Behavioural Issues - performance monitoring, budgeting and transfer pricing

Explain the potential behavioural issues that may arise in the application of performance monitoring, budgeting and transfer pricing and suggest how problems may be overcome.

(1) Performance Monitoring
There is a general acceptance of the idea that an organisation that monitors performance and rewards individuals for ‘good performance’ is more likely to encourage behaviour that is consistent with the objectives of the organisation. This involves the organisation ‘transmitting signals’ to its people as to what it deems desirable activities and outcomes in the workplace. This approach has resulted in such terms and activities as performance monitoring, performance related pay, payment by results, bonus systems. The reward for the achievement of desired outcomes could be money, promotion, job security, preferred work activities, alternative work environments. Unfortunately this is a very complex task and problems are likely to arise in a number of areas:

 It is very difficult in many work environments to measure individual performance – and if you resort to team performance, it is difficult to gauge the contribution from individual members.
 It is difficult to ensure that individual targets are not inconsistent with other individuals or corporate objectives.
 Current measured performance may discourage consideration of longer term issues that may have adverse repercussions.
 Can a performance monitoring system comprehensively measure the key variables? For example, the desire to achieve greater volume/activity may be at the cost of quality that is more difficult to identify and appraise.
 Measure fixation – concentrating on the measurement process and not on what needs to be achieved.
 Misrepresentation – ‘creative’ responses that give a favourable view of activities.
 Myopia – short sighted viewpoint with limited consideration to long term issues.

The problems highlighted above can be managed if the following points are considered:

 Do not underestimate the scale of the task in designing a performance monitoring system.
 Consider the expectations and likely responses of all the parties concerned – take a broad view.
 Ensure that the people designing and operating the system have a comprehensive understanding of the organisation’s activities and the interrelationship between all of the stakeholders.
 Ensure that all parties involved believe that they will be beneficiaries of the system.
 Be prepared to reappraise and modify – it is unrealistic to believe that it can be perfected at the first attempt.



(2) Budgeting
Adverse behavioural consequences of budgeting can arise from insufficient consideration being given to the task during the planning stage. The targets set may be perceived as:

 Imposed
 Complicated
 Unfair
 Irrelevant
 Easy
 Unachievable.

This is likely to foster the ‘them and us’ syndrome and the consequential failure to achieve goal congruence.

These undesirable consequences may be avoided by consulting with all interested parties, setting challenging but achievable targets, considering other people’s perception of the targets and anticipating their likely responses. On the other hand, if budget holders are given complete autonomy or are permitted to have a significant influence on budgetary targets, they may be tempted to build in ‘slack’ to give themselves an easy life which is not in the interests of their organisation.

Having implemented the planning stage, we need to turn our attention towards control.Behavioural problems can arise from:

 A failure to distinguish between controllable and non-controllable factors for each particular budget holder – people will feel aggrieved for being accountable for what they do not control.
 A failure to account for the changing circumstances that have arisen since the budget was determined – may require budget adjustments and/or a flexible budget approach.
 Failure to reward favourable variances – budget under spending that automatically results in cuts in future budget provision merely encourages spending of the entire budget, not something that should be encouraged.
 Budget constrained approach – a requirement to conform to budget may stifle attempts at improvement.
 Insufficient participation in budgetary control and poor communication of the reasons for change decisions may alienate staff.


(3) Transfer Pricing
Transfer pricing is primarily concerned with ensuring that semi-autonomous business units behave in a way that contributes towards the achievement of corporate and not merely divisional objectives. An effective transfer pricing system encourages divisional managers with autonomous decision making authority to pursue the interest of the corporation automatically whilst endeavouring to maximise the performance of their own business unit. Their decisions are made with self (divisional) interest as the driving factor, but coincidentally benefit the entire company. Effective transfer pricing systems consciously endeavour to harness selfish divisional behaviour to induce decisions that foster goal congruence. Problems can arise when inappropriate prices are set that result in ‘wrong signals’ being sent and non-optimal decisions being made:

 Too high a price may result in unused capacity, lost contribution, reduced incentive to find external markets and unnecessary external sourcing from the buying division.
 Too low a price may result in ‘excessive’ internal trading and a loss of valuable external business.

To avoid these pitfalls the transfer pricing determination should consider:
 The cost behaviour (fixed and variable) of the different divisions.
 The adequacy of the information available to the divisions concerning both internal and external prices.
 Both the short and long run consequences of the prices set – internal and external markets and capacity levels.
 The degree of autonomy given to the divisions.




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