Performance evaluation is a topic of ongoing concern, interest and controversy. While the main goal of performance measurement is to provide a basis for the assessment of employee’s objective achievement it also helps to develop strategic plans and when properly designed it gives the motivation to work towards goals that are aligned with the principals residual interests (Ittner & Larcker, 1998). However, this incentive alignment is subject to major discussion. For example Josef Ackermann (2008), CEO of Deutsche Bank, admitted that one reason for the development of the sub prime crisis was the bonus system among banks. He argued that bonuses should establish the right incentives and be oriented towards medium- and long-term goals. He assessed tying bonuses to maximize profits in the short term – which encourages managers to take high risks – as the wrong approach. The question is therefore, which kind of measurement techniques can be used to reflect the subordinate’s incremental contribution to the firm value and how they can be designed to serve the principals’ goals. The paper is organized as follows. The first part provides an overview of performance evaluation in general followed by the main part about objective and subjective performance measures, their benefits and shortcomings. Before concluding, the balanced scorecard – a tool for performance evaluation that combines both financial and operational measures – is analyzed and described. [...]
Table of Contents
1. Introduction
2. Performance evaluation – overview
3. Objective performance evaluation
3.1 Advantages
3.2 Shortcomings
4. Subjective performance evaluation
4.1 Advantages
4.2 Problems
5. Combined evaluation tool: The Balanced Scorecard
6. Conclusion
Objectives and Core Topics
This paper aims to provide a comprehensive analysis of performance evaluation methods, specifically contrasting objective accounting-based measures with subjective assessment techniques to determine how they influence employee motivation and the alignment of agent actions with organizational goals.
- Theoretical overview of agency theory and performance measurement.
- Benefits and limitations of objective, outcome-oriented performance metrics.
- Analysis of subjective measures in mitigating risks and capturing intangible assets.
- Evaluation of the Balanced Scorecard as a combined strategic management tool.
Excerpt from the Book
3.2 Disadvantages
The overall goal of performance measures is to provide the agent with the incentive to work for a predetermined goal that is congruent with the principal’s interests. Although, objective measures of performance are part of most evaluation schemes, they have significant drawbacks and are considered incomplete toward the requirement of incentive alignment. This section gives an overview of the most common problems associated with objective, non-financial performance measures.
Short term and backward focus
The use of objective accounting based performance measures implies that only the outcome – resulting from past actions - is evaluated, not the effect on long-term influences on the company’s degree of future target realization. It has no value for strategic goals like improving customer satisfaction or the investment in intellectual capital, which is necessary for future financial success (Gibbs, et al, 2004). Hence, if financial measures are used, the evaluated subordinate will focus his attention to the achievement of the tasks that are captured by the incentive plan and automatically induce a short-term focus. Feltham & Xie (1994) argue that “divisional accounting profit is described as a short-term financial measure that may induce managers to ignore the future economic consequences of their current actions”.
Summary of Chapters
1. Introduction: Presents the relevance of performance evaluation and the ongoing debate regarding incentive alignment in banking and corporate sectors.
2. Performance evaluation – overview: Explores the role of agency theory and how performance measures function within labor contracts to align agent and principal objectives.
3. Objective performance evaluation: Discusses the utility of quantitative accounting figures as ex-post measures for performance tracking.
3.1 Advantages: Highlights the reliability, explicitness, and cost-effectiveness of using standardized accounting data for performance reviews.
3.2 Shortcomings: Details the issues of short-termism, incompleteness, susceptibility to uncontrollable noise, and potential for accounting manipulation.
4. Subjective performance evaluation: Analyzes the shift towards assessing process-based and intangible factors that traditional metrics fail to capture.
4.1 Advantages: Examines how subjective measures support long-term perspective taking and provide better indicators for future financial performance.
4.2 Problems: Addresses risks such as favoritism, discretionary bias, and weighting challenges inherent in subjective evaluation systems.
5. Combined evaluation tool: The Balanced Scorecard: Describes a holistic framework that integrates financial and non-financial metrics to manage strategy.
6. Conclusion: Summarizes that while objective measures are standard, subjective measures are necessary complements, provided that clear communication and trust are maintained.
Keywords
Performance evaluation, agency theory, objective measures, subjective measures, incentive alignment, Balanced Scorecard, earnings management, long-term perspective, intangible assets, favoritism, performance weighting, corporate strategy, accountability, management control, incentive contracts.
Frequently Asked Questions
What is the primary focus of this paper?
The paper examines the effectiveness of performance evaluation techniques, specifically comparing objective and subjective methods in aligning employee behavior with organizational strategic goals.
What are the central themes discussed in the work?
The central themes include incentive alignment, the dichotomy between short-term financial results and long-term value creation, and the challenges of bias in performance appraisals.
What is the core research goal?
The goal is to determine which measurement techniques best reflect an employee's contribution to firm value while minimizing the distortions caused by traditional accounting metrics.
Which scientific approach is utilized?
The author uses a literature-based synthesis, referencing foundational agency theory and empirical studies to evaluate the merits and drawbacks of different performance metrics.
What topics are covered in the main section?
The main section covers the pros and cons of objective versus subjective measures and the implementation of the Balanced Scorecard as a combined management tool.
How would you summarize the main keywords?
Key terms include performance evaluation, agency theory, subjective/objective measures, and the Balanced Scorecard, all focused on the mechanism of employee motivation.
Why are objective measures considered "incomplete"?
They often focus on past outcomes and short-term financial results, failing to capture critical drivers of future success like customer satisfaction or innovation.
What is the "outcome effect" mentioned in the context of subjective evaluation?
It refers to the psychological bias where supervisors evaluate an employee's performance based on the final result, ignoring whether the actions taken were appropriate.
How can companies mitigate the risks of favoritism in subjective evaluations?
According to the text, clear communication of evaluation standards and the cultivation of a trustful, honest relationship between supervisors and subordinates are essential.
- Quote paper
- BSc in Economics Tobias Westermaier (Author), 2008, Performance Evaluation: Methods and their qualities, Munich, GRIN Verlag, https://www.grin.com/document/113776
