Performance measures have been known to affect behaviour. If employees know that they are being judged according to how their performance meets certain standards, they will strive to uphold those standards in order to be rewarded. Ideally, performance measures should be designed to reward positive behaviour that maximises the corporate goal. However, in the modern business climate, shareholder value maximisation has become a central tenet of the way that most companies are run, usually at the expense of other important criteria. This paper will aim to explore the negative side-effects of an over-fixation with modern performance metrics on employee behaviour.

1. B. I. Corporate Performance Measurement
The financial metrics and their influence on behaviours
By
Olimjon Suleymanov (102309)
Grenoble Graduate School of Business

2. Performance measures have been known to affect behaviour. If employees know that they are being
judged according to how their performance meets certain standards, they will strive to uphold those
standards in order to be rewarded. Ideally, performance measures should be designed to reward positive
behaviour that maximises the corporate goal. However, in the modern business climate, shareholder value
maximisation has become a central tenet of the way that most companies are run, usually at the expense
of other important criteria. This paper will aim to explore the negative side-effects of an over-fixation
with modern performance metrics on employee behaviour.
In order for managers, employees or any other agents to perform their fiduciary duties to the best of their
abilities there needs to be an element of controllability. Without ownership of their operational direction,
it is very hard to motivate agents. Therefore, managers and employees should only be judged on measures
that are within their control.
Another important criterion for the successful implementation of an effective financial metric
infrastructure to motivate employees is accountability. Agency theory suggests that the principal must be
able to hold the agent to account and the agent has to submit regular updates of the manner they are
conducting their duties. In the private sector, agents are usually considered the managers running a
business. Managers (the agents) have to submit quarterly reports to the shareholders (the principals) that
they have a fiduciary duty to. In the public sector, this distinction is often more broad and the agency
theory applies to a more varied mix of roles. In the public sector, civil servants are the agents and the
general populous are considered principals. Agents are assumed to: behave rationally in seeking to
maximise their own utility, seek financial and non-financial rewards, tend to be risk averse hence
reluctant to innovate, their individual interests may not always coincide with that of the principal, prefer
leisure to hard work, they always have more knowledge about their operating performance than is
available to their principal (Access my Library, 2001). Hard accountability encompasses the use of
financial metrics because numbers are involved and performance can be quantified.
Negative effects of metric-fixation defined
Tunnel Vision is one of the main symptoms of metric-fixation. This is the undue focus on specific
performance measures like sales revenue and profit margin, to the detriment of other relevant areas like
Research and Development (R&D). Because R&D is only capitalised under very specific circumstances,
many companies do not warm up to the concept of expending unlimited resources on innovation. Tunnel
vision can be a very fatal handicap to possess in competitive industries with high product turnover, such
as the tech sector.
Tunnel vision can also promote dysfunctional behaviour. In companies that operate in a Budget Culture,
where financial metrics are imposed by the finance department, either through budgeting constraints or
the instigation to meet financial targets could incentivise divisions within the organisation to operate
selfishly and in dysfunctional ways. The resultant tunnel vision on one’s own financial targets catalyses
the deterioration of teamwork and can ultimately lead to failure.
Sub-optimisation is the focus on some objectives so that others are not archived. For example, if
employees at an estate agency are gauged on hours worked, it doesn’t really pay much attention to
maximising sales or correlate directly to the amount of customers that are invited to view property.
Therefore, the compensation system fails to reward the quality of work, and rather rewards the standard
Olimjon Suleymanov 2

