Association of Nonfinancial Performance Measures with the Financial Performance of a Lodging Chain

Transcription

1 .77/ CORNELL UNIVERSITY DOI:.77/ Volume 46, Number Assocaton of Nonfnancal Performance Measures wth the Fnancal Performance of a Lodgng Chan by RAJIV D. BANKER, GORDON POTTER, and DHINU SRINIVASAN A test of nonfnancal measures used as part of a management-ncentve program by a U.S.-based, fullservce hotel chan found that mprovements n the nonfnancal measures were followed shortly by ncreases n revenue and proft. The two nonfnancal measures are customer satsfacton as measured by guests comment card ndcatons of lkelhood to return and level of complants. The lag between the nonfnancal measures and changes n revenue and operatng proft was sx months n ths case. Whle the test apples drectly to that one chan, the lesson s mportant to the rest of the hotel ndustry. Keywords: nonfnancal performance measures; performance evaluaton; ncentve plans; customer satsfacton; executve compensaton; hosptalty ndustry; balanced score card. 394 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

2 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS M any frms now use nonfnancal measures, such as product qualty, customer satsfacton, and market share, to evaluate and reward manageral performance. The prmary reasons suggested for ths approach are that these measures are better ndcators of future fnancal performance than are accountng measures, and they are valuable n evaluatng and motvatng manageral performance. 2 To date, however, there have been few ndependent studes of the relatonshp between nonfnancal measures and fnancal performance. At that, the results of exstng studes have been mxed. 3 In addton, although there have been calls for greater emphass on nonfnancal measures n nternal performancemeasurement systems, 4 and although frms have mplemented such systems, lttle evdence exsts regardng whether ncludng nonfnancal measures n performance evaluaton and ncentve compensaton actually drves corporate success. 5 We studed tme-seres data from a number of lodgng propertes managed by a large hosptalty frm that mplemented an ncentve system based on nonfnancal and fnancal performance measures to address the followng two research questons: () Are the nonfnancal performance measures leadng ndcators of fnancal performance? 6 and (2) Does the adopton of an ncentve compensaton plan that ncreases the emphass on nonfnancal performance measures for key managers lead to mprovements n both fnancal and nonfnancal performance? 7 Hosptalty organzatons were quck to adopt the dea of montorng and reportng nonfnancal performance measures. For nstance, Huckesten and Duboff descrbed the mplementaton of a balanced scorecard at Hlton Hotels. 8 Several reasons have been suggested to explan why nonfnancal measures are used by hosptalty frms to augment fnancal measures n management control. For one thng, nonfnancal measures are beleved to complement short-run fnancal fgures as ndcators of progress toward a frm s long-term goals and reflect overall corporate strategy. 9 Current proft and other fnancal measures only partally reflect the effects of past and current actvtes, whereas nonfnancal measures of customer satsfacton, nternal process mprovements, and an organzaton s nnovaton and mprovement actvtes reflect the effect of current manageral actons that wll not show up n fnancal performance for some tme. The use of nonfnancal measures for performance evaluaton s also consstent wth theoretcal work on compensaton n agency settngs. Because fnancal measures of performance may be mperfect and nosy sgnals of a manager s effort, nonfnancal measures can add value by nducng long-run, focused effort. The prevalence of complng and reportng nonfnancal metrcs n the lodgng ndustry suggests that hotel operatng companes may realze addtonal benefts from trackng these measures. For nstance, hotel management companes wth large franchse operatons are concerned wth the qualty of ther franchsees propertes. Nonfnancal measures of customer experences at a franchsed property may provde nformaton on how certan propertes mprove or dmnsh the franchsor s overall reputaton. Thus, montorng or contractng on the nonfnancal measures of franchsees may help resolve the free-rder problem. In addton, f nonfnancal measures reflect future fnancal performance, they may be useful for captal budgetng as they may provde a clearer lnk between current new nvestment and future cash flows. Because several partes typcally share n a property s cash flow, the relatonshps NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 395

3 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES between nonfnancal measures, ncentve plans, and future fnancal performance take on added sgnfcance. For nstance, f franchsors mpose nonfnancal standards on ther franchsees, owners need to know that complance wth these measures s not gong to result n a drop n operatng profts as they attempt to maxmze nonfnancal measures. Moreover, as management companes mplement ncentve plans based n part on nonfnancal measures, owners need to ascertan whether these new plans, whch they fund, contrbute to the owner s long-term goal of value creaton. Otherwse, these types of plans may smply result n wealth transfers among the nterested partes. Usng an event study desgn, we analyzed longtudnal archval data both before and after a change n an ncentve plan to provde emprcal evdence on the fnancal effects of ncorporatng nonfnancal measures n ncentve contracts. As we explan below, the analyss reveals that nonfnancal measures of customer perceptons are related to future fnancal performance and that both fnancal and nonfnancal performance mprove followng the mplementaton of an ncentve plan that ncludes nonfnancal measures of performance. Research Ste, Incentve Plan, and Data Collecton The research ste for ths study s a hotel chan (whch we call Hotelcorp) operated by the hosptalty dvson of a multbllon-dollar corporaton. Durng the perod of ths study, the chan franchsed more than two hundred hotels and drectly managed more than twenty hotels. The hotels are located around the world, but the focus of ths study s the hotels that Hotelcorp manages n the Unted States. We studed the U.S. hotels so that we could have access to senor managers and, more mportant, for avalablty of comparatve data for a control group of franchsed hotels and compettors that enables us to estmate the relatonshp between fnancal and nonfnancal performance and solate the performance mpact of the ncentve plan. The managed hotels vary from 5 to 45 rooms. Many of the hotels are rated as four star, and all managed hotels offer full servce. Most of Hotelcorp s managed hotels cater largely to busness travelers. Many aspects of the managed hotels operatons are homogeneous, notably ther ncentve system, organzatonal structure, clentele, and nfrastructure. Needless to say, exogenous factors lke geographc locaton and compettors are dfferent for each property. Incentve Plan Nearly two-thrds of hotel operators use some form of ncentve pay for ther managers, and more than one-half use some knd of bonus program for ther hourly employees. The maxmum bonus ranges between 3 and 7 percent of the base salares for managers. 2 Even though a large percentage of the busness n the hotel ndustry s from repeat customers and customer servce s an essental aspect, relance on customer satsfacton and related nonfnancal measures n ncentve pay s a recent phenomenon. A survey conducted by Hotelcorp ndcated that n the 99s other hotel chans had mplemented ncentve programs for ther senor managers based on proft levels and on nonfnancal measures, such as qualty of rooms and food, safety, guest satsfacton, and employee satsfacton. The ncentve programs at major hotel chans dffered n target settng, bonus-pool creaton, maxmum bonus as a percentage of salary, and weghts placed on fnancal 396 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

