Performance Management in Banking

Performance Management in Banking

A Comparison between Share- and Stakeholder Oriented Organizations

Marco Bouma

Performance Management in Banking

A Comparison between Share- and Stakeholder Oriented Organizations

A Case Study of Rabobank Group versus Royal Bank of Scotland

- Master Thesis - Groningen, January 2010

Marco Bouma Student Number: 1839918

University of Groningen, Faculty of Economics and Business. Master of Science Business Administration, Specialization Organizational & Management Control.

Supervisor: dr. E.P. Jansen Co-Assessor: dr. T.A. Marra

Korreweg 193 9714 AK Groningen

Preface

After a half year of examining relevant scientific articles and books, interviewing employees of both banks, discussing items with several supportive people and eventually writing and rewriting the different parts of this document, the process of writing my Master thesis has come to an end. As a result of this period, I am proud to present this paper, which forms the last obstacle in order to graduate for my Master degree in Business Administration, specialization Organizational & Management Control, at the faculty of Economics and Business of the University of Groningen.

The aim of this paper is to give an insight in performance management systems of banking organizations. During a period of financial crisis, in which performance management systems of banks are frequently criticized, I was inspired to look at these mechanisms more closely. The implementation of performance management systems allows organizations to make sure that employees behave in the best interest of the company, performing the right activities. In this paper, I examine whether banks are able to manage this process properly. In that respect, it is important that they translate corporate strategic objectives towards specific targets for individual employees. In that situation, the performance of an employee contributes directly to the accomplishment of organizational objectives.

During the process of writing this thesis, a number of people helped and motivated me. Thanks to their support, I was able to bring my performance up to a higher level. In this context, I would like to thank them specifically. First of all, I would thank dr. E.P. Jansen, my supervisor at the University. He stimulated me to look critical and objective towards scientific theories and organizational characteristics, which improved the quality of my work significantly. Thanks to him, I was able to narrow the focus of this research down to the current level. I also appreciated the cooperation of employees of both Rabobank and Royal Bank of Scotland. Both organizations never ignored my requests for interviewing people, which demonstrates how collaborative they are with respect to students as me. Furthermore, I would thank several fellow students and friends for the discussions about topics, related to this thesis. Finally, my girlfriend and family earn a worth of honor. They inspired and motivated me to complete this last project of my study in a successful manner. Thanks to them, I have been able to produce the document which lies in front of you.

I honestly hope that the subject of this paper stimulates you to read it with most interest and pleasure.

Executive Summary

The aim of this study was to examine how performance management systems in the banking sector are designed. During this time of financial crisis, mechanisms of how compensations of bankers are established, frequently suffered criticism. Bankers would receive extraordinary bonuses, based on short-term oriented performance objectives, which had led to perverse behavior. In this situation, bankers neglected the importance of long-term customer relationships and organizational continuity. However, are these criticisms based on valid arguments? In this research, an examination of performance management systems in the banking sector is provided. In that respect, the linkage between strategy and performance management is analyzed with extra attention. At the moment that strategy is translated into individual performance measures correctly, the probability that this strategy will actually be accomplished increases. In this respect, the aim of the paper is to examine whether these performance management systems were designed properly. If possible, suggestions for improvements will be provided.

In the current business environment, two types of business perspectives can be recognized; share- versus stakeholder oriented. In this situation, shareholder oriented organizations are particularly organized in order to increase shareholder value, by means of pursuing high organizational profitability. On the other hand, stakeholder oriented organizations recognize multiple stakeholder needs which have to be fulfilled. In that respect, customer interest, employee satisfaction, corporate social responsibility and also shareholder value are seen as important antecedents of organizational performance. In the current financial sector, both types of financial institutions can be identified. However, it might be interesting to examine how both types of organizations manage performance of their employees. This research examines how employees of both types of organizations are evaluated and rewarded. In that respect, the objective is to indicate differences in performance management principles between both types of banking perspectives. Therefore, the following research question was formulated:

What is the difference in performance management design between a share- and a stakeholder oriented bank?

In this research, a share- and stakeholder oriented bank were examined respectively. In that analysis, the focus was on the way of how employees of the two institutions were evaluated and rewarded specifically. The aspect of how employees were committed to long-term organizational objectives, and the assurance of accountable employee behavior was investigated with extra attention. At both organizations, semi-structured interviews with different employees were carried out in order to obtain an imagination of both performance management systems. Based on this assessment, several differences in performance management design could be indicated.

First of all, stakeholder oriented banks integrate non-financial performance measures more severely as their shareholder oriented counterparties do. At these stakeholder oriented banks, employee performance is evaluated by means of the appraisal of accomplished results, plus an assessment of individual behavior. In this assessment, customer focus and collaboration with colleagues are seen as very important. As can be imagined, the evaluation of this behavior is complex, and based on a sophisticated evaluation system in order to assure objectivity. On the contrary, shareholder oriented organizations are more focused on the accomplishment of actual results. In that respect, their performance management systems are more simple and comprehensible.

A second difference is related to the level of compensations which are paid to employees. Shareholder oriented banks aim to recruit talented bankers, in order to operate most profitably. In that respect, they are willing to pay a competitive salary package. At the moment that corporate profitability rises, shareholders would not face any difficulties with respect to these high salaries. However, at stakeholder oriented organizations, customers will object at the moment that high compensations are paid at a cost of higher product prices. Therefore, shareholder oriented banks are normally paying out higher compensations as stakeholder oriented banks do. However, due to the fact that these bonuses are as high as they are, shareholder oriented banks use them to commit employees to long-term organizational objectives. By paying out bonuses on a deferred basis, or by means of company shares, employees are also interested in long-term profitability of the organization. On the other hand, stakeholder oriented banks try to create this long-term commitment by means of the sophisticated formulation of employee behavior. When employees operate accountable, long-term objectives will be fulfilled almost automatically.

