BSZ_IM_Ch17_4e - Managerial Economics and Organizational...

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Managerial Economics and Organizational Architecture Instructor’s Manual Part 1: Chapter Overview and Solutions Chapter 17: Page 1 CHAPTER 17 D IVISIONAL P ERFORMANCE E VALUATION This chapter is the second of two chapters on performance evaluation. It focuses on the measurement of divisional performance. It begins by discussing the various ways firms measure subunit performance. It provides a detailed analysis of transfer pricing and discusses issues relating to the use of the internal accounting system in performance evaluation. It contains a short case study on divisional performance evaluation. C HAPTER O UTLINE M EASURING D IVISIONAL P ERFORMANCE Cost Centers Expense Centers Revenue Centers Profit Centers Investment Centers T RANSFER PRICING Economics of Transfer Pricing Common Transfer-Pricing Methods Reorganization: The Solution If All Else Fails I NTERNAL A CCOUNTING S YSTEM AND P ERFORMANCE E VALUATION Uses of the Accounting System Trade-offs between Decision Management and Decision Control C ASE S TUDY : C ELTEX S UMMARY T EACHING THE C HAPTER We summarize the basic contents of the chapter and briefly discuss the various ways of measuring divisional performance (as costs centers, profit centers, and so on). We provide a rather extensive lecture on transfer prices. (Transfer pricing is a relatively difficult topic for most students.) We typically begin our discussion of investment centers by giving examples of poor investment decisions. We argue that often poor investment decisions are made not because managers do not know present value rules for optimal investment (many have been to business school), but because they are not incented to do so. We then discuss a homework problem designed to reinforce this point and which illustrates how different performance measures motivate different investment decisions. Our introductory discussion of transfer pricing makes the following points:
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Managerial Economics and Organizational Architecture Instructor’s Manual Part 1: Chapter Overview and Solutions Chapter 17: Page 2 When business units transfer goods/services among themselves there must be transfer prices to measure performance. Transfer prices are prevalent in organizations. Transfer prices are a frequent source of interunit conflict. Taxes and regulation can influence transfer prices. We focus on organizational issues. Next we ask students to consider the following quote: Divisions in my firm are always fighting over transfer prices. As a CEO, I am not very concerned about this issue. Transfer prices simply affect the division of firm profits among subunits within the firm. I am interested in total firm profits. Anonymous CEO We emphasize that this argument is not correct. Managers make bad decisions when they do not consider the true costs of resources. The following example of an inefficiency due to poorly set transfer prices (E. Kovac and H. Troy [1989], Harvard Business Review , September-October) is used: Bellcore is the research arm of AT&T. In the late 1980s highly talented
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BSZ_IM_Ch17_4e - Managerial Economics and Organizational...

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