4 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS and nonfnancal performance measures, but all of them emphaszed nonfnancal measures. The senor managers beleved that a customer-focused strategy s essental not only for the long-term proftablty of an ndvdual hotel but also for enhancng the hotel chan s brand value. Hotelcorp ntroduced ts ncentve plan for key managers wth the objectve of rewardng employees for meetng the key objectves of owners satsfacton (proftablty) and customer satsfacton, as outlned n ts msson statement. Pror to the new ncentve plan, ndvdual hotel managers compensaton ncluded a base salary and a bonus based on fnancal measures, ncludng operatng proft, revenues, and costs. The maxmum bonus was a percentage of the base salary as determned by the manager s poston at the property. For example, the general manager of a hotel mght earn up to 2 percent of base pay as a bonus for achevng the hotel s proft goals. In addton, a porton of the bonuses of key managers wthn a hotel was based on ndvdual performance measures for ther partcular area of responsblty. Although customer-satsfacton measures were tracked, they were not used explctly for ncentve purposes. Wth the dual objectves of keepng n lne wth compettors and of focusng and drectng the efforts of managers on key company objectves, the hotel chan s new ncentve plan was based on both operatng proft and nonfnancal measures. Based on the prncples of the servceproft chan, 3 the new ncentve plan was developed by a team of regonal vce presdents and corporate executves representng human resources, marketng, plannng, and operatons. The team dentfed both fnancal and nonfnancal measures of performance based on the strategc objectve of satsfyng the two stated consttuences namely, hotel owners and guests. The new bonus plan for all hotel managers can be approxmated by a lnear contract based on hotel proft, propretary factors, and the followng two nonfnancal measures: lkelhood of return and customer complants. The senor manager n charge of the dvson ndcated that the weghts on the fnancal and nonfnancal measures were chosen based on a consensus agreement among the senor managers. Measurement of the varables and the reasons for ther ncluson n the ncentve plan are descrbed later. Wthout dsclosng specfc detals, the bascs of the new plan are as follows. To begn wth, managers base salares dd not change. The new ncentve plan dffers from the old plan n the followng three ways: () the new plan reles on performance measures (both fnancal and nonfnancal) common to all managers, whle the old plan reled on ndvdual performance measures (manly fnancal); (2) the new plan explctly ncorporates nonfnancal measures wth specfc weghts on each measure; and (3) the new plan ncreases the maxmum possble bonus for some managers by ncreasng the bonus rate appled to the base salary, wth a large proporton of that potental bonus based on nonfnancal measures. However, the new ncentve plan contnues to use current gross operatng proft (GOP) as the fnancal performance measure and provdes the same (or slghtly lower) level of ncentves for achevng operatng proft goals as the old plan. 4 Managers could earn the maxmum possble bonus only f both fnancal and nonfnancal targets are attaned. In summary, the new ncentve plan retaned the company s exstng emphass on current fnancal performance but also encouraged attanment of nonfnancal objectves. NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 397

5 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES Data Monthly data were obtaned for a perod of up to seventy-two months for the managed hotels. Company documents and ntervews wth senor managers and corporate staff provded qualtatve data on ther belefs and expectatons about the ncentve plan. In addton, general managers of two hotels were ntervewed to understand hotel operatons and obtan ther vews about effort reallocaton n response to the new ncentve plan. We examned the followng nonfnancal performance measures. Lkelhood of return (LRETURN). Customer satsfacton s consdered a key short-term measure that s a lead ndcator of long-term performance. In evaluatng customer satsfacton, many hotels employ a weghted ndex of customer satsfacton based on a number of questons. The ncentve plan at Hotelcorp uses a measure based only on the response to the comment card queston that asks how lkely t s that a guest wll return. 5 Senor managers beleve that ths queston best captures the customers ntent to provde repeat busness. LRETURN s computed as the percentage of customer-response cards wth the two hghest ratngs (that s, 4 or 5 out of 5). Hotel managers can take a number of actons pertanng to the operatons of the hotel to mprove ths measure, ncludng prce concessons and delverng amentes to the rooms. However, such extra steps may lead to an ncrease n operatng costs that could penalze ther fnancal scores. Customer complants (COMPLNTS). The number of customer complants s another measure used n the plan. Bllng errors, servce catastrophes, and problems wth servce personnel are some of the prme reasons for customers to swtch hotels. 6 Analogous to defect rates n a manufacturng settng, customer complants provde drect feedback on the hotel s operatng processes and are useful for developng correctve actons. Thus, customer complants can also be vewed as an nternal busness-process measure that reflects the effectveness of the operatons at a hotel. 7 Focusng on potental problem areas, respondng quckly to complants, and resolvng customer concerns are examples of manageral actons that can reduce the number of complants and mpact customer loyalty. 8 COMPLNTS s measured as the number of customer complants per thousand room-nghts. Hotelcorp ncluded ths measure also because t provdes an ndependent measure of customer satsfacton. Customers regster ther complants ether by callng the customer servce center drectly or by wrtng. Thus, ths measure cannot be manpulated easly. The crosssectonal correlaton between LRETURN and COMPLNTS ranged between.27 and.39 over the seventy-two-month sample perod. Fnancal Performance Measures As we sad above, GOP s the fnancalperformance measure employed n Hotelcorp s ncentve plan. For our purposes, gross operatng proft per avalable room (GOPPAR) s computed as total revenue per avalable room (TREVPAR) from rooms, food, beverage, and other actvtes lke telephone and moves, less departmental and undstrbuted operatng expenses per avalable room (COSTPAR). The use of ths measure of GOP reflects Hotelcorp s phlosophy that measurements must reflect the manager s effectveness. Fnancal data follow the unform system of accounts for the hotel 398 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

