Determinants of the reliance on value-based performance measures for managerial performance evaluation

Henri C. Dekker* VU University Amsterdam, Department of Accounting, and School of Economics and Commerce, Dept. of Accounting and Business Information Systems, University of Melbourne

Tom L.C.M. Groot VU University Amsterdam, Department of Accounting

Martijn Schoute VU University Amsterdam, Department of Accounting`

Eelke Wiersma VU University Amsterdam, Department of Accounting

May 2011

*Corresponding author Email: hdekker@feweb.vu.nl Acknowledgements: We are grateful for useful comments of Frank Hartmann, Steve Salterio, Naomi Söderstrom, and participants at the 2008 EIASM Conference on New Directions in Management Accounting, the 2009 Global Management Accounting Research Symposium, and the 2009 Annual Meeting of the American Accounting Association.

Determinants of the use of value-based performance measures for managerial performance evaluation

Abstract Value-based (VB) performance measures are argued to be more congruent than earnings measures, since they hold managers accountable for the cost of capital used to generate returns. Prior studies have found, however, that the use of VB measures for managerial performance evaluation is less extensive than might be expected based on their presumed benefits. We posit that important reasons for this relate to differences in firms’ importance to manage capital costs and in managers’ opportunity to do so. Building on strategic and economic arguments, we examine conditions that influence the importance of VB measures in the performance evaluation of middle-level managers. In particular, we examine how this is influenced by on the one hand the strategic importance for the firm to use assets intensively, and on the other hand managers’ influence over VB performance, following from delegated authority for decision making and interdependencies with other firm units. An analysis of survey responses from 123 manufacturing firms provides significant support for the influence of these factors. In addition, we find that reduced delegation of decision rights in response to a need for intensive asset use partially offsets the increase in importance of VB measures for managerial performance evaluation following from greater importance to use assets intensively.

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1. Introduction Financial performance measures are a central element of performance measurement (PM) and evaluation systems in many firms (Merchant and Van der Stede, 2007). An important consideration in the choice of financial performance measures is whether or not managers should be held accountable for the cost of capital used to generate returns. A well-known problem that arises when firms use earnings measures for evaluation is that managers are provided with an incentive to invest in projects that improve their unit’s earnings, even if this comes at the cost of inefficient asset deployment. As a consequence, the use of earnings measures may result in incongruence between manager and firm goals (Bromwich and Walker, 1998; Rogerson, 1997). To resolve this incongruence, the literature on value-based management (VBM) provides various approaches to incentivize managers to include the cost of capital in their decision making. For instance, firms may use capital budgeting with hurdle rates based on the cost of capital, set performance targets based on the cost of capital and compare earnings or return measures (e.g., ROI) against this, and use non-financial performance measures that are reflective of value drivers to incentivize value creation. A key approach forwarded in this literature to reduce goal divergence, which we focus on in this paper, is the use of value-based (VB) measures that explicitly include an estimate of the cost of invested capital, such as Residual Income (RI), Economic Value Added (EVA) and Cash Flow Return on Investment (CFROI).1 Empirical research suggests that managerial behavior can be affected substantially by using financial performance measures that include a capital charge. Wallace (1997), for instance, reported that firms of which the CEO was held accountable for a VB measure (RI or EVA) invested less, divested more, used existing assets

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The claim that VB measures induce more congruent decision making is not unchallenged. Bromwich and Walker (1998, 392), for instance, discuss that responsible units need to be relatively independent, that managers’ personal costs are not considered, and that they might try to optimize current performance at the expense of future performance. Thus these VB measures are better interpreted as partially resolving some of the congruence issues that may arise with ‘traditional’ earnings or return measures.