3. quantity of work time. Within large organisations, this could potentially be catastrophic because divisions
will lack coordination as a consequence of a lack of motivation.
Myopia refers to short-sightedness leading to the neglect of longer-term objectives. For example, an
engineering firm could aim to reduce costs by sourcing from the cheapest suppliers of a particular raw
material. However, there might be further long-term costs associated with wear and tear that the company
hasn’t thought about. Financial metrics could oftentimes cause an organisation to lose focus on its long-
term objectives.
Measure Fixation is the prevalence of undue focus on measures and behaviour within an organisation, in
order to achieve specific performance indicators which may not be effective. The financial metrics might
be outdated in a dynamic business environment –like the technology sector, where trends evolve quickly.
For example, an engineering firm may seek to employ more machinery to improve equipment utilisation.
However, a general recession may mean that the newly-purchased machinery may not be immediately
needed because it might cause over-capacity and tie down the financial commitment of a company to a
non-performing-asset. More non-financial metrics might be needed to measure critical success factors
within organisations that cannot devise adequate financial measures.
Misrepresentation involves using "creative" reporting to suggest that a result is acceptable. This has,
unfortunately, been a prevalent practice that led to the demise of many great companies like Enron,
Bearings Bank and many more important companies. This practice is often aided by the complicity of
regulators and auditors.
Misinterpretation of financial measures could occur and result in failure to recognise the complexity of
the environment in which the organisation operates. Managers might focus on financial metrics that are
not relevant and as a result miss critical strategic decisions that might be more suitable for their industry.
This was particularly evident in the US car manufacturing market before the recession. Both Chrysler and
General motors discovered that most people turn to cost-saving models of vehicles, instead of muscle
cars, when concerned about finances and escalating oil prices.
Gaming is similar to creative accounting but it occurs more frequently internally than through external
annual statements to shareholders. It involves the deliberate distortion of a measure to secure some
strategic divisional/functional advantage. A manager might deliberately underperform in order to secure a
grant if his division doesn’t do well. Profit smoothing could also be sighted as a great example of this
dubious practice. Managers could also deliberately set very low targets in order to secure their bonuses
when their division meets their annual targets. This is indicative of a lack of risk taking when it comes to
setting ambitious targets.
The organisation may become too indoctrinated in internally-set measures and fail to innovate or allocate
the right amount of capital to different divisions based on their need. This is a symptom of Ossification,
where a company’s culture becomes too reactive and inflexible, with heavy reliance in outdated financial
metrics. Ossification: an unwillingness to change the performance measure scheme once it has been set
up.
Another worrying problem that needs mentioning is that financial metrics need to strike a balance in
devising financial metrics to motivate employees is that they need to be realistic. If the metrics are too
Olimjon Suleymanov 3

4. high, employees might be demotivated to attempt to meet them. On the other hand, in organisations that
have a heavy budget-constrained culture, employees might strive to meet the minimum targets in order to
obtain their rewards after breaching a critical level of performance. This is a real danger in a competitive
business landscape because employee discretion in executing tasks to the best of their ability will be
significantly diminished due to a lack in motivation. Furthermore, the calculus of the optimal mix of
performance between different divisional/functional groups might be wrong, hence when underwhelming
targets are breached by most employees, a disproportionate and dysfunctional performance might result.
Financial metrics may encourage divisions and individuals to use more resources than necessary in
striving to achieve their financial targets. This diminishes efficiency, encourages wastage and increases
costs. This may suggest undue reliance on a particular outcome.
Effects on Behaviour in the public markets
The fixation on financial metrics in modern business has resulted in surprisingly high turnover rates for
Chief Executive Officers (CEOs) in most of today’s listed companies. The pressure to perform and satisfy
investor confidence has resulted in the leadership of many companies opting for unethical shortcuts to
boost their share prices. Nowhere is this more evident than with the Enron scandal of 2001.
Performance metrics can be either internal or external. Internal benchmarks include divisional or
functional targets within a company and they might include; a sales team meeting particular sales targets
or a marketing team garnering the interests of a targeted number of new online customers. External
benchmarks are those used by analysts in their research before suggesting “buy/sell” recommendations on
stock prices for clients. External analysts do not usually have all the information needed to make
informed decisions, hence they have to ferret out data and apply it to an idiosyncratic methodology to
interpret a company’s performance. Common financial data that external analysts may seek are, Sales
Growth Rate, Operating Margin and P/E Ratio, all of which are reflected in their “Sell/Buy”
recommendations and can have significant effects on the stock price of a publicly traded company. This
could be very consequential because external analysts only provide estimates of value and external value
metrics are often distorted.
Behavioural aspects of the Enron Scandal
The Enron Scandal incorporates all of the above-mentioned negative effects of financial metrics as
motivational tools. Enron operated a Performance Review Committee (PRC) that evaluated the
performance of employees and ranked them accordingly (Time, 2001). 15% of the bottom performing
tranche of employees was subsequently terminated on an annual basis. The so called “Rank and Yank”
system of evaluating employees ran alongside the reward systems that the firm reserved for its higher
performers. As a result, a very cutthroat culture emerged in which Enron’s traders were willing to commit
frauds in order to get an edge over their peers in the marketplace. For Enron’s executives, who were
mostly rewarded in stock options, promoting the company’s share price was their main focus; hence they
were fixated on one particular aspect of the business. Enron consistently delivered 30% increases in its
share price every quarter of its operation as a result (EzineMark, 2004), and the stock ticker was displayed
in the internal premises of the company in order for employees-who were mostly rewarded in stock
Olimjon Suleymanov 4

