Page 237 - DMGT514_MANAGEMENT_CONTROL_SYSTEMS

Management Control Systems

Notes Decisions on these design variables are influenced by the mission of the business unit as shown
in the following table.

Table 12.3: Different Strategic Implications for Budgeting

Build Hold Harvest
Percent compensation as Relatively high Relatively low
bonus
Bonus criteria More emphasis on non- More emphasis on
financial criteria financial criteria
Bonus determination More subjective More formula-
approach based
Frequency of bonus payment Less frequent More frequent

As for the first question, many firms use the principle that the riskier the strategy, the greater the
proportion of the general manager’s compensation in bonus compared to salary (the “risk/
return” principle). They maintain that, since managers in charge of more uncertain task situations
should be willing to take greater risks, they should have a higher percentage of their remuneration
in the form of an incentive bonus. Thus, reliance on bonus is likely to be higher for “build”
managers than for “harvest” managers.
As for the second question, when an individual’s rewards are tied to performance according to
certain criteria, his or her behaviours are influenced by the desire to optimise performance with
respect to those criteria. Some performance criteria (cost control, operating profits, cash flow
from operations, and return on investment) focus more on the short-term performance, whereas,
other performance criteria (market share, new product development, market development, and
people development) focus on long-term profitability. Thus, linking incentive bonus to the
former set of criteria tends to promote a short-term focus on the part of the general manager,
whereas, linking incentive bonus to the latter set of performance criteria is likely to promote a
long-term focus. Given the relative differences in time horizons of build and harvest managers,
it may be inappropriate to use a single, uniform financial criterion (such as return on investment)
to evaluate the performance of every business unit; rather, it may be desirable to use multiple
performance criteria, with differential weights for each criterion depending on the mission of
the business unit.

As for the third question, in addition to varying the importance of different criteria’s, superiors
must also decide on the approach to take in determining a specific bonus amount. At one
extreme, a manager’s bonus might be a strict formula-based plan, with the bonus tied to
performance on quantifiable criteria (e.g., x percent bonus on actual profits in excess of budgeted
profits); at the other extreme, a manager’s incentive bonus amounts might be based solely on
the superior’s subjective judgement or discretion. Alternatively, incentive bonus amounts might
also be based on a combination of formula based and subjective (non-formula) approaches.
Performance on most long-term criteria (market development, new product development, and
people development) is clearly less amenable to objective measurement than is performance
along most short-run criteria (operating profits, cash flow from operations, and return on
investment). Since, as already noted, build managers – in contrast with harvest managers -
should focus more on the long run rather than the short run, build managers are typically
evaluated more subjectively than harvest managers.

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