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more intensively, and returned more unused capital to shareholders in the form of dividends and share repurchases. Although some proponents of VBM expose a desirability to evaluate managers at all organizational layers on VB measures (e.g., Haspeslag et al., 2001), empirical evidence to date is more indicative of the opposite: only a minority of firms uses financial measures that include a capital charge (Bouwens and Van Lent, 2007; Lovata and Costigan, 2002; Wallace, 1997). This may be even more the case at lower firm levels where additional complications for use arise, such as constrained decision making rights and controllability. This suggests that use of VB measures for measuring and evaluating managerial performance is contingent upon firm context, and raises the question under which conditions firms are more likely to hold managers accountable for the cost of capital. In our exploration of this question, we build on strategic and economic arguments to predict that the importance of VB measures for managerial performance evaluation depends on the strategic importance for the firm to use assets intensively (i.e., to induce strategyconsistent behavior), and on the influence that managers have on VB performance, and in particular the cost of capital. By doing so, we aim to contribute evidence on the determinants of the use of VB measures, and in particular focus on their use for the evaluation of middlelevel managers. Although managers at this level do not always have the formal decision rights to make (dis)investments in the asset base (Bouwens and Van Lent, 2007), they can still have significant opportunities to manage the existing asset base, such as through managing their unit’s working capital (e.g., inventory turnover and accounts receivable/payable), and the efficiency with which existing assets are used (e.g., production and capacity planning). In addition, as Bouwens and Speklé (2007) argue, by being held accountable for VB performance, they may also be incentivized to informally impact investments in new assets and through that influence the size of the asset base by initiating (dis)investment decisions (cf.

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In developing expectations about what explains variation in the importance of VB measures for performance evaluation of middle-level managers. 1997. should increase the importance of VB measures to induce strategy-consistent decision making. 2007).e. Fama and Jensen. We define VB measures as financial performance measures that include a capital charge for the use of (debt and equity) capital. performance measurement choices should be aligned with a firm’s strategy and value drivers (Ittner and Larcker. and (2) factors beyond the manager’s control. 2005). which often face high capital intensity. Bouwens and Van Lent. This value driver should be of particular relevance for the manufacturing firms that we study. 1983). the literature on strategic performance measurement posits that to guide and induce congruent decision making. With respect to the first condition. The second condition concerns the influence the manager has on the performance measure. Greater strategic importance of intensive asset use for the firm. are less noisy). In applying this argument. we focus on a primary value driver identified in the VBM literature.. which we refer to as ‘asset use intensity’. which in prior studies has typically been proxied by publicly available measures such as firms’ capital intensity (Garvey and Milbourn. 2004. 1997). and thus increase in importance for evaluation. we view their influence on VB performance as a result of (1) a manager’s decision authority. in particular dependence on other firm units (Abernethy et al. which proposals however are typically formally ratified at higher managerial levels. we posit that this is affected by two key conditions: (1) the strategic importance for the firm to intensively manage the cost of capital. the strategic importance of intensive asset use (Wallace.. Building on prior research. which for VB measures in particular concerns the extent to which the manager can affect the cost of capital through managing the asset base. 2000) and asset turnover (Hogan and Lewis. 2001).Aghion and Tirole. VB measures should better reflect managerial performance (i. when 4 . and (2) the manager’s influence over these capital costs.

We test our expectations using a sample of survey responses collected from senior managers of 123 manufacturing firms who were asked to reflect specifically on the manager(s) of the firms’ primary operating units. 2004). Hogan and Lewis. senior management may prefer to retain control over key decisions that affect the size and use of the asset base and avoid managerial decisions that lead to local instead of global optimization. Colombo and Delmastro. and when their unit’s dependence on other firm units is lower. 2005. 2002).e.managers have more decision making authority. their primary way to affect VB performance is by increasing the intensity of use of existing assets at their disposal and by reducing working capital. They may. While the delegation of decision rights is seen as an antecedent of performance measurement choices. Since middle-level managers often lack the rights to invest in new assets. through delegation) on the importance of VB measures for the evaluation of middle-level managers. which in turn should have a mitigating effect on the use of VB measures. 2000. Evidence on the extent to which VB measures are used at organizational levels below the executive level is scarce (Rajan. at lower levels it is well possible that firms only partially adopt 5 . also indirectly affect the size of the asset base by initiating new (dis)investments in assets which though typically are ratified at higher managerial levels (Bouwens and Speklé. In our analyses. In particular when these factors are high. Thus. we use a mediation model to decompose these effects of asset use intensity and unit interdependence by identifying their direct and indirect effects (i. Garvey and Milbourne. 2000). Lovata and Costigan. this also represents a structural design choice that can be affected by asset use intensity and unit interdependence. and on the other hand limit incentive loss by partially centralizing decision making (Aghion and Tirole. management may on the one hand stimulate strategy-consistent behavior by evaluating managers on VB measures. 2007).g. 1997. Although prior research has documented contingencies that affect the adoption of VB measures in CEO incentive plans (e. however..

