External consideration and behavioral aspects

External consideration and behavioural aspects

4. External considerations

4.1. Stakeholders: Stakeholders are groups of people or individuals who have a legitimate interest in the activities of an organisation. They include customers, employees, the community, shareholders, suppliers and lenders. There are three broad types of stakeholder in an organisation.

• Internal stakeholders (employees, management)

• Connected stakeholders (shareholders, customers, suppliers, financiers)

• External stakeholders (the community, government, pressure groups)

The stakeholder approach suggests that corporate objectives are, or should be, shaped and influenced by those who have sufficient involvement or interest in the organisation's operational activities.

4.1.1 Internal stakeholders: employees and management: Because employees and management are so intimately connected with the company, their objectives are likely to have a strong influence on how it is run. They are interested in the following issues.

(a) The organisation's continuation and growth. Management and employees have a special interest in the organisation's continued existence.

(b) Managers and employees have individual interests and goals which can be harnessed to the goals of the organisation.

• Jobs/careers  • Benefits           • Promotion

• Money              • Satisfaction    

For managers and employees, an organisation's social obligations will include the provision of safe working conditions and anti-discrimination policies.

4.1.2 Connected stakeholders: Increasing shareholder value should assume a core role in the strategic management of a business. If management performance is measured and rewarded by reference to changes in shareholder value then shareholders will be happy because managers are likely to encourage long-term share price growth.

Connected stakeholder	Interests to defend
Shareholders (corporate strategy)	·       Increase in shareholder wealth, measured by profitability, P/E ratios, market capitalisation, dividends and yield ·       Risk
Bankers (cash flows)	·       Security of loan                     ·  Adherence to loan agreements
Suppliers (purchase strategy)	·       Profitable sales                    ·  Long-term relationship ·       Payment for goods
Customers (product market strategy)	·       Goods as promised                 · Future benefits

Even though shareholders are deemed to be interested in return on investment and/or capital appreciation, many want to invest in ethically sound organisations.

4.1.3 External stakeholders: External stakeholder groups – the Government, local authorities, pressure groups, the community at large, professional bodies – are likely to have quite diverse objectives.

External stakeholder	Interests to defend
Government	·       Jobs	·	Training	·	Tax
Interest/pressure groups / charities / 'civil society'	·       Pollution	·	Rights	·	Other

It is external stakeholders in particular who induce social and ethical obligations.

4.1.4 Performance measures: Organisations may need to develop performance measures to ensure that the needs of stakeholders are met.

Stakeholder	Measure
Employees	Morale index
Shareholders	Share price, dividend yield
Government	Percentage of products conforming to environmental regulations
Customers	Warranty cost, percentage of repeat customers

4.2 Economic environment

Economic growth

• Has the economy grown or is there a recession?

• How has demand for goods/services been affected?

Local economic trends

• Are local businesses rationalising or expanding?

• Are office/factory rents increasing/falling?

• In what direction are house prices moving?

• Are labour rates on the increase?

Inflation: (a) Is a high rate making it difficult to plan, owing to the uncertainty of future financial returns? Inflation and expectations of it help to explain short-termism.

(b) Is the rate depressing consumer demand?

(c) Is the rate encouraging investment in domestic industries?

(d) Is a high rate leading employees to demand higher money wages to compensate for a fall in the value of their wages?

Interest rates

• How do these affect consumer confidence and liquidity, and therefore demand?

• Is the cost of borrowing increasing, thereby reducing profitability?

Exchange rates

• What impact do these have on the cost of overseas imports?

• Are prices that can be charged to overseas customers affected?

Government fiscal policy

(a) Are consumers increasing/decreasing the amount they spend due to tax and government spending decisions?

(b) How is the Government's corporation tax policy affecting the organisation?

(c) Is VAT affecting demand?

Government spending: Is the organisation a supplier to the Government (such as a construction firm) and therefore affected by the level of spending?