6 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS Exhbt : Descrpton of Varables TREVPAR COSTPAR AVGRATE OCCRATE LRETURN COMPLNTS Total revenue per avalable room Operatng cost per avalable room Average rate for a hotel measured as total revenues dvded by number of occuped rooms Occupancy rate for a hotel measured as number of occuped rooms dvded by number of avalable rooms Lkelhood of return measure Number of complants per thousand rooms Exhbt 2: Descrptve Statstcs Standard Frst Thrd Varable Mean Devaton Quartle Medan Quartle TREVPAR COSTPAR AVGRATE OCCRATE LRETURN COMPLNTS Note: All numbers are dsgused by multplyng by a scalar. See Exhbt for defntons of varables. ndustry. 9 We parttoned TREVPAR nto ts prce and occupancy components, average daly rate, and occupancy. Average rate (AVGRATE) was measured as total (not room) revenues dvded by the number of occuped rooms, and occupancy rate (OCCRATE) was measured as the number of occuped rooms dvded by the number of avalable rooms. Results Descrptve Informaton Exhbt summarzes the defntons of the varables, whle Exhbt 2 presents dsgused nformaton on the study s key varables. Average daly TREVPAR s $86.96, and the correspondng cost s $66.5. Revenue can be parttoned nto the average amount per room occuped, $26.2, wth an occupancy rate of 69 percent. Over the study perod, 9 percent of respondents sad they were lkely to return to the hotel f they agan vsted the area (LRETURN). Customer complants (COMPLNTS) averaged.92 per thousand rooms occuped. Estmaton Models Nonfnancal Measures as Lead Indcators of Fnancal Performance We use pooled tme-seres data of up to sxty months for eghteen propertes to examne the relatonshp between current nonfnancal performance measures and future fnancal measures. Our estmaton models specfy fnancal performance per NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 399

7 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES avalable room and ts components as functons of exogenous parameters, past fnancal performance, and lagged values of nonfnancal measures. 2 The exogenous varables that affect fnancal performance n the hotel ndustry nclude hotelspecfc factors; seasonalty; and local, regonal, and other economy-wde factors lke nflaton. To control for exogenous factors that affect revenues, we nclude an ndex (labeled COMPREV) that measures compettors average revenue per avalable room (RevPAR). Ths measure (COMPREV) s the most wdely used benchmark n the hotel ndustry and best captures the external varables that affect the local hotel ndustry. COMPREV s computed by an ndependent agency that collects the relevant confdental nformaton from partcpatng hotels. Unlke the revenue model, compettors cost data, whch may help the model to control for seasonalty and other factors, are not avalable. Snce hotels seasonal and trend varatons n operatng costs are prmarly drven by volume, we nclude occupancy rate (OCCRATE) to control for varatons n operatng costs. To control for changes n operatng costs due to nflaton, we nclude the Employment Cost Index (ECI), whch measures the average total wages and benefts pad to employees, snce payroll costs can consttute more than half of operatng costs. Because of the lack of compettor data, for the GOPPAR model we control for seasonal and other varatons by ncludng COMPREV as a control varable. We also nclude the prevous perod s fnancal performance to control for hotel-specfc tme trends and to examne whether nonfnancal measures provde addtonal nformaton on future fnancal performance that s not reflected n current fnancal measures. 2 Whle earler studes recognze that nonfnancal measures may have longterm effects, no formal theory dentfes the specfc number of lags for nonfnancal measures. Anderson, Fornell, and Lehmann use a half-year-lag model, for example, but they do not present a theoretcal justfcaton for usng that length of tme. 22 Therefore, t s necessary to undertake a specfcaton search to determne the approprate lag length. The results of that search are AVGLRETURN and AVGCOMPLNTS. These two varables, whch are the movng average of the past sx months of the nonfnancal measures, are ncluded as ndependent varables rather than multple lags. 23 Consequently, for ths frm changes n nonfnancal measures affect the next sx months of fnancal performance. Exhbts 3 through 6 present estmates of the relatonshps between nonfnancal measures and future fnancal performance as measured by the levels of revenues, operatng cost, and proft per avalable room. The overall regressons are sgnfcant (p =.) wth adjusted R 2 rangng from.8 to.9. The two nonfnancal measures n these regressons have ncremental R 2 rangng from.5 to.25 and account for 5 to 25 percent of the unexplaned varance n fnancal performance. Exhbt 3 reveals that the pror-sx-month average of LRETURN s postvely assocated wth TREVPAR and GOPPAR. (It s also sgnfcant, p <..) The exhbt reports that a. ncrease n LRETURN would result n about a $2.75 ncrease n TREVPAR per day and about a $.64 ncrease n GOPPAR per day. Whle costs also ncrease, $.53, the amount s not sgnfcantly dfferent than zero. Exhbt 4 reveals that most of the gan n revenue s explaned by ncreases n occupancy, rather than from ADR rses. Indeed, a. 4 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