Table of Contents

1.3 Structure of the Report ... 12

2 Performance Management: A Tool to Implement Strategy ... 13

2.1 Performance Measurement ... 13

2.2 Reward Systems ... 14

Conclusion ... 16

3 The Banking Sector: Strategy and Performance Management ... 17

3.1 Strategic Issues in Banking ... 17

3.2 Performance Management in Banking ... 19

Conclusion ...22

4 Rabobank: A Stakeholder Oriented Bank ... 23

4.1 Organizational Structure ... 23

4.2 Organizational Strategy ...24

4.3 A Stakeholder Oriented Perspective ... 25

5 Performance Management at a Stakeholder Oriented Bank... 26

5.1 Individual Performance at Rabobank ... 26

5.2 Planning ... 27

5.3 Performance and Evaluation ...28

5.4 Reward ... 29

6 Analysis of Performance Management at Rabobank ... 32

6.1 Theoretical Correctness ... 32

6.2 Practical Appropriateness ... 34

Conclusion ... 38

7 Royal Bank of Scotland: A Shareholder Oriented Bank ... 39

7.1 Organizational Strategy ... 39

7.2 Performance Management ...40

7.3 Theoretical Correctness ... 44

Conclusion ... 46

8 Types of Performance Management: An Assessment ... 47

8.1 Theory into Practice ... 47

8.2 Typical Employee Behavior ... 50

Conclusion ... 52

9 Conclusions and Recommendations ... 53

9.1 Theoretical Foundation ... 53

9.2 Conclusions ... 54

9.3 Managerial Implications ... 56

9.4 Limitations and Suggestions for Further Research ... 57

References ... 58

APPENDICES: ... 62

A: Questionnaire for Interviews at Rabobank Nederland ... 62

B: Questionnaire for Interviews at Local Offices of Rabobank ... 63

C: Questionnaire for Interview at Royal Bank of Scotland ... 64

1

Introduction

The fact that managers are rewarded with high earnings and bonuses is widely accepted as one of the main causes of the current financial crisis. Top managers collected large bonuses, based on financial indicators of company performance, such as profitability figures, which influenced managers’ behavior sincerely. These performance measures were mostly dominated by short-term performance indicators and stimulated managers to make short-term oriented decisions. In that respect, high short-term returns will be preferred above lower, but more stable and less risky, long-term profits. These kind of performance management systems seem to result in decision making, which is unfavorable for long-term company performance, and have ultimately led to the current financial crisis. At this moment, national governments are developing regulations, which obligate organizations to reward employees, based on an assessment actual performance. The most crucial part of these systems is that managers should deliver observable and accountable performance to earn a justified reward.

The goal of management control systems is to manage activities of employees in order to secure a company value adding attitude (Merchant and Van der Stede, 2007). By introducing these kinds of systems, employees are stimulated to do their jobs precisely and effectively. A crucial aspect of these control systems is that they should be designed in order to deliver outcomes, which are desired by the organization. Important components of these management control systems are performance measurement and reward systems. By paying employees, based on structured evaluation principles, they can be controlled to deliver specified tasks. According to Merchant and Van der Stede (2007), a well developed performance management system has some obvious advantages. First of all, it informs employees of their duties and responsibilities. When rewards are based on particular tasks or outcomes, the activities which have to be performed are clearly indicated. Moreover, a well structured performance management system motivates employees to deliver high-quality performance. Especially when the organization makes use of performance based reward systems, employees will perform better in order to earn a higher salary.

A logical design of performance management systems is a crucial aspect in order to secure that desired outcomes are accomplished. According to lots of scholars, management control systems, including performance and reward systems, should be linked towards the strategic objectives of an organization (Govindarajan and Gupta, 1985; Simons, 1990; Merchant and Van der Stede, 2007). When critical success factors of a company form the foundation of the management control system, possibilities of actually accomplishing these strategic targets will be higher. By translating strategy into intended tasks of employees, value adding performance will be delivered more easily. Employees will be able to understand better what their tasks are, and are extra motivated to accomplish these objectives effectively.

At this moment, especially the extraordinary bonuses of top managements are criticized. However, closer analyses of rewards, which are paid at lower levels in the organization, are mostly ignored. A reward system is not only focused on top management, but includes arrangements at all levels of the organization. Lower level employees in particular, can easily be directed towards a desired form of behavior, by means of a clear performance management system. Especially the performance of these individuals can be improved by informing them of their tasks and providing them with acceptable incentives at the moment that these tasks are accomplished (Bloisi et al., 2003).

In the banking industry, two specific types of organizations can be distinguished; share- and stakeholder oriented banks (Llewellyn, 2005). In this situation, shareholder oriented banks are primary focused to deliver shareholder value, so they aim to be highly profitable and efficient. In contrast, a stakeholder oriented bank aims to satisfy multiple stakeholder needs. Customer and employee satisfaction are examples of important objectives for that type of organization. The aim of this study is to analyze the differences in performance management systems between both types of banks. Performance measurement aspects, and the issue of strategic linkage between these measures, will be analyzed specifically.

1.1

Research Questions

In this research, the functioning of performance management systems in share- and stakeholder oriented banks will be analyzed. As mentioned earlier, performance management systems can be seen as applications to implement strategy in daily operations. The primary objective of stakeholder oriented banks is to satisfy all stakeholder needs. This should be translated into strategic objectives for the organization. It will be vital that these strategic objectives are correctly incorporated into the performance management system of the organization. At a shareholder oriented bank, the main target is to gain as much profit as possible, in order to increase shareholder value. In this thesis will be examined how these strategic concepts are translated into the performance management systems of both banks specifically. The aim of this process is to indicate differences between performance management design of both types of organizations. Consequently, the research question of this study will be:

What is the difference in performance management design between a share- and a stakeholder oriented bank?

In order to analyze differences in performance management systems between share- and stakeholder oriented organizations, an in depth analysis of both organizations is needed. Therefore, this research could be split up into three different research sections. First of all, an investigation of how specific strategic targets are integrated and translated into the performance management system of a stakeholder oriented bank. Secondly, an analysis of a shareholder oriented organization will be provided. Therefore, these two sub-questions can be formulated:

− How integrates a typical stakeholder oriented bank its strategy into a well functioning performance management system?

− How is the performance management system of a shareholder oriented bank designed?

