Chapter 12
Uploaded by
Yuxuan SongChapter 12
Uploaded by
Yuxuan SongCommon questions
Powered by AIApplying adjustments for negative but not positive uncontrollable factors could lead to biased assessments that reward bad performance unduly while not adequately recognizing the impact of favorable uncontrollable events. This could skew managerial perceptions, leading to complacency or opportunism, and potentially misalign strategic objectives .
Adjustments for partially uncontrollable factors can lead to the creation of an 'excuse culture' where managers are prone to make excuses instead of addressing actual problems. This results in costly management time spent investigating claims and determining appropriate adjustments, ultimately leading to inefficiencies .
The potential benefits include more accurate performance evaluations, lower levels of managerial frustration, enhanced motivation, improved decision-making due to less noise in performance measures, and lower compensation costs over time due to decreased risk and turnover .
Shareholders should bear the risks associated with uncontrollable factors because they are better able to diversify these risks. Unlike managers, shareholders can absorb these risks across their portfolio, which allows for more stable performance evaluation measures without distorting managerial accountability .
Making adjustments for uncontrollable factors can lead to more accurate performance evaluations, which can reduce managerial frustration and enhance motivation. It minimizes the feeling of unfairness due to uncontrollable circumstances affecting evaluations, thereby encouraging better performance and decision-making .
Adjustments for uncontrollable factors can lower compensation costs in the long run. By reducing the risks perceived by managers through these adjustments, less compensation is needed to incentivize managers, which may also result in reduced turnover and less demand for risk premiums .
Considering uncontrollable factors in performance evaluations can introduce subjectivity, which in turn introduces evaluation bias. This occurs because the effect of many uncontrollable factors can only be estimated, leading to potential inaccuracies and biased judgments, which disrupts the objectivity of performance assessments .
A company might decide not to fully shield managers from uncontrollable factors if it wants managers to respond to those factors. By not providing complete protection, it preserves some motivation for managers to adapt and innovate in response to certain changes, thereby promoting resilience and strategic thinking .
The controllability principle is based on the rationale that uncontrollable factors distort performance measures and evaluations, and that uncontrollable risks are best borne by shareholders who can diversify them. If managers bear these risks, they must be compensated, but this can lead to undesirable actions such as 'gameplaying' to protect themselves .
Methods used to make adjustments for uncontrollable factors include variance analysis, flexible performance targets like 'flexed budgets', relative performance evaluations (RPE), and subjective judgments. These methods allow for tailored adjustments that can potentially provide more accurate performance assessments .