Aggregate Performance Measures in Business Unit Manager Compensation: The Role of Intrafirm Interdependencies

Abstract

The purpose of this paper is to investigate the determinants of the extent to which the incentive compensation of business unit managers is based on aggregate performance criteria measured at an organizational level higher than a manager's business unit level. We present a simple agency model of a multidivisional firm to show that the use of aggregate performance measures relative to more localized performance measures is an increasing function of intrafirm interdependencies. Using proprietary compensation data from Hewitt Associates LLC, we test whether the relative use of aggregate performance measures is related to our empirical proxies for intrafirm interdependencies and find evidence consistent with our predictions. Management accounting textbooks usually emphasize the controllability principle within the framework of responsibility accounting as the basis for