1.2

Research Method

In this research, several steps have to be taken in order to answer the different research questions. First of all, a theoretical framework will be established, in order to develop a broad understanding of theoretical principles, related to performance management. Relationships between strategy, performance management, employee motivation and different types of rewards are examined. Furthermore, a closer look on the banking sector is required, in order to understand the different perspectives and attitudes of the specific types of banks. In that respect, existing theories about share- versus stakeholder perspectives, and their impact on performance management systems, are examined.

The next step is to test how these theoretical findings are implemented in the real banking sector. In that respect, performance management systems of RBS and Rabobank, a share- and stakeholder oriented bank respectively, are analyzed. This analysis can be characterized as a case study. Annual reports and presentations of both banks are used to describe strategies and business structures. In order to review both performance management systems objectively, a detailed analysis of these systems will be required. Specific design choices, will be indicated and analyzed. In that respect, several sub-questions will be formulated, which form the structure of both case analyses.

− What is the objective of the performance management system?

− How are performance indicators determined?

− How are employees evaluated and rewarded?

− How can long-term objectives be integrated in performance management?

− Is the performance management system operating effectively?

These sub questions will be answered by means of in depth case studies of Rabobank and Royal Bank of Scotland. By speaking with different employees of both banks, by means of carrying out semi-structured interviews, an image of the design and integration of performance management systems in both organizations will arise. In the situation of Rabobank, I interviewed employees till the moment that basically no new information was acquired, which was at an amount of six interviews. In case of RBS, I was satisfied with one long and detailed interview with the head of Human Resource Management of the bank. Due to the fact that performance management at this bank was rather clear, and solely differences with a stakeholder oriented performance management system had to be indicated, I was satisfied with this interview solely.

1.3

Structure of the Report

2

Performance Management: A Tool to Implement Strategy

Strategic issues were incorporated into management control systems since the 1980`s (Langfield-Smit, 1997). When you consider that strategy has become important since the 1950`s, this is quite surprisingly. Currently, many contingent factors influence organizational structures and control systems of a company (Chapman, 1997). In that respect, strategic issues are definitely important factors in the design of a management control system. According to Govindarajan and Gupta (1985), strategy is perhaps the pre-eminent source of contingencies in the design of organizations. Dent (1990) even states that management control systems were recognized to play a pro-active role with respect to strategic change within an organization. So in essence, an apparent linkage of management control systems with the strategy the company holds, increases the probability of success. However, due to the many contingent factors, there exists no regular design plan, describing one successful method of linking these concepts to each other. Specific strategies of companies require explicit designs of control systems in order to execute that specific strategy most efficiently. In this chapter, the functioning of performance management systems in relation to the implementation of strategy will be elaborated. Firstly, an analysis of performance measurement systems will be performed. After that, the focus will lie on reward systems and their strategic value for the organization.

2.1 Performance Measurement

When top management has chosen for a specific strategic plan, this strategy has to be implemented correctly. Lower management should be able to understand and execute the strategic direction effectively. Behavioral control mechanisms help organizations to implement strategies (Picken and Dess, 1997). According to Ittner and Larcker (1997), effective implementation controls include the development of action plans and targets for achieving organizational objectives, the assignment of accountability for implementing these action plans, and the alignment of reward systems with strategic objectives to ensure that managers’ actions are consistent with organizational strategy. Performance measures help management to have some authority over lower level employees (Abernethy and Lillis, 2001). It is a form of decentralization of power in the organization. Lower employees are authorized to behave in a way, which they think is best to accomplish their goals. However, at the end of the accounting period, they are evaluated based on the measures, which are set by higher management. This structure stimulates employees to perform at a high level.

Banker et al. (2000) state that these non-financial measures contribute to a longer term orientation of management, which stimulates continuity in an organization. Therefore financial and non-financial performance measures should be integrated in a performance management system of an organization.

The choice of specific performance measurements might have negative side-effects in certain situations. Merchant and Van der Stede (2007) mention that, as a result of financial performance measures, managers may become particularly focused on the accomplishment of these targets, which are mostly term oriented. According to Kaplan and Atkinson (1998), a focus on short-term performance may damage future value of the organization seriously. In order to reduce that problem, several academics mention that evaluations and compensations should be based on longer term objectives and performances (Tomasko, 1982). He states that the reach of company objectives should match performance measurement and appraisal timeframes. A close fit with respect to this time dimension, creates highest strategic value. In the design of a performance management system, the assessment of long- versus short-term performance measurement is vital in order to keep employees stimulated to perform in the best interest of the organization. Most of the time, a combination of these two, leads to highest company performance.

2.2 Reward Systems

The next step in the strategy implementation phase is the appraisal of employee performance. Historically, a reward system was designed in order to attract, retain and motivate employees. Providing competitive pay was the most critical element of these pay systems (Cameron and Simon, 1995). However, a reward system can also be a tool to improve company performance. Lawler (2003) states that performance management systems are more effective when there is a clear connection between performance measurement and employee appraisal within an organization. He mentions that reward systems help to drive performance by influencing individual and organizational behavior. Armstrong (1993) confirms this, by stating that internal consistency in a performance management system is vital to its success. There should be a logical basis in developing job descriptions, measuring performance and rewarding employees. If designed properly, reward systems have a significant impact on the effectiveness of the organization and the quality of employees work life (Lawler, 1995).

Also in the design of a reward system, several types of incentives can be integrated. Kaplan and Atkinson (1998) distinguish immediate verses long-term, cash versus equity and monetary versus non-monetary incentives. Most of the time, organizations choose to pay employees based on a combination of these incentive types, in order to achieve highest employee motivation and performance. As already mentioned, immediate cash payments of incentives leads to short-term orientation of decision makers. Therefore, an organization should design a specific construction, which commits employees to longer-term objectives of the organization, but still keeps them motivated to perform well in the current situation. In that respect, most stock listed companies offer company shares to its employees (Kaplan and Atkinson, 1998). However, in this study, the performance management system at Rabobank, an organization which is not listed on the stock market, is examined. Therefore, at this organization, all kinds of stock option plans cannot be used in order to keep employees motivated to perform well for a longer time period. Therefore, Rabobank must invent a construction in their pay system which encourages employees to continue to be committed to the organization. Kaplan and Atkinson (1998) mention several incentive types which can help an organization to commit employees to long-term organizational objectives. Organizations can opt to pay out deferred bonuses and compensations. In that perspective, the payment of bonuses is postponed over a longer-term period. In some companies, bonuses are not paid to employees until they leave the company. This leads to higher organizational commitment of employees, because they will become interested in the continuity of the organization.

