What Determines Performance

1
What Determines Performance?

• Previous training (Human Capital)
• Innate ability (psychologists G)
• Effort

2
Evaluation

• Evaluations serve several purposes.
• Measuring performance to use in implementing
  incentive compensation (feedback and raises)
• Measuring the workers general ability to forecast
  her performance on another job. (Screening and
  job allocation)
• Evaluation is costly. This means that the firm
  must choose the optimal degree of evaluation.

3
How much and when?

• Evaluations should occur less often
• If workers have highly specific training. If is
  unlikely that the firm will need to meet outside
  offers quickly.
• If the firm can screen workers easily before the
  job is taken.
• If the worker has long tenure with the firm.
  General ability is known. Senior workers should
  be evaluated on achievement not ability.

4
How do we measure performance?

• Ideal Performance measure Value of person to the
  organization and NOTHING ELSE
• controllables effects of efforts on firm
  value qi
• improves alignment between employee firm
• uncontrollables effects of other factors
• measurement error, effects of other employees on
  firm value, or effects of external events on firm
  value
• exposes employee to risk
• example stock price as a performance measure for
  a CEO or a janitor

5
How do we measure performance?

• Effect on organization bottom line (broad)
• Performance on tasks (narrow)
• Quantity of work
• Quality of work
• Objective evaluation (Quantitative) or Subjective
  evaluation (Qualitative)

6
Scope of a Performance Measure
Narrow Broad (fewer factors) (more
factors) High Distortion Low Distortion Low
Risk High Risk

• Narrower measures are those that tend to focus
  on fewer aspects of performance, or on inputs
• Narrower measures tend to reduce risk, but also
  to distort incentives more
• the greater the distortions, the weaker should
  the incentives be
• measures may be broader/ narrower or narrower on
  several dimensions
• broader job designs tend to imply broader
  performance measures

7
Scope Distortions

• Measures trade off risk v. distortions are
  narrower or broader along several dimensions
• 1. how many tasks to include?
• e.g., quantity v. quality
• 2. should intangibles or difficult-to-measure
  effects be included?
• e.g., opportunity costs
• 3. how large a unit should be measured?
• e.g., individual v. team v. unit v. division v.
  corporate
• 4. what time horizon?
• e.g., sales v. customer retention / growth
• Accounting s often have some of all 4 problems

8
Broad vs Narrow Measures

• Narrow Measures
• Easier to measure
• Filter out some uncontrollable effects on
  performance (example accounting earnings vs
  stock price) therefore reduce employee risk
• Distort incentives by focusing only on the narrow
  view (short term for executives specific task at
  expense of others for lower level)

9
Broad vs Narrow Measures

• Broad Measures
• Allow tailored responses to specific issues
• Give correct incentives
• Line of sight issue is very important
• Often highly risky for employee due to
  uncontrollables

10
Likely Problems with Performance Measures

• Hard to measure qualities (intangibles)
• Opportunity cost of doing things
  differently-value potentially unknown
• Differing group sizes and qualities
• Individual performance often neglects cooperation
• Team performance can run into 1/n problem
• Small groups may differ in average quality
• Time period for performance often too
  short-encourages short run actions that are bad
  in the long run
• Potential for manipulation (gaming)
• Distorts incentives (wrong weights)

11
Possible Scope of Performance Measure for
Division Manager Constraints get less Decisions
are more
12
Examples

• Balanced Scorecard
• emphasizes financial plus other measures to
  reduce distortions
• customer perspective quality, service, delivery
• internal perspective employee satisfaction,
  unit cost, yield
• innovation learning time to market, new
  products, sales from new products
• EVA (Economic Value Added)
• emphasizes inclusion of opportunity costs to
  reduce distortions
• residual income after cost of capital
• designed to support decentralization
• careful performance meas., reallocation of
  decision rights, stronger incentives
• goal ownership incentives for divisional
  managers

13
Summary

• Properties of performance measures to think about
• how aligned with firm value (how distorted)?
• can distortions be reduced by adding an incentive
  on a second measure?
• how risky for the employee?
• should the firm incur greater costs to measure
  more accurately?
• how manipulable?
• could this degrade the value of the measure?

