PERFORMANCE

MANAGEMENT
SYSTEM

DR NOORAISAH KATMON

THE CASE OF AIG FAILURE

OF COMPENSATION SYSTEM
- AIG financial results in 2007 were a failure
- Company revenue was down 56% from 2006 results.
- AIG CEO, Martin Sullivan earned USD14.3 million in salary, bonus, stock options
and other incentives.
- In June 2008, AIG replaced Sullivan. The reported cumulative losses totaling
USD20 billion.
- During 3 year tenure of Sullivan in AIG, AIG lost 46% of its market value.
- At the time of dismissal, the AIG board give Sullivan about USD47 million in
severance pay, bonus and long-term compensation.
- Under government control, executive compensation at AIG was subject to
restriction.
- Recent case: ABN AMRO BANK, UK

ACCOUNTING-BASED
PERFORMANCE MEASURES
Requires several steps:
1.
2.
3.

Choose performance measures that align with top managements financial

goals.
Choose the details of performance measures.
Choose a target level of performance and a feedback mechanism for each
performance measure.

Four common measures of economic performance:

1.
2.
3.
4.

Return on investment
Residual income
Economic value added
Return on sales

Selecting subunit operating income as a metric is

inappropriate because it obviously differs simply on
the differing size of the subunits.

EXECUTIVE COMPENSATION
PLANS
Based on both financial and nonfinancial performance
measures, and include a mix of:
Base salary
Annual incentives, such as cash bonuses
Long-run incentives, such as stock options

Well-designed plans use a compensation mix that

balances risk (the effect of uncontrollable factors on
the performance measure, and hence compensation)
with short-run and long-run incentives to achieve the
firms goals.

ISSUES IN PERFORMANCE
MANAGEMENT SYSTEM
(1) Additional difficulties faced by multinational
companies:
The economic, legal, political, social, and cultural environments
differ significantly across countries.
Governments in some countries may impose controls and limit
selling prices of a companys products.
Availability of materials and skilled labor, as well as costs of
materials, labor, and infrastructure may differ across countries.
Divisions operating in different countries account for their
performance in different currencies.

(2) Moral Hazard

Moral hazard describes situations in which an employee prefers to
exert less effort (or report distorted information) compared with the
effort (or accurate information) desired by the owner because the
employees effort (or the validity of the reported information)
cannot be accurately monitored and enforced.

PREFERRED PERFORMANCE
MEASURE
Preferred performance measures are those that are sensitive
to or change significantly with the managers performance.
They do not change much with changes in factors that are
beyond the managers control.
They motivate the manager as well as limit the mangers
exposure to risk, reducing the cost of providing incentives.
May include benchmarking.

FAILURE OF PERFORMANCE
MANAGEMENT SYSTEM
(ACCORDING TO DR MARKO
SARAVANJA)
1. Lack of integration
2. Design challenges
3. Lack of leadership support
4. Implementation failure
5. Incompetence
6. Lack of rewards
7. Communication challenges
8. Inspiration challenges

9. Lack of monitoring
10. Lack of evaluation

INTEGRATED PERFORMANCE
MANAGEMENT SYSTEM (DR
MARKO SARAVANJA)