Another technique to ensure long-term employee commitment, is to integrate non-financial incentives in the reward system. Appelbaum and Kamal (2000) mentioned four important non-financial incentives, which increase firm attractiveness and provide the company with the ability to gain valuable human resources; job enrichment, employee recognition, internal pay equity and skilled managers. All these incentives stimulate employee satisfaction, which eventually will lead to higher organizational commitment and performance (Ostroff, 1992). Communication with employees will be vital in the process of integrating non-financials in the reward system. Employees have to recognize the intention of the incentives, before they actually get motivated. In this respect, employee participation in the formulation of objectives will be helpful (Noe et al., 2006). Objectives, designed by management and employees together, will be better understandable for employees. Consequently, employees will be higher motivated to actually accomplish their targets. Integrating these non-financial incentives in the reward system, will be a relatively inexpensive method to increase organizational performance significantly.

Conclusion

In this chapter, strategic importance of performance management systems was discussed. The mechanism of performance measurement, and aligning rewards to these performances, is of significant importance in the strategy implementation process. In the design of these systems, a number of choices can be made, which have major implications for the effectiveness of the system. Especially the integration of long-term and non-financial performance measures and rewards increase the probability that objectives of an organization are accomplished at an accountable way. In order to ensure that employees behave as management expects them to do, a combination of different performance measures and incentive types will be helpful. With respect to the banking industry, the focus on long-term objectives and quality standards might be neglected easily, which was a considerable source of the recent financial crisis. The former Dutch minister of Finance, Drs. G. Zalm, stated in a workshop which I attended, that the integration of non-financials and long-term objectives in performance management systems decrease the possibility that financial institutions take excessive risks1. He argued that customer satisfaction should obtain an important position in performance management systems of financial institutions.

In the next chapter, an analysis of strategic issues, and their implications for performance management at the banking industry specifically, will be performed. Attention will be given to the integration of non-financial performance and long-term strategic objectives in the banking sector.

1

3

The Banking Sector: Strategy and Performance Management

In the previous chapter, the importance of a structured performance management system was encouraged. The aim of these kind of performance management systems is to ensure that organizational objectives will be accomplished. When performance management systems in the banking sector are examined, specific strategic objectives of banks are essential. However, due to the complex characteristics of this sector, a very specific design of performance management system is required. The complex nature of financial products, and their exposure to financial risks, results in specific limitations in relation to the formulation of a banking strategy. Banks simply cannot take excessive risks in their operations. Furthermore, the banking sector is a diverse and competitive market, open to lots of changing conditions. Several different financial products are delivered, and customers claim these services at any moment and at every specific location. Therefore, a high degree of innovation is needed in order to meet these demands (Harker and Zenios, 2000). Finally, governments and central banks have set specific banking regulations in order to secure that banks operate sustainable. The fact that banks control customer savings deposits, requires regulations in order to secure that financial property of consumers is treated carefully. However, these regulations limit banks in executing a competitive strategy. All these aspects have significant impact on the performance management system of a financial institution, which will be elaborated in this chapter. Banking strategies, and their implications for banking performance management systems will be examined. At the end of this section, the theoretical foundation of this study will be complete.

3.1

Strategic Issues in Banking

When analyzing corporate organizational performance in the banking sector, different performance aspects can be recognized. In this process, specific strategic objectives of a bank should be incorporated. Who is the bank aiming to serve, and what are they willing to deliver? Therefore, banking strategies and specific target groups of a bank are treated separately in the following section. These issues have significant implications for the performance management system of banks, which will be examined after this paragraph.

3.1.1 Banking Strategy

A Strategic Map of the Banking Industry

Figure 1

hard INFORMATION QALITY soft

standardised PRODUCT DIFFERENTIATION personalized small SIZE large high low UNIT COST

In another study, DeYoung et al. (2004) mentioned that out of these different strategies, two generic banking strategies emerge (Figure 1). They apply four variables to distinguish these strategies; bank size, bank unit cost, product differentiation and information quality. In this framework, the size of the organization leads to higher economies of scale. Financial services will be standardized in larger organizations and produced at lower costs. This development leads nearly automatic to a more standardized information attitude of the bank towards customers. Consequently, a distinction between strategies of larger and smaller banks can be distinguished. Larger banking organizations can operate at a more standardized approach in order to be most profitable between the limitations of their risk exposure. Smaller banking organizations tend to focus more on customer needs in order to attract and retain their clients. Also in the perspective of consumer personalization, the owners of the organization will have a voice in the determination of the strategic path of the organization. In essence, the owners of the bank have a remarkable influence on strategic objectives of the company, because they determine the maximum amount of risk exposure, and have a determining voice in the way of how a bank operates.

3.1.2 The Target Group of a Financial Institution

He mentions that a bank can opt a shareholder value approach, by attempting to maximize Return on Equity (ROE) and Economic Value Added (EVA), or a stakeholder value maximizing approach. In organizations, striving for shareholder value, the aim to achieve lowest costs of operations and infrastructures dominates. Most of these organizations pursue a strategy, equal to the strategy positioned in the left corner of figure 1. In this strategy, a relatively low-cost and standardized product will be delivered. Employees are particularly treated as a resource in order to serve shareholder needs. Specific customer demands will be seen as less important. The primary objective of these organization is to maximize shareholder value.

