Handout Performance Evaluation and Compensation -...

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Performance Evaluation andCompensationSteve Wu11.29.2012
Objectives for todayPerformance Evaluation for Business UnitsCommonly used financial performance measuresDetails about accounting-based performance measuresTarget setting and feedback mechanismsPerformance Evaluation and Compensation forIndividualsHow to tie compensation to performancePreferred performance measuresExecutive compensationLevers of Control Framework
Financial and Nonfinancial MeasuresFirms are increasingly presenting financialand nonfinancial performance measures fortheir subunits in a balanced scorecard, andit’s four perspectives:1.Financial2.Customer3.Internal business process4.Learning and growth
Accounting-Based Performance MeasuresRequires several steps:1.Choose performance measures that align withtop management’s financial goals.2.Choose the details of performance measures.3.Choose a target level of performance and afeedback mechanism for each performancemeasure.
Choosing Among Different PerformanceMeasuresSelecting subunit operating income as a metricmay be inappropriate because it obviously differssimply on the differing size of the subunits.Four common measures of economicperformance:1.Return on investment2.Residual income3.Economic value added (EVA)4.Return on sales
Return on Investment (ROI)ROI is an accounting measure of income dividedby an accounting measure of investment.ROI may be decomposed into its two componentsas follows (DuPont method of profitabilityanalysis):ROI = Return on Sales x Investment TurnoverIncomeIncomeRevenuesInvestmentRevenuesInvestmentX=ROI =InvestmentIncome
Return on Investment (ROI)Most popular metric for two reasons:1.Blends all the ingredients of profitability(revenues, costs, and investment) into a singlepercentage2.May be compared to other ROI’s both insideand outside the firmHas many different variations.
A Hotel Chain ExampleSan Fran HotelChicago HotelNew Orleans HotelRevenue1,200,0001,400,0003,185,000Variable Costs310,000375,000995,000Fixed Costs650,000725,0001,680,000Operating Income240,000300,000510,000Current Asset400,000500,000660,000Long-term Asset600,0001,500,0002,340,000Total Asset1,000,0002,000,0003,000,000Current Liabilities50,000150,000300,000
A Hotel Chain Example on ROIOperating Income(1)Total Asset(2)ROI(3)= (1)/(2)San Fran240,0001,000,00024%Chicago300,0002,000,00015%New Orleans510,0003,000,00017%OperatingIncome(1)Revenue(2)TotalAssets(3)ROS(4)= (1)/(2)InvestmentTurnover(5)= (2)/(3)ROI(6)= (4)x(5)San Fran240,0001,200,0001,000,00020%1.224%Chicago300,0001,400,0002,000,00021.43%0.715%NewOrleans510,0003,185,0003,000,00016.01%1.0617%
A Hotel Chain Example on ROIOperatingIncome(1)Revenue(2)TotalAssets(3)ROS(4)= (1)/(2)InvestmentTurnover(5)= (2)/(3)ROI(6)= (4)x(5)Original240,0001,200,0001,000,00020%1.224%Plan 1240,0001,200,000800,00020%1.530%Plan 2300,0001,500,0001,000,00020%1.530%Plan 3300,0001,200,0001,000,00025%1.230%How to increase San Francisco Hotel’s ROI from 24% to 30%?Plan 1: reduce total assets by $200,000Plan 2: increase revenue by $300,000 (while keeping ROS constant)Plan 3: cut costs by $60,000

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Term
Spring
Professor
CHAN
Tags
Accounting, Balance Sheet, Return On Investment ROI, Valuation, Generally Accepted Accounting Principles, San Fran, Hotel Chain Example

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