Academic journal article Journal of Organizational Culture, Communications and Conflict

The Joint Effect of Performance Evaluation Windows and Project Risk on Continuous Improvement Initiatives: Evidence from the Balanced Scorecard

Academic journal article Journal of Organizational Culture, Communications and Conflict

The Joint Effect of Performance Evaluation Windows and Project Risk on Continuous Improvement Initiatives: Evidence from the Balanced Scorecard

Article excerpt

INTRODUCTION

This paper reports the result of an experiment that tests whether people's willingness to undertake risky projects is affected by the performance evaluation window and the level of project risk. Managers constantly are faced with tradeoffs between current and future performance. Through the impact on cash flows, their decisions directly affect firm value (Chang et al., 2002; Merchant, 1997). To align management behavior with corporate strategy, the balanced scorecard is widely used by companies in the US and abroad (Kaplan and Norton, 1992, 1996; Silk, 1998). Its emphasis on long term goals and incorporation of leading (nonfinancial) and lagging (financial) indicators could eliminate myopic management behavior (Kaplan and Norton 1 992, p. 34) (1,2).

The effectiveness of the balanced scorecard depends upon the extent to which it improves management decisions (Lipe and Salterio, 2000). If the balanced scorecard is effective in communicating the firm's strategy and promoting actions consistent with it, decision makers will take actions (e.g., resource allocation decisions) in accordance with the firm's goals (Malina and Selto, 2001). Prior balanced scorecard academic research has focused mainly on assessing the effectiveness of the balanced scorecard for evaluations (eg. Roberts et al., 2004; Ittner et al., 2003; Lipe and Salterio, 2002), while practitioner research has focused on balanced scorecard implementation (e.g., Brewer et al., 2005; Kaplan and Norton, 1996).

A recent survey of executives suggests that 80 percent of managers would be willing to reduce their discretionary expenditures (eg. R&D, advertising, and maintenance) to meet earnings targets (WSJ, April 2004). This result is consistent with prior research, both experimental and archival, suggesting that managers, under certain conditions, exhibit myopic behavior. That is, under certain conditions, they choose actions that improve short-term profitability at the expense of long-term profitability (e.g., Bhojraj and Libby, 2005; Libby et al., 2004; Guidry et al,, 1999; Bushee, 1998; Gayer et al., 1995; and Hoithausen et al., 1995).

Myopic behavior often occurs when managers have a different time horizon than the firm (Dikolli 2001) (3). Consequently, managers could take actions to achieve their own short-term goals (e.g., increase and/or earn a bonus) rather than the firm's long-term goals. Dikolli (2001) argues that contracting at least partially on forward-looking measures, such as customer and employee satisfaction (which often are leading indicators of financial performance), can mitigate managers' tendency to place excessive focus on short-term financial performance. Accordingly, performance evaluations increasingly use nonfinancial measures linked to long-term financial goals (e.g., Said et al., 2003; Banker et al., 2000; Ittner et al., 1998).

By including nonfinancial measures, the balanced scorecard potentially is effective in reducing the weight managers put on short-term financial measures. Two other actions that potentially can reduce the often excessive emphasis placed on short term earnings are setting reasonable targets and increasing the measurement horizon (Merchant, 1997: p. 468). Consequently, an increasing number of companies have started using long-term incentive plans, rewarding managers for meeting three year to six year performance targets (Merchant, 1997). This paper provides evidence related to this issue by keeping the target constant, while basing performance evaluations on multiple years' balanced scorecard evaluation windows, i.e., increasing the horizon.

This paper contributes to the balanced scorecard literature in two ways. First, it considers the impact of the balanced scorecard on management's resource allocation decisions, rather than on subordinate performance assessment decisions. Secondly, it considers an alternative evaluation window (three year rolling) for performance evaluation. …

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