In the other approach, where satisfying stakeholder values is seen as a key objective, other business performances are recognized to be important (Llewellyn, 2005). By recognizing the value of different stakeholders, corporate profitability will not be the primary objective of the bank. A stakeholder oriented bank balances the interests of different stakeholders; employees, customers, suppliers, shareholders and regulators. In comparison with a shareholder oriented bank, the focus will not be on profit maximization with the same intensity. Most Dutch organizations pursue a stakeholder approach by recognizing employee and customer interests (Looise and Paauwe, 2001). In general, most of stakeholder oriented organizations can be positioned in the right-upper corner of figure 1, aiming for higher customer satisfaction. Atkinson et al. (1997) mention that by focusing on these kind of secondary objectives, the primary objective of maximizing profit will be accomplished nearly automatic. Most of these organizations focus on customer satisfaction and strive for long-term customer relationships. Therefore, these stakeholder oriented organizations are less oriented on short-term strategies than organizations which are aimed to create shareholder value. Consequently, it appears to be common that most stakeholder oriented banks are exposed to a significantly lower risk than shareholder oriented banks are.

3.2

Performance Management in Banking

3.2.1 Financial Performance in a Shareholder Oriented Bank

As a result of the specific and complex nature of the banking sector, banking performance is hard to measure. Profits which a bank generates should constantly be placed in the context of the amount of risk to which the organization is exposed. Therefore, several specific performance indicators have to be integrated, in order to measure both risk and profitability. In the design of a performance management system, banks have to make complicated decisions about how it wishes to operate in the market. As mentioned earlier, the interest of the owners of the organization, and the main target group of the organization, are essential in this process. In order to satisfy share- or stakeholders needs, an accountable performance measurement system, measuring ultimate banking performance, has to be designed. Based on the measurement of primary goals of the organization, a detailed network of performance measures, including secondary objectives, can be designed in order to regulate lower management. By mentioning the performance measurement system, used by the Federal Reserve (Fed), the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC), the complexity of banking performance management can be indicated. These organizations together, developed the CAMELS rating method, aiming to supervise financial institutes (Lopez, 1999). This model measures banking performance by means of several performance indicators; Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity. Within each performance category, again several measures determine performance in that specific area. When considering the aim of this performance measurement method, it will be reasonable that only primary objectives of a bank are measured; maximizing profit between the boundaries of a specific risk exposure. Regulating institutes are only concerned with primary financial performance of these organizations; the creation of shareholder value. At the moment that this rating model indicates decreasing financial performance, further analysis of the organization can be performed.

In most shareholder value oriented banks, performance management is oriented towards this type of financial performance. According to Jansen et al. (2009), shareholder oriented organizations paid out relatively high incentives, based on organizational financial performance. Employees receive bonuses when organizational performance increases, which resulted in short-term decision making and low organizational commitment.

3.2.2 Performance Management in a Stakeholder Oriented Bank

Several scholars promote this integration of the balanced scorecard in the banking sector (Kimball, 1998; Karr, 2005). In this approach, financial performance indicators as shareholder value and risk-adjusted return on equity will still be pre-eminent performance measures of the bank, but satisfaction of other stakeholders of the bank will be of equal importance.

If customers are satisfied, they are likely to become loyal to the organization. As Kuckuk and Miller (1997) mention, banks which are serving their more profitable and loyal customers are able to achieve a long-term cost advantage. In that way, a bank may try to attain lower costs and constant growth, but will still be able to deliver a highly personalized service. When a bank is aiming to embrace this kind of operating, it has to evaluate and appraise their employees in a way which stimulates a customer oriented attitude. According to Jansen et al. (2009), these stakeholder based organizations pay out relatively lower bonuses as shareholder oriented companies, founded on a more complex performance measurement system. This includes a system which measures non-financial employee performance and behavior. The organization has to figure out which service aspects are appreciated by customers and translate this into operational activities of their employees. Ultimately, employees have to be paid, based on their effort to increase stakeholder`s satisfaction.

3.2.3 Long-Term Employee Commitment

Conclusion

In this chapter, the focus was on banking strategies and performance. The type of target group for the organization; share- or stakeholders, proved to be a significant factor for the type of performance which a bank is aimed to deliver. In this respect, a stakeholder approach focused much more on the importance of different parties with an interest in the bank. In these types of banks, the introduction of non-financial performance measures seems to attain higher importance. Shareholder oriented banks, which are structured in order to operate at lowest cost, will normally hold a performance management system, which encourages just financial cost objectives. However, in a stakeholder oriented bank, performance management will be designed in order to stimulate customer satisfaction by integrating different non-financial performance measures. This appears to correspond with the competitive banking strategies, described by DeYoung et al. (2004), where cost structures at the one hand and customer based strategies on the other hand dominate.

4

Rabobank: A Stakeholder Oriented Bank

Now the theoretical framework is established, a more detailed analysis of the case study objects can be delivered. The aim of the first casus is to distinguish specific characteristics of the performance management system of a stakeholder oriented bank. This chapter forms the introduction of this casus, in which Rabobank Group represents a typical stakeholder oriented bank. In this section, the main aspects of the theoretical analysis are tested, with respect to the performance management system of Rabobank. Ultimately, the influence of strategic issues on the performance management systems of a stakeholder oriented bank will be examined.

4.1 Organizational Structure

Rabobank is a cooperative financial institution, serving several kinds of financial services and products worldwide. In the Netherlands, the focus of the bank lies on all-finance services, in which it gained a market leading position. Their international focus is on food and agribusiness. Rabobank operates in 43 countries, serving 9.5 million clients and holds more than 60.000 employees worldwide. This results in a complicated organizational structure, focused on several products and regions. The main objective of the organization is to serve its customers, based on a reliable and structured business approach. In order to serve their customers most efficiently, Rabobank developed a relative unique business structure. This structure demonstrates clearly that Rabobank holds a stakeholder oriented business approach. Local offices and their members are seen as the cooperative core of Rabobank. In this situation, clients can become members of the organization. These members have a significant influence on the strategic direction, which Rabobank pursues; members are involved in decision making processes. In 2009, 1.7 million customers are subscribed as members of the organization. In essence, these members can be seen as shareholders of the entire organization; Rabobank is obligated to operate at the demands of their members. Other than shareholder`s claims, customers do not aim high organizational profitability, but desire a well organized service process. In that respect, the primary objective of Rabobank is to maximize customer satisfaction.

