SPECIFIC KNOWLEDGE AND DIVISIONAL PERFORMANCE MEASUREMENT

Michael Jensen and William H. Meckling

Journal of Applied Corporate Finance, 1999, vol. 12, issue 2, 8-17

Abstract: This paper discusses five common divisional performance measurement methods—cost centers, revenue centers, profit centers, investment centers, and expense centers—and provides the beginnings of a theory that attempts to explain when each of these five methods is likely to be the most efficient. The central insight of the theory is that each of these methods offers an alternative way of aligning decision‐making authority with valuable “specific knowledge” inside the organization. The theory suggests that cost and revenue centers work best in cases where headquarters has good information about cost and demand functions, product quality, and optimal output mix. Profit centers—defined as business units whose managers have responsibility for overall profits, but not the authority to make major capital spending decisions—tend to supplant revenue and cost centers when the line managers have a significant informational advantage over headquarters and when there are few interdependencies (or “synergies”) between divisions. Investment centers—that is, profit centers in which unit managers are allowed to make major investment decisions—tend to prevail when the activity is capital‐intensive and when it is difficult for headquarters to identify the value‐maximizing investment strategy. In evaluating the performance of profit centers, rate‐of‐return performance measures like RONA (return on net assets) are likely to be effective when unit managers have little influence over the level of new investment. But, in the case of investment centers, Economic Value Added, or EVA, is likely to be the most effective single‐period measure of performance because it is best designed to encourage value‐maximizing investment decisions.

Date: 1999
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://doi.org/10.1111/j.1745-6622.1999.tb00004.x

Related works:
Journal Article: Specific Knowledge and Divisional Performance Measurement (2009)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bla:jacrfn:v:12:y:1999:i:2:p:8-17

Ordering information: This journal article can be ordered from
http://www.blackwell ... bs.asp?ref=1078-1196

Access Statistics for this article

Journal of Applied Corporate Finance is currently edited by Donald H. Chew Jr.

More articles in Journal of Applied Corporate Finance from Morgan Stanley
Bibliographic data for series maintained by Wiley Content Delivery ().