Divisional Performance Measurement
Michael C. Jensen
Social Science Electronic Publishing (SSEP), Inc.; Harvard Business School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
William H. Meckling
Simon School, University of Rochester (Deceased)
Michael C. Jensen, FOUNDATIONS OF ORGANIZATIONAL STRATEGY, Harvard University Press, 1998
Our purpose in this paper is to examine divisional performance measurement methods and related aspects of the rules of the game that govern the behavior of managers. Performance measurement is one of the critical factors that determine how individuals in an organization behave. It is one aspect of what we call the organizational rules of the game, which consist of (1) the performance measurement and evaluation system, (2) the reward and punishment system, and (3) the system for partitioning decision rights among individuals in an organization.
Performance measurement includes the objective and subjective assessments of the performance of both individuals and subunits of an organization such as divisions or departments. Performance evaluation is the process of attaching value weights to various measures of performance to represent the importance of achievement on each dimension.
The reward and punishment system relates the rewards granted to individuals to results measured by the performance measurement system. Rewards and punishments include nonmonetary factors such as honor, attention, and rank, as well as monetary factors such as salary changes and bonuses.
We analyze the peculiar characteristics of common divisional performance measures associated with what are often called cost centers, revenue centers, profit centers, investment centers and EVA and expense centers. We analyze the counterproductive incentives induced by these various performance measures and the conditions under which each of them could be sensibly used in an organization.
Note: Sadly, Dr. Meckling, Dean Emeritus of the Simon School, passed away in May 1998.
Number of Pages in PDF File: 22
JEL Classification: D21, D82, M41
Date posted: November 29, 1998 ; Last revised: January 17, 2011