinancial) measures, the less costly it is to contract on
financial measures. As a result, the better the relative incentive properties (quality) of
financial performance measures, the greater their relative incentive use can complement the
delegation choice, and thus the greater the extent of delegation.
(1) the manager’s actions (sensitivity), (2) factors outside the control of the manager
(precision), and (3) the measurement process (verifiability).
the greater the relative sensitivity and precision of financial performance measures, the
greater the returns to delegation when using these measures for incentive purposes. I further
find that the greater the relative verifiability of financial performance measures, the greater
the extent of delegation.
internal nonfinancial performance measures consist of nonfinancial measures that are
directly related to the tasks performed. Examples of these performance measures are
productivity, efficiency, and successful implementation of projects. Finally, the external
nonfinancial performance measures are defined as those nonfinancial measures that reflect
performance in the market. Examples of these performance measures are customer
satisfaction, market share, and market growth.
If financial performance measures are good incentive measures, i.e., have relatively high
sensitivity, precision, and verifiability, then using these measures for incentive purposes can
complement the delegation choice, which results in increased delegation. Furthermore, I find
that delegation is affected by variables related to the internal and external environment,
which is consistent with the argument that delegation increases when the marginal benefits
of delegation are higher
Lecture 1:
Principal: boss
Agent: employee
Agency problem:
Decision facilitating: guide decision making -> data, analytics, scientific experimentation
Decision influencing: attract talent, offer incentives -> variable segment in salary and perks
Incentives are aligned -> decision facilitating
- info such that people take better decisions
Incentives are not aligned -> decision influencing
- Adverse selection (agent has private information before a contract is written, agent
only signs if it is beneficial for him)
- Moral Hazard: hidden information, hidden action (agent can gather information after
contract is written/ has info that principal is not aware of at time contract is written)
Hidden action: principal can not perfectly control agents effort
Moral hazard: time theft
Management control system: everything a company can do to incentivize employees to act
in firms best interest
- Economics (hard)
- incentive-based compensation
- employee selection
- monitoring systems
- Behavioral (soft)
- leadership
- social norms
- honor codes
Home economicus: rational and focussed on incentives
Decrease moral hazard -> monitoring
- monitoring systems
- internal control procedures
- increased documentation
Moral hazard hidden action: slowing down
,Lecture 2:
The higher (lower) in the hierarchy the more likely that companies will use more aggregated
(more specific) measures of performance; Aggregated financial measures are more goal
congruent
The higher (lower) in the hierarchy the more likely one uses more aggregated measures;
The advantage is that they are more comprehensive leading to higher thinking in trade-offs
and less dysfunctional behavior.
Aggregated measures:
Sensitivity: Influence of action (effort) choices of the manager on outcome
Precision: difference between measurement and achieved performance
-> What is the effect of random variation, uncontrollable factors, noise (e.g. a high score on
financials due to luck?)
Verifiability: Is the measurement process done objectively or not?
-> The extent to which it is ex ante clear how the performance measure is calculated
Audited: e.g. profit before or after tax
Unaudited: pro-forma earnings, CSR emission rights
Typically, nonfinancial PMs are not very congruent as they mainly measure a subset of the
actions a manager can take
Financial PMs are typically quite congruent but sometimes lack sensitivity, precision and
verifiability
Quality of PM:
- Understandable and recognition (Specific)
- Should be easy to measure (Measurable)
- Should be achievable with appropriate effort (Attainable)
- Realistic but some challenge (Realistic)
- Should fit with current organizational culture/ goals (Timely)
Manipulation; Measures should not be able to be influenced by actions we do not want as a
firm (distortions)
Best is to have 1) high quality, and 2) “aggregate” measures
IF not better maybe to keep Decision rights at higher level
Extending employment horizon by offering promotion opportunities:
- Probability of promotion induces employees to work harder (reduce moral hazard)
- Firm also wants to promote most capable employees to higher hierarchy, matching
effect (reduce adverse selection)
Aggregate Financial PM -> determine how much decision rights are allocated to managers
Non Financial PM -> informative to make better promotion decisons
, Moers, F. 2006. Performance Measure Properties and Delegation. The Accounting Review
81(4): 897-924.
if financial performance measures are ‘‘good’’ (‘‘poor’’) incentive measures, i.e., high (low)
on sensitivity, precision, and verifiability, then using these measures for incentive purposes
increases (decreases) delegation
t the ability to resolve the incentive problem depends on the quality of contractible
performance measures and, more specifically, on the quality of performance measures that
aggregate information about all actions. An aggregate performance measure can
complement the delegation choice because it provides the agent with the required discretion
and the principal with an instrument to constrain the extraction of private benefits
(Prendergast 2002).
Comprehensive financial (accounting) measures are the most aggregate performance
measures because they ultimately reflect the consequences of all decisions. However, the
degree to which this aggregation feature can be exploited depends on the costs of
contracting on financial measures. The more sensitive, precise, and verifiable financial
measures are relative to other (nonfinancial) measures, the less costly it is to contract on
financial measures. As a result, the better the relative incentive properties (quality) of
financial performance measures, the greater their relative incentive use can complement the
delegation choice, and thus the greater the extent of delegation.
(1) the manager’s actions (sensitivity), (2) factors outside the control of the manager
(precision), and (3) the measurement process (verifiability).
the greater the relative sensitivity and precision of financial performance measures, the
greater the returns to delegation when using these measures for incentive purposes. I further
find that the greater the relative verifiability of financial performance measures, the greater
the extent of delegation.
internal nonfinancial performance measures consist of nonfinancial measures that are
directly related to the tasks performed. Examples of these performance measures are
productivity, efficiency, and successful implementation of projects. Finally, the external
nonfinancial performance measures are defined as those nonfinancial measures that reflect
performance in the market. Examples of these performance measures are customer
satisfaction, market share, and market growth.
If financial performance measures are good incentive measures, i.e., have relatively high
sensitivity, precision, and verifiability, then using these measures for incentive purposes can
complement the delegation choice, which results in increased delegation. Furthermore, I find
that delegation is affected by variables related to the internal and external environment,
which is consistent with the argument that delegation increases when the marginal benefits
of delegation are higher