following from delegated authority for decision making and interdependencies with other firm units. such as dependencies between firm units (i. use at lower levels creates additional complications. In sum. which in turn may reduce the extent to which managers can be held accountable for VB performance. 2000).. but also of how it puts constraints on the delegation of decision rights. Second. in particular the delegation of operational decision rights impacts the use of VB measures. This setting thus allows an effective test of whether the importance of VB measures for managerial performance evaluation varies with a strategic value driver (i. This analysis not only includes an examination of how asset use intensity induces use of VB measures.VB measures instead of using them firm-wide (Rajan. we distinguish between delegation of strategic and operational decision rights. we aim to provide two contributions to the literature. they are in a position to directly influence the intensity with which assets are used.e.. First. in the 6 .e. While in principle firms can use VBM at all organizational levels. 2007). and accordingly. and managers’ influence over these costs. we extend research on performance measure choices. and VB measures in particular. delegation and performance measurement) to be made. and find that for the managerial level that we study. For instance. to influence the capital charge. We do this by examining how the use of VB measures for managerial performance evaluation is affected by both the importance to hold managers accountable for capital costs to provide incentives to manage assets intensively. asset use intensity) that should determine how important managing the cost of capital is for the firm. and with factors that determine managers’ influence on these costs. When managers are granted sufficient operational decision rights.g.. reduced controllability of performance outcomes) and the proper allocation of decision rights that enables managers to affect VB performance (Bouwens and Van Lent. An examination of the use of VB measures at organizational levels below top management thus can provide insight into the interplay between these variables and tradeoffs among choices (e.

find that managers at this level are held less accountable for VB performance than could be expected at higher organizational levels. In section 3. In the next section. Introduction Financial performance measures form a core part of most firms’ PM and evaluation systems. we also observe much variation across firms in the importance of VB measures for managerial performance evaluation. Our study instead focuses on a lower level of analysis. target setting. such as performance-based compensation and promotion prospects. delegation of (operational) decision rights and unit interdependencies.examination of VBM practices. detail the results of the empirical analyses. and are typically associated with the provision of explicit and/or implicit incentives. both at executive and lower management levels. 2. A key consideration in the choice of financial performance measures for managerial performance evaluation and incentive provision is whether or not to include a charge for the cost of capital. as expected. we review the literature on the use of VB measures for managerial performance evaluation and develop hypotheses. 1997). Including a capital charge in financial measures is argued to enhance goal congruence (Rogerson. The results of the partial least squares (PLS) models that we estimate provide support for our expectations that this variation is associated with asset use intensity. In sections 5 and 6. we describe the sample selection and variable measures. and in particular should incentivize managers to more intensively manage 7 . and examines to what extent and under which conditions middle-level managers are evaluated on VB measures. and in section 4. we discuss these results and conclude.1. performance measurement and evaluation. Financial measures fulfill an important control function through performance planning. Literature review and hypothesis development 2. While we. prior research has primarily focused on the top management level.

used this as the only measure. and a lower R&D intensity (Lovata and Costigan. 2000). and to only engage in new investment opportunities when the expected returns exceed the cost of capital. In addition. for instance. Consistent with these observations. 2005). Rajan (2000) argued that whereas prior studies have focused primarily on the adoption of VB measures in CEO bonus contracts.the firm’s existing asset base. we do not explore firm-wide adoption of VB measures. in particular at the CEO level. capital-intensive firms in a stable environment benefit most from the use of VB measures for evaluation. Similarly. examined the impact of VBM on the 8 . and use them differently across organizational levels). but not in others. Lovata and Costigan (2002) find that VBM adoption is higher for defender than for prospector firms. firms often use a combination of measures for performance evaluation. Survey evidence from Sibson & Co reported by Ittner and Larcker (1998) supports this and shows that only 26. managers may use different strategies. Malmi and Ikäheimo (2003) and Claes (2006) found that the case firms they studied used VB measures in combination with other financial and non-financial measures for evaluation purposes. These studies report that VB measures are adopted more often by firms with a large asset base (Garvey and Milbourn.3% of the firms that included a VB measure in their incentive plan. but more specifically examine their importance for the evaluation of middle-level managers responsible for firms’ primary operating units. a lower Market-to-Book ratio (Hogan and Lewis. Rajan (2000) additionally commented that while prior studies only examine firm-wide adoption of VBM systems. In order to reduce the capital charge to realize adequate VB performance. These studies examine firm-wide adoption of VBM and together suggest that large.e. it is very well possible that firms partly adopt VB measures (i.. 2002). use it only in some divisions. Wallace (1997). Several empirical studies have explored conditions under which VB performance measures are used in incentive plans. In his discussion of Garvey and Milbourn (2000).