4.3 Competition: Performance management must consider information on competitors' prices and cost structures and identify which features of an organisation's products add most value. Management accounting information has to be produced speedily and be up to date so that managers can react quickly and effectively to changing market conditions.

5. Behaviour aspects of performance management

It is generally considered to be unreasonable to assess managers' performance in relation to matters that are beyond their control. Therefore management performance measures should only include those items that are directly controllable by the manager in question.

If people know that their performance is being measured then this will affect the standard of their performance, particularly if they know that they will be rewarded for achieving a certain level of performance.

Ideally, performance measures that reward behaviour which maximises the corporate good will be devised. In practice, however, it is not quite so simple.

(a) There is a danger that managers and staff will concentrate only on what they know is being measured. This is not a problem if every important issue has a measure attached to it, but such a system is difficult to devise and implement in practice.

(b) Individuals have their own goals, but good performance that satisfies their own sense of what is important will not necessarily work towards the corporate good. Each individual may face a conflict between taking action to ensure organisational goals and action to ensure personal goals.

Point (b) is the problem of goal congruence.

5.1 Example: Performance measurement and behaviour

(a) As we saw in Chapter 17, a divisional manager whose performance is assessed on the basis of their division's ROI might reject a proposal that produces an ROI greater than the group's target return if it reduces their division's overall return.

(b) Traditional feedback control would seek to eliminate an adverse material price variance by requiring managers to source cheaper, possibly lower quality, suppliers. This may run counter to an organisational objective to implement a system of TQM with the aim of reducing quality costs.

5.2 Measuring managerial performance: It is difficult to devise performance measures that relate specifically to a manager to judge their performance as a manager. It is possible to calculate statistics to assess the manager as an employee, like any other employee (days absent, professional qualifications obtained, personability, and so on), but this is not the point. As soon as the issue of ability as a manager arises it is necessary to consider them in relation to their area of responsibility. If we want to know how good a manager is at marketing, the only information there is to go on is the marketing performance of their division (which may or may not be traceable to their own efforts).

5.3 The controllability principle: As we have seen, the controllability principle is that managers of responsibility centres should only be held accountable for costs over which they have some influence. From a motivation point of view this is important because it can be very demoralising for managers who feel that their performance is being judged on the basis of something over which they have no influence. It is also important from a control point of view, in that control reports should ensure that information on costs is reported to the manager who is able to take action to control them.

5.4 Reward schemes and performance measurement: In many organisations, senior management try to motivate managers and employees by offering organisational rewards (more pay and promotion) for the achievement of certain levels of performance. The conventional theory of reward structures is that, if the organisation establishes procedures for formal measurement of performance, and rewards individuals for good performance, individuals will be more likely to direct their efforts towards achieving the organisation's goals.

5.4.1 Problems associated with reward schemes

(a) A serious problem that can arise is that performance-related pay and performance-evaluation systems can encourage dysfunctional behaviour. Many investigations have noted the tendency of managers to pad their budgets either in anticipation of cuts by superiors or to make subsequent variances more favourable.

(b) Perhaps of even more concern are the numerous examples of managers making decisions that are contrary to the wider purposes of the organisation.

(c) Schemes designed to ensure long-term achievements (that is, to combat short-termism) may not motivate since efforts and reward are too distant in time from each other (or managers may not think they will be around that long!).

(d) It is questionable whether any performance measures or set of measures can provide a comprehensive assessment of what a single person achieves for an organisation. There will always be the old chestnut of lack of goal congruence, employees being committed to what is measured, rather than the objectives of the organisation.

(e) Self-interested performance may be encouraged at the expense of teamwork.

(f) High levels of output (whether this is number of calls answered or production of product X) may be achieved at the expense of quality.

(g) In order to make bonuses more accessible, standards and targets may have to be lowered, with knock-on effects on quality.

(h) They undervalue intrinsic rewards (which reflect the satisfaction that an individual experiences from doing a job and the opportunity for growth that the job provides) given that they promote extrinsic rewards (bonuses and so on).