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It is well accepted that performance measurement plays many important roles in running an organization. These include translating strategy into desired behaviors and results, communicating these expectations, monitoring progress, providing feedback, and motivating employees through performance-based rewards and sanctions. For a long time, managers had primarily used accounting-based measures for these purposes. But with the advent of new competitive realities such as increased customization, flexibility, and rapid response to customer expectations, as well as new manufacturing practices such as Just in Time and total quality management, many have argued that accounting-based performance measurement systems are no longer adequate. In the past decade especially, a wide variety of measures and systems have been proposed and implemented to overcome the purported limitations of accounting-based measures in these environments. A prominent example of these new approaches is integrated performance measurement systems, such as the balanced scorecard. (1)
While proponents have made a persuasive case for the new measures and measurement systems, the support they have provided for these new systems mostly has been in the form of anecdotal evidence with limited scope, claims based on proprietary studies, or even simple, though intuitively appealing, illustrations. Furthermore, there is a tendency to downplay, if not outright ignore, the potential shortcomings and limitations of the alternatives being proposed. While the limited scope of such support does not necessarily negate the potential usefulness of the proposed changes in performance measurement, it is insufficient for guiding informed adoption decisions.
Managers need a more systematic understanding of the advantages/benefits and the disadvantages/costs of the new approaches compared to those of traditional accounting-based systems. The aim of this article is to contribute toward building such an understanding. Specifically, we investigate the relative use of financial, quantitative nonfinancial ("nonfinancial" for short), and subjective performance measures by a sample of 128 firms. The term "subjective measures" is used to represent nonfinancial measures that are derived from subjective judgment. We further explore whether financial, nonfinancial, and subjective performance measures differ on such characteristics as controllability and vulnerability to measurement errors and, more importantly, impact on such behaviors as risk taking, efforts at innovation, and gameplaying.
The results indicate that companies with different manufacturing strategies use different mixes of the three types of measures. This is consistent with each type of measure performing a different role in supporting operations. Further supporting this inference is that the three types of measures do have some different effects and properties which, interestingly, are not always in the directions suggested by prior literature.
To help readers follow our study and to interpret our findings, we start by reviewing the key points that have been made about the characteristics and impacts of financial, nonfinancial, and subjective performance measures. Then we explain our data collection approach and present the results. We conclude with a discussion of the implications for management accounting practice.
Recent coverage of performance measures has criticized periodic financial measures as being too aggregated, too late, and too backward-looking to help managers understand the root causes of performance problems, initiate timely corrective actions, encourage cross-functional decision making, and focus on strategic issues. A typical example used to illustrate these shortcomings is "dollarized" variance information. (2) Most unfavorable variances have multiple causes that stem from problems in multiple departments. Yet traditional accounting-based reporting systems tend to be structured along departmental lines. This mismatch between the root causes and report structure, along with a focus on the aggregate financial impact rather than operations, may induce managers to avoid taking responsibility, attempt to optimize locally, and/or engage in dysfunctional behaviors to maximize short-term performance at the expense of long-term effectiveness and competitiveness.
These and many other criticisms of financial measures are intuitively appealing and likely have considerable validity. In deciding whether to increase the use of nonfinancial measures--and, if so, which ones--it is important to recognize that nonfinancial measures are not free of limitations. For example, if a firm tracks the percentage of shipments delivered on time, there …