5. options and vested their pensions in the company-to keep an eye on the appreciation of their portfolios
and be subsequently motivated to perform for the company.
Additionally, the managers of the company attempted to misrepresent their actual sales revenue by using
mark-to-market accounting to book unrealised profits into their financial statements. They misrepresented
their revenue base by assuming that they were acting as wholesale merchants while serving as
intermediaries in transactions between customers and suppliers of wholesale natural gas (Dharan, Bala G.;
William R. Bufkins, 2008). In actual fact they were agents that should have recorded only the trading and
brokerage fees that they charged to facilitate the transactions. The overall act constituted a violation of
their agency duties to their clients and shareholders, because they abdicated their fiduciary responsibility
of reporting true and fair financial statements. Nevertheless, their competitors followed suit because they
also had to use misrepresentative financial reporting in order to remain competitive and achieve the same
stock market valuations as Enron.
Additionally, mark-to-market accounting was used to record long-term transactions and contracts. This
method of accounting for costs and revenue dictates that the figures have to be recorded at their prevailing
market prices. This practice often yields misleading results because it assumes that the market has an
efficient pricing mechanism and, as we have recently discovered during the recession of 2008, markets
sometimes create bubbles. Enron also ensured that it reported, as revenue, deals that fell through and were
terminated. This was very evident in its deal with Blockbuster when it continues to recognise revenue
from the deal, even though it did not materialise (Tech Investor, 2005).
The executives in the trading divisions gamed the system by misrepresenting the reported data from their
divisions. Had the act of fraud not been so pervasive, one could legitimately argue that it was a case of
misrepresentation that led to misinterpretation by the managers and subsequently, external analysts and
shareholders. However, given that the act was condoned from the very top, one could conclude that the
myopia of Enron’s management, with regard to the stock price, was the primary cause of the fraud.
Meanwhile Enron’s influential oil traders, who generated most of the revenue, employed increasingly
dubious tactics in order to beat the markets. It is no coincidence that a firm with such a fixation to the
stock ticker derives a significant amount of revenue from a business whose nature is essentially myopic
and profit/loss is decided within seconds.
Conclusion
In conclusion, it is advisable for financial and non–financial measures should be used in equal measure to
set strategic and operational targets. Key Performance Indicators (KPIs) should always be set after careful
consideration of Critical Success Factors (CSFs) of an industry. Strategy and quantifiable benchmarking
could proceed from this basic principle. Non-financial metrics of gauging performance are easier to
devise, less likely to be manipulated and can be understood by non-financial managers. They also have
the added advantage of being more adaptable to changes in a company’s cost structure as it grapples with
a dynamic industry going through significant change. However, financial metrics are highly effective
because they facilitate benchmarking and quantify performance. They also enable greater understanding
of processes, promote accountability of organisations to shareholders and facilitate the formulation of
strategy. Effective performance schemes are highly attractive in the services sectors like banking and IT,
where individual talent commands a premium. The size of reward schemes may correlate to the risk
Olimjon Suleymanov 5

6. threshold of employees in industries that require employee discretion in a consequential environment-
financial sector
In spite of all the benefits of good financial metrics and accompanying performance schemes to support
them, there have been quite a few major corporate failures that have resulted from an overreliance on
measures to guide companies. Corporate failures like Enron and Worldcom, perhaps, signify that focusing
too much on the stock prices of companies can hamper effective management and corporate governance
within large companies. Perhaps, it is a wider fault of the financial ecosystem that companies are
frequently judged on quarterly earnings and rapid expansion rather than the fundamentals of sound
business health. The myopia within the financial ecosystem seems to have spread to the corporate world
and can result in indelible corruption in order for managers to keep up with public expectation and keep
their jobs. The reverse is also true; a lack of accountability and poor reward schemes, could encourage
corruption to the scale that was evident in the Expenses Scandal of public sector workers in Britain.
Olimjon Suleymanov 6

7. Bibliography
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extensions and extrapolations. Access My Library [Online] Retrieved on 19th May 2011 from:
http://www.accessmylibrary.com/article-1G1-81113840/reexamination-agency-theory-assumptions.html
Greenwald, John (2001) Rank And Fire. Time [Online] Retrieved on 16th May 2011 from:
http://www.time.com/time/business/article/0,8599,129988,00.html
Gas Boiler Buyability (2004) Enron: What Really Happened? Ezine Mark [Online] Retrieved on 15th
May 2011 from:
http://society.ezinemark.com/enron-what-really-happened-17a21480da5.html
Dharan, Bala G.; William R. Bufkins (2008) Red Flags in Enron's Reporting of Revenues and Key
Financial Measures [Online] Retrieved on 15th May 2011 from:
http://www.ruf.rice.edu/~bala/files/dharan-bufkins_enron_red_flags.pdf
Hays, Kristen (2005) Next Enron trial focuses on broadband unit [Online] Retrieved on 16th May 2011
from:
http://www.usatoday.com/tech/techinvestor/corporatenews/2005-04-17-new-enron-trial_x.htm
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