they may still be able to influence such decisions by pursuing their superiors to invest (Aghion and Tirole. by being able to decide which customers to serve and under which conditions. increasing machine utilization. (2003)). For instance. and the level of dividends and share repurchasing. Accordingly. This may be a reason not to hold managers accountable for VB measures. 1997.level of new (dis)investments in the asset base. which in turn affects production speed and inventory levels. analytically derive how EVA can be enhanced by lowering inventory. middle-level managers may still have many other ways to influence their unit’s VB performance through operational decisions that impact working capital and the intensity of use of existing assets (Bouwens and Van Lent. Bouwens and Van Lent. 2007).. Furthermore. Altendorfer and Jodlbauer (2011). the level of working capital (inventory turnover. and lowering delivery times. managers can also determine production speed and capacity utilization. On the other hand. most empirical studies on VBM take as level of analysis the CEO or top management of the firm (some exceptions are Claes (2006) and Malmi and Ikäheimo. even when middle-level managers do not themselves have the formal decision rights to make large investments in assets. as it is often assumed that managers have sufficient formal authority to make project selection and (dis)investment choices (Bromwich and Walker. they may influence accounts receivable (Bouwens and Speklé. And by being able to select production technologies and schedule production orders. accounts receivable. for example.g. nor influence dividends and share repurchasing decisions. 2007). Consistent with the argument that VB measures are useful to incentivize managers at lower firm levels to improve asset use. 1998). Prior literature shows that middle-level managers do not always have the decision rights to make (large) (dis)investments to directly manage the asset base (e. 2007). By being able to select suppliers they may influence materials quality and speed of delivery. Bouwens and 9 . and accounts payable). the operations research literature also emphasizes strategies for these managers to enhance the efficiency of use of existing assets.

2007. 1997). 2004.2. implementing rights. we examine managers’ delegated decision rights and the scope of influence over the firm’s value chain activities. Hypothesis development In our theory development. the efficient deployment of the firm’s asset base. Second. As key determinants of this influence. Keating. Bouwens and Van Lent. 2001). for instance by examining the influence of delegated decision rights to middle-level managers and interdependencies between firm units (Abernethy et al. Fama and Jensen (1983) decompose decision rights into initiation rights. ratification rights. in order to guide and induce congruent decision making (Ittner and Larcker. we build on strategic and economic reasoning to develop the argument that the use of VB measures for managerial evaluation depends on the strategic importance for the firm to manage assets intensively and on managers’ influence on the performance measure (in particular on the asset base and associated capital charge). managers’ degree of influence. Recent studies on PM design have given particular interest to the latter aspect. Following this reasoning. suggests that a primary design criterion is that PM choices should align closely with the firm’s strategy and value drivers. 2.Speklé. increases in importance for the firm to gain a competitive advantage. we first argue that firms are more likely to include a capital charge in financial performance measures when a key value driver. middle-level managers often are provided the rights to initiate investment decisions and to implement the decision as they possess better knowledge of market requirements. The strategic performance measurement literature. 2007). and monitoring rights. and his controllability over the measure. however. the manager’s influence on the asset base and capital charge can be viewed as a function of his authority to make decisions that affect the measure. While the right to ratify investment decisions as well as the monitoring of the performance of implementation are typically retained at a higher managerial level. which determines the 10 ..

Figure 1 summarizes the research model. managers are more likely to ignore their impact on decision making. which increases incongruence between managerial and firm objectives. [Insert Figure 1 about here] The strategic importance to manage capital costs The strategic performance measurement literature suggests that PM design should be closely linked to a firm’s strategy and value drivers (Ittner and Larcker. 1997).. Abernethy et al. Bouwens and Van Lent. 11 . 2002). a key value driver identified in the VBM literature is the importance to the firm of efficient asset use to obtain and maintain a competitive advantage. With respect to the choice whether or not to hold managers accountable for the cost of capital. consistent with prior studies we model this choice as mediating the effects of asset use intensity and unit interdependencies on the importance of VB measures for managerial performance evaluation. Abernethy and Lillis. Nagar. it is suggested in this literature that the benefits of using VB measures for incentive provision increase when the importance of intensively managing the asset base is more important to the firm.2 In particular. When performance measures do not represent important value drivers. 2004.g. Malmi and Ikäheimo (2003) found that of the six firms they studied.. Since the delegation of decision rights is also an important organizational design choice (e. 2000) and asset turnover (Hogan and Lewis. 2007. is to reflect how important intensive asset management is for the firm. 2005). 2001). The role of these proxies. Consistent with this argument. which we label as asset use intensity. Garvey and Milbourn (2000) found that the adoption of VB measures (EVA) in CEO contracts is positively associated with the size of firms’ asset base. for four the primary reason to adopt VB 2 Prior studies that use archival data to examine firms’ use of VB measures have proxied for this importance using measures such as capital intensity (Garvey and Milbourn.extent of interdependencies with other firm units. Accordingly. however. 2001. the capital charge over the investment base should induce more congruent managerial decision making regarding investments in new assets and efficient use of existing assets (Wallace.

