Often government-owned companies in planned economies reward managers based on nonfinancial measures. For example, the government might give managers a bonus for exceeding a 5-year-planned target for production quantities. A problem with this method is that managers tend to predict low volumes so that officials will set the targets low. This makes it easier for the managers to meet the targets, but it severely hinders planning because managers do not provide accurate information about production possibilities.

The former Soviet Union developed an alternative performance measurement and reward system.

Suppose F is the forecast of production, A is actual production, and X, Y, and Z are positive constants set by top officials, with X, Y, Z > 0. The following performance measure was designed to motivate both high production and accurate forecasts. 

performance measure = (Y * F) + [X * (A – F) ] if F ≤ A

(Y * F) - [Z * (F – A) ] if F > A

Assume that Cuba adopted this measure at a time when Soviet influence was great. Consider the Havana Television Manufacturing Company (HTMC). During 19X3, the factory manager, Che Chavez, had to predict the number of TVs that HTMC could produce during the next year.

He was confident that at least 700,000 TVs could be produced in 19X4, and most likely they could produce 800,000 TVs. With good luck, they might even produce 900,000. Government officials told him that the new performance evaluation measure would be used, and that X = .50, Y = .80, and

Z = 1.00 for 19X4 and 19X5.

1. Suppose Chavez predicted production of 800,000 TVs and HTMC actually produced 800,000.

Calculate the performance measure.

2. Suppose again that HTMC produced 800,000 TVs. Calculate the performance measure if Chavez had been conservative and predicted only 700,000 TVs. Also calculate the performance measure if he had predicted 900,000 TVs.

3. Now suppose it is November 19X4, and it is clear that HTMC cannot achieve the 800,000 target.

Does the performance measure motivate continued efforts to increase production? Suppose it is clear that HTMC will easily meet the 800,000 target. Will the system motivate continued efforts to increase production?