8 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS Exhbt 3: Assocaton of a. Increase n Lkelhood of Return wth Fnancal Performance (per Avalable Room) (Holdng All Other Varables Constant) $ Change n TREVPAR $ Change n Cost per Avalable Room $ Change n Proft per Avalable Room.5.5 TREVPAR COSTPAR GOPPAR Note: See Exhbt for defntons of varables. ncrease n LRETURN s estmated to result n an ncrease n occupancy of 3.7 percent. Exhbt 5 reveals that COMPLNTS s negatvely assocated wth revenues and proft per avalable room (but t s not sgnfcantly so at p <.). The exhbt reports that a. decrease n COMPLNTS would result n about a $. ncrease n TREVPAR per day and about a $.4 ncrease n operatng proft per room per day. Whle costs also ncrease, about $.7, the amount s not dfferent from zero. In ths case, most of the gan s explaned by ncreases n average revenue per room sold (as shown n Exhbt 6). In fact, a. decrease n COMPLNTS s estmated to result n sgnfcant ncrease n daly revenue per room sold of more than $3.. In summary, the results suggest that the nonfnancal measures used by Hotelcorp are lead ndcators of future fnancal performance. The analyses of the lead-lag relatonshp between Hotelcorp s nonfnancal performance measures and ts fnancal performance suggest that nonfnancal measures of customer satsfacton help predct future fnancal performance for the next sx months. Our results also suggest that the assocaton between fnancal and nonfnancal performance may be a result of repeat purchases rather than ncreased prce premums. Ths fndng s smlar to that of Ittner and Larcker, who reported that customer-satsfacton NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 4

9 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES Exhbt 4: Assocaton of a. Increase n Lkelhood of Return wth Rate and Occupancy (Holdng All Other Varables Constant) Change n OCCRATE % $ Change n AVGRATE.5 OCCRATE % AVGRATE $ Note: See Exhbt for defntons of varables. Exhbt 5: Assocaton of a. Decrease n Customer Complants wth Fnancal Performance (Holdng All Other Varables Constant) $ Change n TREVPAR $ Change n Cost per Avalable Room $ Change n Proft per Avalable Room.2 TREVPAR COSTPAR GOPPAR Note: See Exhbt for defntons of varables. 42 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

10 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS Exhbt 6: Assocaton of a. Decrease n Customer Complants wth Rate and Occupancy (Holdng All Other Varables Constant) Change n OCCRATE % $ Change n AVGRATE.5 OCCRATE % AVGRATE $ Note: See Exhbt for defntons of varables. measures are assocated wth growth n new customers but not wth ncreased proft from exstng customers. 24 Moreover, we fnd lttle evdence that ncreased customer satsfacton s assocated wth ncreased operatng costs other than through the mpact on occupancy-related varable costs. Impact of Incentve Plan on Nonfnancal Performance Our second research queston focuses on the performance effects of ncludng nonfnancal measures n ncentve plans. Intutvely, one would expect a performance measure to mprove when t s postvely lnked to monetary ncentves. Agency theoretc research supports the vew that ncludng a performance measure n an ncentve plan results n a reallocaton of effort by managers that leads to an mprovement along the measured dmenson. 25 As dscussed earler, nonfnancal measures were reported at Hotelcorp but not used for ncentve purposes pror to the mplementaton of the new plan. As shown n Exhbt 7, the mplementaton of the ncentve plan can affect fnancal performance ether ndrectly by mprovng nonfnancal performance measures, whch then affect fnancal performance, or drectly through enhanced cost effcency or value-added actvtes. Implementaton of an ncentve plan based on customer-satsfacton-orented nonfnancal measures ncreases customer-servce actvtes and, consequently, nstallng such a plan s lkely to ncrease customer satsfacton. An ncrease n operatng costs may also result from an ncreased customer-satsfacton effort. For example, managers may have to tran ther employees n customer servce. Whle t s possble that costs may ncrease, we expect that NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 43

11 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES Exhbt 7: Relaton between Incentve Plan, Nonfnancal Measures, and Fnancal Performance + LRETURN + + REVENUE + Plan - COMPLNTS - + COSTS PROFIT - Nonfnancal Performance Fnancal Performance + + Drect Impact of the Incentve Plan + Note: See Exhbt for defntons of varables. any cost ncrease would be lower than the correspondng revenue ncrease, meanng that profts are expected to ncrease as a consequence of an ncreased emphass on customer satsfacton. Fnally, the new ncentve plan provdes hgher bonus potental for some managers, and bonus costs are lkely to ncrease followng the mplementaton of the plan. Therefore, operatng costs (both nclusve and exclusve of bonus costs) are lkely to ncrease followng the mplementaton of the new ncentve plan. Estmates of the effects of the change n the ncentve plan on nonfnancal measures are presented n Exhbt The exhbt reveals that nonfnancal performance mproved followng the plan s mplementaton. The exhbt reports that LRETURN ncreased a small but statstcally sgnfcant. due to the plan. Ths suggests that the ncentve plan resulted n an ncrease n customer satsfacton as measured by the lkelhood-of-return measure. The exhbt also reveals that COMPLNTS dropped a sgnfcant.9, also presumably as a result of the ncentve plan. Overall, these results support the asserton that what you measure s what you get. 27 Impact of Incentve Plan on Fnancal Performance Exhbt 9 presents the ncentve plan s estmated effect on the three measures of fnancal performance (all statstcally sgnfcant). 28 Estmates from the revenue model suggest that the plan resulted n a TREVPAR ncrease of about $.56. Ths 44 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