Bouwens and Van Lent. 12 .measures was to increase the efficiency of asset use. Claes (2006) identified similar motives in the three case firms that he studied. and in particular the capital charge. as compared to non-adopters. Abernethy et al. 1992). Milgrom and Roberts. by being able to manage the asset base. invested less in new assets..g. divested more and increased payouts to shareholders. The theoretical literature and prior empirical studies that primarily rely on economic (agency-based) reasoning. 2004. Hypothesis 1: The importance of VB measures for managerial performance evaluation is positively influenced by the strategic importance for the firm to use assets intensively.e. The opportunity to influence VB performance While asset use intensity describes the importance for the firm to incentivize managers to use assets intensively. 1997).. Given the primary role of firm assets. we hypothesize that the inclusion of such a charge in financial performance measures (i. However. 2007. but also the type of decision rights can affect managers’ opportunity to manage the asset base and capital charge. A consequence of the introduction of VB measures in these firms was a reduced “hunger” for capital investments and an increased concern about the cost of working capital. if managers are to be held accountable for VB measures. the literature also recognizes that the process of delegating decision rights is complex and multifaceted (Aghion and Tirole. A primary way for the firm to provide this influence is through the delegation of decision rights. Wallace (1997) documented that adopters of VB measures used existing assets more intensively. have documented that the delegation of decision rights is an important determinant of PM choices (e. and in particular the stimulation of efficient asset use in the decision to hold managers accountable for a capital charge. and that not only the extent of delegation. use of VB measures) is positively affected by the strategic importance for the firm to use assets intensively.. they should also have the opportunity to influence VB performance. In an earlier study.

for instance. 2003). scheduling of production and optimization of capacity use. in new production technology). Bouwens and Van Lent. As Bouwens and Speklé (2003) note. Typically.g. 1997)..g. Nevertheless.These types of decision rights can involve strategic decisions that typically include rights to make (dis)investments in new (existing) assets. Accordingly. hiring of workers. 2007). for middle-level managers often these rights are limited to the initiation of investments (e. More delegation of both types of decision rights thus in different ways should increase middle-level managers’ influence on their unit’s cost of capital. Claes 2006. Another reason why the distinction between strategic and operational decision rights is important is that superiors typically overrule subordinates’ decisions more frequently when decisions increase in importance.g. Strategic decision rights can. and operational decisions that typically relate to the use of existing assets (Malmi and Ikäheimo. even if these are formally delegated (Aghion and Tirole. we expect the delegation of both types of decision rights to increase managers’ opportunity to influence capital costs and. Malmi and Ikäheimo. 1983). involve decisions to develop new products or enter new markets that require investments in new assets. this implies that operational decision rights likely will be more strongly associated with use of VB measures for the managerial level that we study. a key function of VB measures in relation to strategic decision rights is to incentivize managers to select projects/investments only if these are expected to generate returns that meet the firm’s or unit’s cost of capital.. 2003). Jointly with the expectation that strategic decision rights are typically retained at higher managerial levels (e. as a 13 . and the primary role of VB measures is to incentivize more intensive use of these assets and a reduction of working capital (e. these decision rights concern the use of existing assets. Operational decision rights include decisions such as the selection of suppliers.. while ratification takes place at higher managerial levels (Fama and Jensen.