14
Let them do their work

• Constraints should be as few as possible with
  good management performance measures should be
  as broad as possible

15
Benefits of Subjective Evaluations

• Refine quantitative performance
• Improve risk taking by introducing flexibility
  for uncontrollable events
• Change incentive system on-the-fly
• Expand communication
• Improve training

16
Subjective Evaluation

• Judgment is an alternative to quantitative
• Typical problems
• inflation compression
• reluctance for negative feedback
• de-motivating effects?
• low trust of evaluator
• favoritism
• problems are more significant when promotion
  stakes are higher
• ½-life of appraisal systems ? 5 yrs

17
Example TopGrading

• Pioneered at GE, tried by many other firms
• some form of forced curve
• GE top 20 middle 70 bottom 10
• those w/ consistently low ratings typically
  forced out
• Where does it work best?
• larger workgroups
• teamwork is less important
• culture is more aggressive / Darwinian
• extensive attention is paid to coaching
  development
• employees are given clear expectations about
  weeding out
• potential legal liabilities are monitored
  carefully
• great care is taken to make sure evaluations are
  based on performance

18
Who should do the evaluation?

• To minimize politicking, the person doing the
  evaluation should not be accessible by the
  worker.
• This introduces a tradeoff since outside persons
  have less information about the worker.
• One compromise is to review from both above and
  below (360 degree evaluation)

19
Subjective Evaluations

• Supervisors do not like to do evaluations
• the supervisor absorbs all the grief from a poor
  evaluation
• everyone will be rated above average
• Negative feedback is not easy to give in a
  positive way
• Creates agency problem with supervisors
  evaluations tend to have small variance around
  above average
• Incentives must be given for correct evaluations
• Evaluations need to move from past focus to
  future focus
• Forced distribution is an extreme form of
  incentive

20
Relative or Absolute Ratings?

• Absolute - Encourages cooperation between
  workers. Encourages politicking. Introduces
  tension between workers and management because
  workers want low standard and management wants
  high.
• Relative - Cooperation between workers hurt.
  Workers may collude to lower effort. Increases
  tension among workers. Reduces opportunities for
  supervisor bias and therefore leads to less
  politicking.

21
Dirty Little Secret in Business

• Lack of candor Very few workers get real
  evaluations that allow them to see what they need
  to improve.
• Candor yields speed
• Candor reduces cost
• Why isnt candor used?
• Socialized to make nice
• More popular
• Easier not to talk about it
• Real reason self-interest rather than interest
  in other person

22
Candor/Differentiation

• Very difficult to instill Took GE nearly 20
  years
• GE 20/70/10
• Criticisms
• Unfair
• Undermines team
• Mean/immoral
• Only possible in the US
• Biggest Problem Top of 70 not much different
  from Top 20. Less problem of bottom 10 not much
  different from bottom of 70

23
Ways to Mitigate Problems w/ Appraisals

• Reduce the stakes
• pay compression, weaker incentive intensities
• Evaluator Incentives
• pay for performance
• constraints monitoring
• multiple evaluators review of evaluations
  grievance procedures
• Culture of constructive feedback
• Avoid conflicts between evaluation coaching
  goals
• Other approaches 360, MBO

24
The Appraisal Process

• Strive for day-to-day coaching, rather than a
  comprehensive annual appraisal
• reduces defensiveness to criticism
• more closely tied to events
• Focus on goal setting rather than criticism
• constructive
• mutual goal setting
• but fight the tendency to avoid tough feedback
• Consider separate appraisals for separate
  purposes
• evaluation for salary promotion
• coaching development

25
Properties of A Successful System

• Successful Measurement System Provides
• Feedback that tells you whether you are - or
  aren't - doing the right things, and doing them
  well
• Motivation that will spur you on to improve your
  performance
• Incentive for you and your team to 'do it better'
  
• But for all this to happen you must make sure
  that you measure
• the right things
• at the right time, and
• in the right place

26
Receiving an Appraisal

• Ask for feedback, regularly
• Avoid defensiveness / check emotions
• take responsibility for mistakes
• dont politicize / lobby
• Focus on constructive suggestions
• set goals
• discuss priorities
• Identify what you need
• new skills
• information
• resources

27
How much and when?

• Evaluations should occur less often

• There is little downside risk (or vice versa when
  there is large upside gain)
• When there is a high probability that the worker
  will succeed at the job.
• Workers are less likely to have outside offers
• At the end of careers