12 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS Exhbt 8: Assocaton of Incentve Plan wth Nonfnancal Performance Measures LRETURN COMPLNTS -.4 Change n LRETURN Change n COMPLNTS Note: See Exhbt for defntons of varables. result s consstent wth the earler results that the nonfnancal measures are postvely assocated wth revenues and that these measures mproved followng the change n the ncentve plan. Overall, the results ndcate that the ncentve plan change has a postve and sgnfcant effect on revenues, controllng for nflaton and compettors performance. Exhbt reveals that revenue gans came through both rate and occupancy ncreases. At the same tme, the plan also resulted n a decrease n operatng costs of about $.2 per room per nght, after controllng for changes n costs due to changes n occupancy. Contrary to our expectatons, ths result ndcates that hotel managers dd not stfle cost-reducton efforts or ncrease spendng to mprove customer satsfacton. The mpact of ncentve plan change on GOPPAR s estmated at about $. per avalable room. Followng the ncentve plan change, revenues ncreased and costs decreased sgnfcantly, resultng n a net proft ncrease. Overall, these results suggest that both nonfnancal and fnancal performance mproved followng the mplementaton of the ncentve plan that ncluded nonfnancal performance measures. Whle t s temptng to attrbute ths mprovement solely to the fact that nonfnancal measures were added to the ncentve compensaton plan, cauton needs to be exercsed n drawng that nference because of the nature of the ncentve-plan mplementaton. Therefore, the mprovement n fnancal performance cannot be entrely ascrbed to the ncluson of nonfnancal measures. Impact of Incentve Plan on the Hotel Chan s Performance Marketng lterature suggests that there may be postve externaltes for mprovements n customer satsfacton. Typcal of most hotel chans, much of Hotelcorp s revenues come from franchse and management fees. As hotel manager, Hotelcorp NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 45

13 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES Exhbt 9: Assocaton of Incentve Plan wth Fnancal Performance Measures TREVPAR COSTPAR GOPPAR $ Change n TREVPAR $ Change n Cost per Avalable Room $ Change n Proft per Avalable Room Note: See Exhbt for defntons of varables. Exhbt : Assocaton of Incentve plan wth Rate and Occupancy Change n OCCRATE (%) $ Change n AVGRATE.5 OCCRATE % AVGRATE $ Note: See Exhbt for defntons of varables. collects a flat fee, plus ncentve fees based on ether revenues or profts of ndvdual hotels. The emphass on customer satsfacton can lead to mproved overall brand-name reputaton and ncreased proftablty for the whole chan. Based on better brand-name reputaton, Hotelcorp may be able to ncrease the number of 46 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

14 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS Exhbt : Assocaton of Incentve Plan wth Systemwde Rooms and Revenues Revenues Rooms Change n System-wde Room Revenues due to Plan ($ mllons) Change n System-wde Rooms due to Plan (n,'s) franchsed hotels, thereby ncreasng ts profts through franchse fees. Over the seven-year perod precedng our study, the number of franchsed hotels nearly doubled, and total revenues (wthout nflaton adjustment) more than trpled. Exhbt shows the ncentve plan s effect on the hotel chan as a whole. For ths analyss, we examned the growth n the avalable number of rooms under the Hotelcorp brand name after controllng for the overall ndustry growth as measured by the number of rooms added n a year by the upscale and mdscale hotel chans n the Unted States. In addton, we examned the growth n annual revenues generated by all Hotelcorp hotels relatve to annual revenues generated by the upscale and mdscale hotel chans n the Unted States. As shown n Exhbt, both the number of franchsed hotels and the total revenues ncreased more for Hotelcorp than for ts compettors followng the mplementaton of ts new ncentve plan. Ths fndng provdes one more ratonale for the use of customer-satsfacton measures n hotel-performance evaluaton. Once agan, we must warn that the results should be vewed wth cauton because of externaltes that we dd not measure. Changes n franchse-fee structures, market nche, promotonal efforts, contractual oblgatons, and other macroeconomc factors may have nfluenced the chan s growth n franchsed hotels and revenues. Concludng Remarks Despte the cautons we have urged n nterpretng our fndngs, the fact remans that we have documented that the nonfnancal measures used n the Hotelcorp s ncentve plan were sgnfcantly assocated wth the chan s subsequent fnancal performance as measured by ndvdual busness unt revenues and operatng proft. Moreover, our analyss provded some qualfed support for the argument that these customer-satsfacton measures are assocated more wth long-term profts than wth mmedate fnancal performance. In addton, these smple measures of customer satsfacton were more effectve than a complex measure n predctng NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 47

15 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES fnancal performance. Our analyss also documented that nonfnancal performance mproved followng the mplementaton of the ncentve plan that ncluded nonfnancal measures. Fnancal performance, as measured by GOP, also mproved. There are several lmtatons to ths study. To begn wth, we studed just one chan. However, f Hotelcorp s representatve of other hotel chans, our fndngs may be generalzed to the hosptalty ndustry, albet wth the cautons we have offered above. Our analyss ndcates that there s an average lag of sx months between the tme of a customer-satsfacton measurement and the resultng fnancal performance. The relatvely short lag between measured satsfacton and a hotel s fnancal results s smlar to that of retal bankng and seems to capture the economc consequences of customers frequent vsts. 29 Another lmtaton pertans to data avalablty. The absence of full data for a carefully desgned control group necesstates cauton n nterpretng the results. The study reles on alternatve control measures n the form of comparatve data for compettors or franchsed hotels, but such comparable measures were not avalable for some models. Our fndngs are also lmted by our model specfcaton n the absence of a theoretcal functonal relaton between nonfnancal measures and fnancal performance. Fnally, because the ncentve plan capped the bonus payouts as a percentage of operatng proft, the ncentve plan was able to cover ts expenses and produce a net proft, and, hence, we conclude that t had a postve mpact on proftablty. Nevertheless, we are unable to provde a measure of overall ROI for the ncentve plan because the potental postve externaltes of nonfnancal measures on systemwde performance mprovements and the costs of ncentve plan desgn and mplementaton need to be quantfed n a more rgorous way. We leave t for future research to address ths. We conclude wth some practcal mplcatons. Before begnnng, t s mportant to keep n mnd that at no tme dd Hotelcorp consder ts plan based on nonfnancal measures to be optmal, and the frm has lkely made refnements snce our study. Acknowledgng ths, one mplcaton of the study s that even smple measures of nonfnancal performance, such as lkelhood of return and number of complants, are related to future fnancal performance and appear to nduce some approprate manageral actons. Thus, frms may not need to nvest n complex survey sources and expensve nformatongatherng technques to mplement an effectve performance measurement system. Another mplcaton s that t s mportant for hotel management to document the relatonshps between varous nonfnancal measures and fnancal performance. At our research ste, top management had an dea about ths relatonshp but dd not have any quantfable method to convnce ndvdual hotels. Nor dd the company have clear gudelnes on how mprovement n these measures could be attaned. Understandng the lnks should help operatng companes obtan the necessary support of employees, owners, and franchsees. It wll also help publc enterprses n complyng wth the Securtes and Exchange Commsson s recent rulng that management s dscusson and analyss should dentfy and dscuss key performance metrcs, ncludng nonfnancal performance measures that are materal and used to manage the busness. 3 Such an analyss wll also help determne the approprate measures and weghts to be placed on these measures. For example, quantfyng the relatonshps between nonfnancal measures and 48 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

16 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS fnancal performance across a wde range of observatons could help n settng targets for nonfnancal measures. More s not always better; n fact, t may hurt overall performance beyond some threshold. Thrd, t s mportant for top management to dentfy other organzatonal factors such as culture and top manageral atttude toward customer satsfacton that may enhance or mpede the success of ncentve plans. Whle our study has documented an average effect across the eghteen propertes, ndvdual propertes could exhbt varyng levels of effectveness. A more detaled comparatve study of ndvdual hotels wll be of help n dentfyng such contextual factors. Endnotes. Ittner, Larcker, and Rajan reported that 36 percent of the companes surveyed n ther study use nonfnancal measures n executve compensaton. C. Ittner, D. Larcker, and M. Rajan, The Choce of Performance Measures n Annual Bonus Contracts, Accountng Revew, Aprl 997, pp For detals on the varous studes that report ncreasng use of nonfnancal measures n compensaton, see Journal of Accountancy, May 993, pp. 7-8; and J. R. Hauser, D. Smester, and B. Wernerfelt, Customer Satsfacton Incentves, Marketng Scence 3, no. 4 (994): Other studes of Japanese and Brtsh companes also ndcate ncreasng use of nonfnancal measures n performance measurement (T. Hromoto, Another Hdden Edge Japanese Management Accountng, Harvard Busness Revew, July- August 988, pp ; W. Rees and C. Sutclffe, Quanttatve Non-fnancal Informaton and Income Measures: The Case of Long Term Contracts, Journal of Busness Fnance and Accountng, Aprl 994, pp ). 2. The argument that nonfnancal measures are better ndcators of future fnancal performance s based on cause and effect. An mplct assumpton s that manageral actons result n outcomes such as nnovaton, qualty, or customer satsfacton, whch, n turn, drve future fnancal performance (R. Kaplan and D. Norton, The Balanced-Scorecard: Measures that Drve Performance, Harvard Busness Revew, January-February 992, pp. 7-79, at 7; Hauser, Smester, and Wernerfelt, Customer Satsfacton Incentves, 33). However, current fnancal measures do not reflect the value of these long-term orented manageral actons. Therefore, nonfnancal measures of performance are useful to help refocus managers on the long-term aspects of ther actons (T. Hemmer, On the Desgn and Choce of Modern Management Accountng Measures, Journal of Manageral Accountng Research, 996, pp. 87-6, at 87-88). 3. C. Ittner and D. Larcker, Comng Up Short on Nonfnancal Performance Measurement, Harvard Busness Revew, November 23, pp ). 4. R. Kaplan and D. Norton, The Balanced Scorecard (Boston: Harvard Unversty Press, 996). 5. C. Ittner and D. Larcker, Innovatons n Performance Measurement: Trends and Research Implcatons, Journal of Manageral Accountng Research, 998, pp A prncpal justfcaton for the uses of nonfnancal performance measures descrbed above s that they are leadng ndcators of fnancal performance. Two surveys (Ittner and Larcker, Innovatons n Performance Measurement ; Arthur Andersen & Co. SC., Customer Satsfacton Strateges and Tactcs [994]) suggest that many frms dd not fnd a sgnfcant assocaton between customer satsfacton and accountng or market returns. Usng cross-sectonal annual data from seventyseven Swedsh frms from dverse ndustres, Anderson et al. found that, on average, customer satsfacton s postvely assocated wth contemporaneous ROI but found weaker or negatve assocatons n servce frms. See E. Anderson, C. Fornell, and D. Lehmann, Customer Satsfacton, Market Share, and Proftablty: Fndngs from Sweden, Journal of Marketng, July 994, pp ; E. Anderson, C. Fornell, and R. Rust, Customer Satsfacton, Productvty and Proftablty: Dfferences between Goods and Servces, Marketng Scence 6, no. 2 (997): Ittner and Larcker s analyses based on customer- and busness-unt-level data for two servce frms ndcated that customer satsfacton measures are postvely related to future fnancal perfor- NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 49

17 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES mance (see C. Ittner and D. Larcker, Are Nonfnancal Measures Leadng Indcators of Fnancal Performance? An Analyss of Customer Satsfacton, Journal of Accountng Research 36 [998]: -35). However, ther frmlevel analyss of cross-sectonal data dd not fnd consstent assocatons between customer satsfacton and market returns. Tme-seres data can help overcome some potental shortcomngs such as omtted varables, endogenety, and spurous correlaton assocated wth analyses based on cross-sectonal data. Our research settng wth more than sxty tme-seres observatons per busness unt provdes a greater statstcal power to detect such a relaton. Moreover, unlke prevous studes that assume the lag perod (such as a quarter, sx months, or a year) because of data lmtatons, we are able to explore the tmng of the lead-lag relaton based on a statstcal search. 7. Despte an ncreasng use of nonfnancal measures n manageral compensaton (Ittner, Larcker, and Rajan, The Choce of Performance Measures n Annual Bonus Contracts ), there s lttle emprcal evdence of the performance mpacts of such plans. Incentve plans that nclude nonfnancal measures can affect fnancal performance ether drectly or ndrectly by mprovng nonfnancal performance, whch then mpacts fnancal performance. Although pror emprcal studes have documented the performance mpact of ncludng fnancal measures n ncentve plans (J. A. Wagner, P. A. Rubn, and T. J. Callahan, Incentve Payment and Nonmanageral Productvty: An Interrupted Tme Seres Analyss of Magntude and Trend, Organzatonal Behavor and Human Decson Processes 42 [988]: 47-74; R. D. Banker, S. Lee, G. Potter, and D. Srnvasan, Contextual Analyss of Performance Impacts of Incentve-Based Compensaton, Academy of Management Journal 39, no. 4 [996]: 92-48), emprcal support for the hypotheszed performance mpacts of ncludng nonfnancal measures n compensaton plans s at best weak (Ittner and Larcker, Innovatons n Performance Measurement ). Ittner, Larcker, and Rajan, n The Choce of Performance Measures n Annual Bonus Contracts, analyzed the determnants of the use of nonfnancal measures n CEO compensaton but dd not examne the performance mpacts of such compensaton plans. Symons and Jacobs s study of a total qualty management (TQM) based reward system for producton workers found that operatonal performance mproved, but t dd not examne the effects on fnancal performance. R. T. Symons and R. A. Jacobs, A Total Qualty Management-Based Incentve System Supportng Total Qualty Management Implementaton, Producton and Operatons Management 4, no. 3 (995): D. Huckesten and R. Duboff, Hlton Hotels: A Comprehensve Approach to Delverng Value for All Stakeholders, Cornell Hotel and Restaurant Admnstraton Quarterly, August 999, pp Amercan Accountng Assocaton, Report of the Commttee on Non-fnancal Measures of Effectveness, Accountng Revew 46 (97 suppl.): 65-2; H. Johnson and R. Kaplan, Relevance Lost: The Rse and Fall of Management Accountng (Boston: Harvard Busness School Press, 987); R. Kaplan and D. Norton, Havng Trouble wth Your Strategy? Then Map It, Harvard Busness Revew, September- October 2, pp Kaplan and Norton, The Balanced Scorecard: Measures that Drve Performance ; B. Sngleton-Green, If It Matters, Measure It, Accountancy, May 993, pp G. Feltham and J. Xe, Performance Measure Congruty and Dversty n Mult-task Prncpal/Agent Relatons, Accountng Revew, July 994, pp ; Hemmer, On the Desgn and Choce of Modern Management Accountng Methods. 2. K. Kefgen, Prce/Value Relatonshp Also Usable as Measure for Executve Talent, Hotel Busness, January 2, 996, p J. L. Heskett, T. O. Jones, G. W. Loveman, W. E. Sasser Jr., and L. A. Schlesnger, Puttng the Servce-Proft Chan to Work, Harvard Busness Revew, March-Aprl 994, pp The new ncentve plan provdes the same maxmum bonus elgblty as the old plan for most managers, wth the excepton of the general manager and controller, who have hgher maxmum bonus than before. Now the general manager can earn up to 5 percent of hs base salary as bonus, achevng only the operatng proft goals wll earn hm one-thrd of the maxmum bonus (or 7 percent of the base salary). The remanng two-thrds of the maxmum bonus (or 33 percent of the base salary) s earned only f nonfnancal goals are acheved. 4 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25

18 NONFINANCIAL PERFORMANCE MEASURES PERFORMANCE AND ANALYSIS 5. HOTELCORP also computes for each hotel a monthly composte ndex of customer satsfacton (CSINDEX) based on customer responses to a number of questons that cover varous aspects of customer servce such as front desk encounters, cleanlness of rooms, qualty of food and beverage servces, and general upkeep of the hotel. However, ths measure s not used for ncentve purposes because the senor management wanted to use a smple measure of customer satsfacton n the ncentve plan and they were also uncertan about how customer satsfacton measured on these dmensons translates nto repeat busness. Although not reported n the artcle, the regresson results based on CSINDEX ndcate that the relatonshp between ths alternatve measure of customer satsfacton and fnancal performance s very smlar to the relatonshp between LRETURN and fnancal performance. The total varaton explaned by the two sets of regressons are very smlar, suggestng that the explanatory power of the two dfferent measures of customer satsfacton s nearly the same. In addton, the regresson results of the models usng both these measures as ndependent varables suggest that CSINDEX does not have any explanatory power over and above LRETURN. Overall, the smple measure used at HOTELCORP captures vrtually all of the explanatory ablty of a complex measure of customer satsfacton. 6. S. M. Keaveney, Customer Swtchng Behavor n Servce Industres: An Exploratory Study, Journal of Marketng, Aprl 995, pp Kaplan and Norton, The Balanced Scorecard; Ittner and Larcker, Innovatons n Performance Measurement. 8. T. O. Jones and W. E. Sasser Jr., Why Satsfed Customers Defect, Harvard Busness Revew, November-December 995, pp Hotel Assocaton of New York Cty, Inc., A Unform System of Accounts for Hotels (996). 2. We employ the followng models: TREVPAR 8 R t R R HOTEL COMPREV R AVGLRETURN R t 7 HOTEL t R REVENUE, t R AVGCOMPLNTS, t6, t6 2 COSTPAR 8 C C 2 C C t 7 C HOTEL OCCRATE HOTEL C ECIt AVGLRETURN C AVGCOMPLNTS, t6 t GOPPAR 8 P t 7 t P HOTEL t C COST, t6 P P HOTELCOMPREV PROFIT P AVGLRETURN P t, t, t P AVGCOMPLNTS, t6, t6 2 where COMPREV = compettve set s room revenue per avalable room and ECI = employment cost ndex. 2. Autocorrelaton of error terms s controlled wth the 954 Pras Wnsten adjustment. 22. Anderson, Fornell, and Lehmann, Customer Satsfacton, Market Share, and Proftablty. 23. Specfcally, Akake s Informaton Crteron (AIC) s used to determne the lag length (see W. H. Greene, Econometrc Analyss [New York: Macmllan], 55-7). AIC s smlar n sprt to adjusted R 2 n that t rewards good ft but penalzes the loss of degrees of freedom. A search over a maxmum length of twelve lags ndcated that the model wth a lag length of sx resulted n the mnmum AIC and hence was chosen as the most approprate model. The coeffcent of a nonfnancal measure s nterpreted as ts average long-run mpact (see bd., 52-3). 24. Ittner and Larcker, Are Non-fnancal Measures Leadng Indcators of Fnancal Performance? 25. Feltham and Xe, Performance Measure Congruty and Dversty n Mult-task Prncpal/ Agent Relatons. 26. Estmatng whether the new ncentve plan resulted n a change n nonfnancal performance requres a model of the behavor of nonfnancal measures. It s dffcult to specfy a model of customer satsfacton measures (LRETURN and COMPLNTS). Data on lkelhood of return are avalable for HOTELCORP s franchsed hotels that dd not mplement the new ncentve NOVEMBER 25 Cornell Hotel and Restaurant Admnstraton Quarterly 4

19 PERFORMANCE AND ANAYLSIS NONFINANCIAL PERFORMANCE MEASURES plan and thus serve as a control for exogenous factors affectng ths performance measure. HOTELCORP s franchsed hotels form a natural control group because they follow the same operatonal rules and gudelnes, but they dd not mplement the ncentve plan or make any major organzatonal changes that affect performance. Therefore, we specfy LRETURN L t L L L LRETRURNF PLAN t 7 HOTEL L t t where LRETURNF t = average lkelhood of return ndex for franchsed hotels n month t and PLAN t = a dummy varable representng tme perods followng new ncentve plan mplementaton. No such comparatve data are avalable for COMPLNTS that can serve as a control for exogenous factors affectng ths nonfnancal measure. Therefore, we employ a commonly used mpact assessment method n tme-seres analyss known as nterventon or the transfer functon model. For most models wth COMPLNTS as the dependent varable an AR() process wth a constant parameter, resulted n resduals that are whte nose, justfyng the use of lagged values as ndependent varables. Therefore, we specfy COMPLNTS 8 M M t M t 7 M HOTEL COMPLNTS, t HOTEL M PLAN 27. Sngleton-Greene, If It Matters, Measure It. 28. A drect test of the mpact of the new ncentve plan on fnancal performance s conducted by estmatng the followng nterventon models: t 7 C' C' COSTPARt 8 C' HOTELOCCRATE t C' C' C' ECIt PLAN t TREVPAR 8 t R' 7 R' HOTEL HOTEL R' R' HOTELCOMPREV t PLANt GOPPAR 8 P' t 7 P' HOTEL P' P' HOTELPROFIT,t-2 PLAN t 29. Ittner and Larcker, Are Non-fnancal measures leadng ndcators of fnancal performance? 3. Securtes and Exchange Commsson Release nos , (December 29, 23). Rajv D. Banker, Ph.D., s dean and Anderson Char n Management at the Anderson School of Management at the Unversty of Calforna, Rversde (rajv.banker@ucr.edu). Gordon Potter, Ph.D., s an assocate professor at the Cornell Unversty School of Hotel Admnstraton (gsp6@ cornell.edu). Dhnu Srnvasan, Ph.D., s an assstant professor at the Unversty of Pttsburgh (dhnus@katz.ptt.edu). Ths artcle provdes a synopss and extenson of the authors lengther study, An Emprcal Investgaton of an Incentve Plan that Includes Nonfnancal Performance Measures, Accountng Revew 75, no. (2): R' t P' t 42 Cornell Hotel and Restaurant Admnstraton Quarterly NOVEMBER 25