Cost Accounting (14th Edition)

incentives. Sullivan’s compensation was in the 90th percentile for
CEOs of S&P 500 firms for 2007.
On June 15, 2008, AIG replaced Sullivan as CEO. By then, AIG
reported cumulative losses totaling $20 billion. During Sullivan’s
three-year tenure at the helm, AIG lost 46% of its market value.
At the time of his dismissal, the AIG board of directors agreed
to give the ousted CEO about $47 million in severance pay,
bonus, and long-term compensation.
Two months later, on the verge of bankruptcy, the U.S.
government nationalized AIG. At a Congressional hearing in the
aftermath of AIG’s failure, one witness testified on Sullivan’s
compensation stating, “I think it is fair to say by any standard of
measurement that this pay plan is as uncorrelated to
performance as it is possible to be.”
Companies measure reward and performance to
motivate managers to achieve company strategies and goals.
As the AIG example illustrates, however, if the measures are
inappropriate or not connected to sustained performance,
managers may improve their performance evaluations and
increase compensation without achieving company goals.
This chapter discusses the general design, implementation,
and uses of performance measures, part of the final step in the
decision-making process.
Financial and Nonfinancial Performance
Measures
Many organizations are increasingly presenting financial and nonfinancial performance
measures for their subunits in a single report called the balanced scorecard (Chapter 13).
Different organizations stress different measures in their scorecards, but the measures are
always derived from a company’s strategy. Consider the case of Hospitality Inns, a chain
of hotels. Hospitality Inns’ strategy is to provide excellent customer service and to charge
a higher room rate than its competitors. Hospitality Inns uses the following measures in
its balanced scorecard:
1. Financial perspective—stock price, net income, return on sales, return on investment,
and economic value added
2. Customer perspective—market share in different geographic locations, customer satisfaction,
and average number of repeat visits
3. Internal-business-process perspective—customer-service time for making reservations,
for check-in, and in restaurants; cleanliness of hotel and room, quality of room
service; time taken to clean rooms; quality of restaurant experience; number of new
services provided to customers (fax, wireless Internet, video games); time taken to
plan and build new hotels
Learning
Objective 1
Select financial
performance measures
. . . such as return on
investment, residual
income
and nonfinancial
performance measures
to use in a balanced
scorecard
. . . such as customersatisfaction,
number
of defects