In order to obtain highest customer satisfaction, the bank consists of 153 independent local offices, controlled, facilitated and advised Rabobank Nederland; the central entity of the corporation. Rabobank Nederland facilitates the local Rabobank offices. In that respect, Rabobank Nederland carries out several staff functions for Rabobank Group as a whole, including the design of a performance management system.

4.2 Organizational Strategy

As a stakeholder organization, Rabobank is aiming to satisfy demands of different stakeholders by means of specific business operations. In that respect, they determined several important strategic objectives which they aim to accomplish 2. As mentioned, the organizational structure of Rabobank is based on a cooperative system, in which customer value is the most vital objective. Therefore, the structure and strategy of Rabobank is primary originated in order to serve their clients in an optimal way. By delivering an all-finance service, Rabobank strives to fulfill most of these customer demands. However, also the demands of employees, regulators and the entire environment should be satisfied. Therefore, Rabobank strives to deliver financial products at a specific manner. Hereby, the corporate culture of Rabobank largely determines the way of how the bank is aiming to fulfill these stakeholder demands. Their corporate values; respect, integrity, professionalism and sustainability are important in this process. By pursuing these values, Rabobank is able to fulfill demands of different stakeholders. However, the organization has also stated some strategic objectives, which must ensure specific attention to important aspects in Rabobank`s operations. As mentioned, Rabobank strives to deliver products in all specific segments of the finance market in the Netherlands. The organization gained a market leading position and logically, they aim to maintain this. At the international level, the bank is aiming for a leading position in the food and agribusiness. However, as already indicated, Rabobank aims to operate, based on the values which represent their corporate identity. Therefore, they stated some other important objectives, which are aimed to satisfy stakeholder needs more accurately.

First of all, Rabobank gives high priority towards reliability and sustainability. Several rating agency`s assigned the bank with a AAA-status, signaling a credible investment option. At this moment, Rabobank is the only bank in the world, which has attained this status. Logically, Rabobank aims to maintain this status. This requires that financial services are based on long-term objectives and continuity. By maintaining their rating, Rabobank fulfills demands of several stakeholders. Interests of regulators will be satisfied, and also customers who aim to place their savings at a reliable bank account will attain high value towards the credibility of the bank.

However, Rabobank aims to do more than only delivering financial products. In that respect, social responsibility is an important strategic objective. Rabobank aims to serve their stakeholders in the broadest sense of the word. Therefore, environmental and social projects are incorporated in the operations of the bank. In this respect, Rabobank aims to help their environment in a broad manner. Rabobank also gives high priority to the relation with their employees. Human Resources are very important in the execution of their strategy. Employees are responsible for customer contacts and translate Rabobank`s business philosophy into practice. Therefore, Rabobank beliefs that it should invest in talented people and should create the conditions in which they can perform at a maximum level.

In summary, Rabobank aims to maintain their market leading position, by setting customer interest at a high priority. Also the creditworthiness of the organization, employee satisfaction and corporate social responsibility activities are seen as important drivers in Rabobank`s operations.

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4.3 A Stakeholder Oriented Perspective

These specific strategic drivers of the bank, combined with the absence of pure shareholders who are only demanding for financial results, leads to the proposition that Rabobank holds a stakeholder oriented business perspective. The fact that Rabobank embraces a relatively moderate risk profile confirms this suggestion. This leads to the proposition that customer interests are more important than profitability aspects in organizational operations. However, as in every large organization, a focus on cost control is vital to guarantee organizational continuity.

Therefore, the design of a performance management system, including the assessment of several performance indicators, might contradict in certain situations. Rabobank should make an estimation of specific issues which determine performance of local offices and individuals specifically. In that respect, it might be interesting to investigate which selection of performance measurement and reward options Rabobank uses, in order to fulfill all their strategic plans. In other words: How does Rabobank integrate customer demands, credibility issues, efficiency, social responsibility and short versus long-term objectives in their performance management system.

The main objective of this case study is to investigate the way of how Rabobank motivates the linkage between their strategy and performance management structure. In that respect, the research question of this first case study, as mentioned in the introduction already, can be formulated as follows:

How integrates a typical stakeholder oriented bank its strategy into a well functioning performance management system?

5

Performance Management at a Stakeholder Oriented Bank

After the examination of existing theoretical knowledge about performance management systems, specific characteristics of Rabobank were mentioned in the previous chapter. The main objective of this case study, is to investigate how a stakeholder oriented bank is able to integrate strategic objectives in their performance management system at an adequate way. Data, which was required by interviewing employees of Rabobank, will be presented in this chapter. This includes a detailed description of the performance management system of the organization and the arguments of why Rabobank uses these specific performance indicators. This chapter will be structured in order to answer the sub-question, mentioned in the previous chapter. Based on data, presented in this chapter, the performance management system of Rabobank in relation to their strategy will be analyzed in the next chapter.

5.1 Individual Performance at Rabobank

As mentioned in the previous sections of this report, performance management is aimed to enforce certain actions of employees, which have a positive influence on the accomplishment of organizational objectives. Therefore, Rabobank has also chosen to integrate a performance management system in their operations. In this process, they identified three objectives, which they aim to achieve3:

− Stimulate and motivate people by ambitious target stetting, continuous coaching and performance based pay

− Enhance more result oriented performance

− Align individual performance with strategy and organizational targets

In order to accomplish these objectives, Rabobank based their performance management system on a performance cycle, illustrated in figure 2. Planning, performing, evaluating and eventually the payment of a reward, form the basis of an interactive process of strategic development and performance delivery within the organization. In the next section, the implementation of the different components of this performance cycle will be elaborated.

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Annual Performance Management Cycle

Planning

Performance

Evaluation

Reward

5.2 Planning

The performance management process starts with the preparation of organizational objectives and targets. In case of Rabobank, the CKV designs a strategic plan, which involves an execution period of approximately five years. Based on this strategic path, which contains organizational objectives and a strategic position which the organization aims to achieve in the future, a framework of required organizational performance can be developed. This long-term performance plan is an important keystone for the formulation of annual individual performance targets. Based on the annual targets of the organization, for every department specifically can be determined which performance is needed. Eventually, this process results in targets for every individual in the organization. When these yearly performances will be delivered, the intended multiple year plans will be accomplished automatically.

