13 Performance Evaluation of Business Units
This chapter describes the methods by which the performance of divisions and their
managers is evaluated. It builds on the foundation established in Chapter 2, which
explained how divisionalized business structures have evolved to implement
business strategy. We also consider controllability and the transfer pricing problem
and introduce the theory of transaction cost economics. This chapter suggests that
some techniques may provide an appearance rather than the reality of ‘rational’
decision-making.
The decentralized organization and divisional performance
measurement
The evaluation of new capital expenditure proposals is a key element in allocating
resources by the whole organization (see Chapter 12). However, a further aspect
of strategy implementation is improving and maintaining divisional performance.
Businesses may be organized in a centralized or decentralized manner. The
centralized business is one in which most decisions are made at a head office
level, even though the business may be spread over a number of market segments
and geographically diverse locations.Decentralizationimplies the devolution of
authority to make decisions.Divisionalizationadds to decentralization the concept
of delegated profit responsibility (Solomons, 1965). We introduced the notion of
divisional structures and responsibility centres in Chapter 2.
Divisionalization makes it easier for a company to diversify, while retaining
overall strategic direction and control. Performance improvement is encouraged
by assigning individual responsibility for divisional performance, typically linked
to executive remuneration (bonuses, profit-sharing, share options etc.).
Shareholder value is the criterion for overall business success, but divisional per-
formance is the criterion for divisional success. However, divisional performance
measurement has also moved beyond financialmeasures to incorporate the drivers
of financial results, i.e. non-financial performance measures (see Chapter 4).
Solomons (1965) highlighted three purposes for financial reporting at a divi-
sional level: