(b) Relative Performance (Relative Improvement) Contractsunder this plan managers would be rewarded for how their respective business units perform relative to some appropriate benchmark performance, not relative to a fixed budget target. To complement the use of relative performance contracts, some recommend the use of "rolling financial forecasts" rather than a traditional master annual master budget (as described in the text). Such forecasts provide a constant planning horizon but more important are disassociated from performance evaluation and control. The overall intent is to motivate and allow employees to adapt to changing environments (including newly identified competitive threats)
(a) Linear Compensation Plansthe idea here is essentially to sever the relationship between budgets and managerial compensation. In such a situation, managerial reward is a linear function of actual performance, and not a function of actual performance relative to budgets: the greater the actual performance, the greater the managerial reward. Put another way, such a plan rewards individuals for what they actually do, not what they do relative to what they say they can do. Given criticisms of so-called "fixed performance contracts," at least two alternative plans have been introduced: Feedback: Under a "traditional model" employee reward/compensation is linked to budgetary performance, that is, comparison of actual results to budgeted results (where budgeted results are determined along the lines discussed in Chapter 10). This type of compensation/reward plan is sometimes referred to as a "fixed performance contract" because actual performance (ales, operating income, net income, return on sales, return on investment, etc.) is compared to a fixed (budgeted) target. Experience shows that such an incentive model can have undesirable consequences (e.g., it may encourage managers to submit biased information in their budgets, that is,excessive amounts ofbudgetaryslack"). Another dysfunctional consequence of using fixed performance contracts is that such contracts may encourage managers to game the performance indicator, that is, to take actions that make the performance indicator look better but that do not increase the value of the firm.