Besides this selection of measurable performance indicators, every employee must also indicate maximal six competences on which he/she would improve its individual behavior and skills. These competences focus on aspects of behavior which an employee has to show in order to create outputs. These competences reflect the way of how an employee delivers performance. In this selection of individual competences, every employee must include customer focus and teamwork on a mandatory basis. In essence, every individual has to make progression on these abilities in order to stimulate behavior which results in desired and accountable performance.

Finally, collective performance targets will be determined. These are mainly targets for a specific department or project team within the organization. Regularly, these collective objectives are based on profitability, but a department could also opt to improve customer satisfaction in a specific year.

5.3 Performance and Evaluation

When targets for individual employees are determined, the most important stage of the performance cycle will commence; delivering actual performance. Employees must be motivated to achieve their targets by means of accountable operating. Therefore, this performance stage requires the integration of constant evaluation of employee behavior. Superiors must be able to give an objective evaluation of the development of relatively subjective individual competences at the end of the year. Therefore, dialogues between employees and their superiors take place frequently, in order to be familiar with the progression and/or potential difficulties an employee experiences. Rabobank assigns high importance towards individual competences because it aims to deliver a service, based on a social responsible style of operating, aiming for high customer satisfaction. This requires a kind of employee behavior, which is constantly driven by positivism and dedication. However, due to the fact that these skills and competences cannot be quantified in hard performance measures, a manager must constantly be alert on the development which an employee demonstrates.

5.4 Reward

As discussed in the theoretical section of this study, a clear linkage between performance management and the reward structure of an organization stimulates employees to perform better. In that respect, Rabobank decided to connect their salary payment structure towards employee performance. However, due to the specific characteristics of Rabobank, this integration appears to be rather complex. Based on the norms and values of the culture of the organization, a reward system with extraordinary bonuses cannot be expected. However, it must be said that Rabobank pays out higher incentives to employees of their international department. However, the fact that the organization is not listed on the stock market, eliminates the possibility to reward employees by means of company shares or stock options. Therefore, Rabobank should integrate an incentive system, which involves constructions which motivate employees in an optimal manner. In that respect, Rabobank has designed a reward structure, which connects individual performance to the amount of income an employee receives. In this structure, two types of remuneration can be distinguished; a fixed annual payment and a variable income (Figure 3).

Annual Salary Adjustment whithin Scale Assesment Individual Results Individual Competences Variable Income Collective Results

Reward System

Besides the fixed annual salary payments, Rabobank gives employees the opportunity to earn a variable income. These variable payments are paid out on a yearly basis, and can be seen as a part of the remuneration package of the organization. However, a comparison with the extraordinary bonuses, which are severely discussed in the press and by regulators, is not justified. At Rabobank, variable salary payments are given to employees, which have accomplished their targets and have shown desired behavior. At Rabobank, the amount of this variable incentive can rise up to twenty percent of fixed income, in case of a senior employee. In this respect, incentives for high performance are provided, without creating perverse incentives. In this respect, a reward system should properly be designed, and provide a satisfactory income, in order to satisfy employees. Employees may easily become dissatisfied by a reward system at the moment that the system is not properly designed. Therefore, the system must be correct, clear and objective so that employees cannot discuss their evaluation of performance.

A clear linkage between rewards and employee performance is proved to stimulate highest performance. Therefore, the determination of the amount of variable income is based on an assessment of delivered performance. As illustrated in figure 3, variable income is determined, based on the assessment of individual performance and the realization of collective objectives. This stimulates employees to operate as a team and to become accountable for performance of the entire organization or department. Due to the complexity of these different objectives, it will be hard to attain the maximum amount of variable income. However, employees will be challenged to perform at a maximum level.

Conclusion

This chapter described how a stakeholder oriented bank manages their performance management system in order to assure highest company performance. This performance should contribute to demands of all stakeholders of the organization; customers, employees, the environment and regulators. Rabobank aimed to accomplish this by integrating three types of evaluation aspects in their performance management.

First of all, employees are evaluated on the accomplishment of their yearly objectives. These are normally outcome-based and could be measured relatively easily. Moreover, an employee is evaluated, based on individual behavior. At this way, Rabobank assures that employees behave as stakeholders expect them to do. Lastly, collective performance is integrated in the evaluation of individuals. At the moment that the entire bank is performing well, each employee will benefit. At this way, Rabobank aims to stimulate teamwork and collaboration in their operations. Based on delivered individual performance, an employee can attain a higher amount of fixed salary. Moreover, individual performance in combination with group performance determine the amount of variable incentives, an employee receives.

6

Analysis of Performance Management at Rabobank

The objective of this chapter is to examine whether Rabobank is able to integrate their corporate strategy into a well structured performance management system. This analysis can be divided into two different assessments. First of all, the performance management system, as described in the previous chapter, will be examined based on theoretical concepts, which were discussed in the first two chapters of this paper. This analysis will test whether employees are motivated to perform at an accountable way. Secondly, a critical analysis will be delivered with respect to the integration of strategic targets in this performance management system specifically. As discussed in the third chapter, Rabobank distinguishes five different key strategic drivers in order to operate successfully; customer focus, all finance market leadership, creditworthiness, corporate social responsibility and employee satisfaction. In the second part of this analysis, the focus lies on how Rabobank integrates these drivers in order to operate in the best interest of their stakeholders.

6.1 Theoretical Correctness

Before that the utilization of strategic performance measures of Rabobank will be analyzed, the system itself should be correctly designed in order to achieve highest employee performance. As discussed in the theoretical framework of this study, two important aspects should be incorporated into an accountable performance management system. First of all, the question whether the design of the system is aimed to stimulate a long-term orientation of employees. Moreover, the integration of financial versus non-financial performance measures will be examined in this paragraph. After that analysis, a more in depth investigation of specific strategic targets of Rabobank, and their integration in the performance management system, will be delivered.

