PROBLEM 1-7.

You Get What you Measure! [LO 3]

Each year the president of Smart-Toys Manufacturing selects a single performance measure and offers significant financial bonuses to all key employees if the company achieves a 10 percent improvement on the measure in comparison to the prior year. She recently said, This focuses my managers on a single, specific target and gets them all working together to achieve a major objective that will increase shareholder value. Sarabeth Robbins is a new member of the companys board of directors, and she has begun to question the presidents approach to rewarding performance. In particular, she is concerned that placing too much emphasis on a single performance measure may lead managers to take actions that increase performance in terms of the measure but decrease the value of the firm.

Required:

a. What negative consequence might occur if the performance measure is sales to new customers total sales in the current year versus the prior year? (Note: To receive a bonus, managers would need to increase this ratio compared with the prior year.)

b. What negative consequence might occur if the performance measure is cost of goods sold sales in the current year versus the prior year? (Note: To receive a bonus, managers would need to decrease this ratio compared with the prior year.)

c. What negative consequence might occur if the performance measure is selling and administrative expenses sales in the current year versus the prior year? (Note: To receive a bonus, managers would need to decrease this ratio compared with the prior year.)