6.1.1 Creating Long-Term Employee Commitment

However, also in this situation, long-term commitment is based on a pattern of behavior which is unconsciously executed by employees. When keeping long-term customer relations in mind, should employees at Rabobank not constantly and explicitly be aware of long-term objectives? In the situation that a new customer is acquired, the intention should be to start a relationship which will be successful in the long-term. In that situation, employees should consciously be aware of this desired long-term performance.

In my interviews at local offices, several times is mentioned that employees are confronted with these long-term objectives by means of a presentation of the local CEO at the beginning of each year. However, employees are not evaluated and rewarded, based on the accomplishment of results, relating to long-term objectives. Especially in daily activities, employees must constantly be aware of the long-term interest of the bank. In that respect, the performance management structure, designed by Rabobank, might not confront employees with the importance of these long-term relationships convincingly enough. Therefore, it might be valuable that the performance management system will be expanded, by means of three to five year targets for each individual. In that respect, the aim of Rabobank, to stimulate long-term oriented behavior by means of individual competences, will be harmonized by integrating targets which have to be accomplished in the long term.

6.1.2 Defining the Correct Performance Measurements

This issue leads to the next part of the analysis of the performance management of Rabobank; an analysis of the translation of strategy into the right objectives and performance management indicators. Rabobank has developed a business structure, which initiates to incorporate the interest of different stakeholders. In the next section, an examination is provided, related to the issue whether Rabobank is actually satisfying stakeholder needs by means of accurate target setting.

6.2 Practical Appropriateness

Many scholars mention that a well functioning performance management system should be linked towards strategic targets (Govindarajan and Gupta, 1985; Simons, 1990; Merchant and Van der Stede, 2007). An organization might have developed a perfect performance management structure, which integrates both financial and non-financial objectives and aims for short- and long-term performance respectively, if incorrect strategic objectives are determined, no additional value will be created. The strategic targets of Rabobank; customer focus, all finance market leadership, creditworthiness, corporate social responsibility and employee satisfaction, indicate the stakeholder orientation of the organization. Therefore, when these strategic drivers are integrated in the performance management system on an accountable way, the specific characteristics of a performance management system, designed for a stakeholder bank specifically, could be specified.

6.2.1

A Customer Focus

As mentioned several times, the corporate structure of Rabobank guarantees the participation of customers in decision making processes. The recognition of interests of the members of the bank, by organizing several meetings a year, indicates that customer demands will be heard. However, also in daily operations, employees must be aware that customer interests are positioned at a high level with respect to the corporate objectives of Rabobank. Therefore, customer preferences must be included in the performance measures of each employee.

Another method which Rabobank uses in order to guarantee a corporate customer focus, is by formulating collective objectives with respect to customer satisfaction. However, also in this respect, it cannot be fully guaranteed that every individual is positively stimulated to behave in the best interest of the customer, due to differences in functions and their impact on customer satisfaction.

So in essence, when Rabobank aims to behave in the best interest of their customers, it is important that desired employee behaviour is clearly formulated, and can be objectively observed. In a later stage of this study, attention will be given towards this formulation of desired behaviour, and the way of how these competences can be evaluated objectively.

6.2.2

All Finance Market Leadership

Logically, the main strategic target of Rabobank is to maintain their leading position on the Dutch financial market. Ultimately, delivering financial products is the core activity of Rabobank. Therefore, every employee who has the job to deliver financing activities, has included targets, related to the number of successful sales in the specific accounting period. Formulating these targets is relatively straightforward, because this performance is easy to measure. However, this strategic objective must be achieved by means of the specific way of operating, which Rabobank claims to stand for. So, the interest of customers, creditworthiness and a social responsible way of operating are aspects which have to be taken into account. Therefore, employees have certain limitations in the process of selling their products and services. These are monitored and observed trough supervisors, by means of the formulation of individual targets and competences on these several aspects. At the end of the year, individual turnover is an important issue in the evaluation of employees, which are involved in sales activities. However, this performance must be seen in the context of how this turnover is being generated. At this way, Rabobank will be able to assure a proper way of operating by their employees. They are stimulated to sell their products, but within the corporate norms and values to which Rabobank aims to comply with.

6.2.3 Creditworthiness

6.2.4 Corporate Social Responsibility

As a typical stakeholder organization, Rabobank aims to be more than a bank which operates in order to gain profits. One of the secondary objectives of the organization is to serve their social environment in the broadest sense of the word. In that respect, the bank strives to operate in accordance with arrangements, which are in favor of the environment in which they operate. In that respect, Rabobank will not finance businesses which are not in line with sustainable and social values of the bank. Moreover, employees face objectives which are created in order to stimulate environmental friendly operations. For example, the minimization of printing documents and the use of public transport are stimulated. Also in the sense of collective objectives, corporate social responsibility will be taken into account.

Most of the time, local offices have their own projects, by which they aim to deliver something extra for the society. For example, the office in Groningen helps at a school where children, who faced problems in their social environment, are educated. However, these actions are difficult to measure with respect to the performance management system of the bank. Most of these actions do not provide extra outcomes or better results, so the behavior of individuals and teams should be observed. However, Rabobank has not yet managed to integrate this strategic objective in their performance management system in an efficient way. Some offices include collective objectives and others try to formulate individual competences for employees. In this respect, it might be helpful that Rabobank Nederland provides the local offices with some guidelines, related to how the corporate social responsibility aspects can be integrated in performance management structures.

6.2.5 Employee Satisfaction

In order to give the performance management system the highest likelihood to succeed, the system should not only be designed properly, but also be generally accepted by employees. They face the consequences of this system constantly, and will react adversely at the moment that they dislike it. Rabobank gives high priority to employee satisfaction and in that respect, the performance management system should take into account employee preferences. Essentially, the system must stimulate a kind of behavior which contributes to the accomplishment of strategic targets in the best way, which only will succeed when employees are motivated at a maximum level. In that respect, one of the designers of the performance management system of Rabobank Nederland argued that the system may not include any inaccuracies or ambiguities, which could easily lead to dissatisfied employees.