For example. a broader scope of influence in general should provide greater influence on efficient asset use as compared to a narrow scope. 14 . 2007). this may increase inventory levels and reduce production efficiency and capacity use due to 3 While there may always be some externalities. Hypothesis 2: The importance of VB measures for managerial performance evaluation is positively influenced by the delegation of (a) strategic decision rights and (b) operational decision rights. a unit conducts not only production activities but also R&D. and purchasing decides to buy larger batches materials of lower quality. Following prior research. a broader scope of those activities conducted by the unit should limit the dependence on other firm units and provide a greater direct influence on the intensity of asset use. to be associated with increased importance of VB measures for performance evaluation.. dependence on other units likely increases and the manager’s opportunity to influence the efficiency of asset use decreases.consequence.3 Accordingly. Bouwens and Van Lent. If. the performance and decisions of other units may reduce the focal unit’s opportunity to use assets efficiently and influence its performance. the manager has the opportunity to make tradeoffs between product design and manufacturing efficiency. we particularly examine interdependencies with other firm units that may affect the focal unit’s performance (Abernethy et al. for instance. In contrast. for a given set of assets. Given the number of value chain activities taking place within the firm. and through that improve production speed and capacity use. we consider these interdependencies to be a function of the scope of the firm’s value chain activities performed by the focal unit. A second element that affects managers’ influence on the cost of capital includes factors that are beyond the control of the manager. In our research setting of middlelevel managers responsible for firms’ primary operating units. when the purchasing function is not part of the focal unit. when the scope of value chain activities performed by the unit is narrow. 2004.

Abernethy et al. Bouwens and Van Lent. Bouwens and Speklé. 2004. are often better informed. since they are closer to the market. Accordingly. 2004). Reasons to delegate decisions rights abound.. but by doing so. and thus adds noise to the manager’s VB performance. we also expect delegation of decision rights to be endogenous and to be affected by the strategic importance for the firm to use assets intensively and by unit interdependencies.interruptions. An additional concern that arises when the scope of activities within the unit is narrow is that VB measures can create negative externalities of unit decisions on other units by incentivizing managers to optimize local performance. a broader scope of firm activities performed by the unit should reduce the dependence on other units (reducing noise in the performance measure). responsibility for VB performance may induce a production manager to schedule activities in order to minimize inventory. even if this comes at the expense of firm performance (Abernethy et al... cf. and provide better opportunities to affect asset use. Colombo and Delmastro (2004) classify these reasons in an “information processing” and an “incentive loss” perspective. For instance. The mediating role of delegation of decision rights As shown in Figure 1. 2002). mitigate negative externalities. create inefficiencies onwards in the value chain (so-called ‘parochial behavior’. Nagar.g. This situation provides the unit manager with limited opportunities to manage tradeoffs between decisions that affect working capital and intensity of asset use. 2007. and following prior studies (e. 2007). We hypothesize that: Hypothesis 3: The importance of VB measures for managerial performance evaluation is negatively influenced by interdependencies with other firm units. The information processing perspective follows the argument that subordinate managers need more flexibility to implement urgent decisions and. The incentive loss perspective suggests that by delegating 15 .

it is less likely that decision rights will be delegated. (2009) replicate this result in a university setting. As a consequence. hospital managers need more decision rights to be able to react quickly when needed. argue and find that when service orientation is an important strategic choice for a hospital. which reduces the possible impact of the information processing perspective. it also is expected to have an offsetting negative indirect effect by reducing the delegation of decision rights to avoid incentive loss. when intensive use of assets is an important value driver and therefore managers’ “capital hunger” needs to be restricted. since there is more at stake. This delegation of decision rights in turn is associated with more emphasis on performance measures. organizational structure) that proxies for information differences between units. 16 . they find that decisions about capitalintensive production technologies (in contrast to workforce decisions) are delegated less often. while asset use intensity is expected to have a positive direct effect on the importance of VB measures for evaluation to induce strategy-consistent behavior (cf. In particular. we expect that when intensive use of firm assets gains greater strategic importance. Accordingly. In contrast. Chung et al. it can be expected that the incentive loss perspective gains greater importance. this will induce senior management to retain decision control by centralizing more decisions.. Colombo and Delmastro (2004) find empirical support that the extent of delegation to middle-level managers is less when there is more at stake in the decisions to be made.decision rights.4 This implies that when the strategic importance of intensive asset use is high. based on the incentive loss perspective. H1).e. for example. top management looses the ability to directly monitor decisions. Aghion and Tirole (1997) show analytically that important decisions will be monitored more closely by superiors. reducing top managements’ willingness to delegate. Prior studies have mainly focused on the information processing perspective. and on the other hand retain 4 In the empirical analysis we also include a control variable (i. Abernethy and Lillis (2004). This tension in the research model reflects the alternative ways in which we expect senior management to on the one hand incentivize middle-level managers to direct effort towards VB performance.

Colombo and Delmastro.. 2004. Specifically. we thus hypothesize that asset use intensity and unit interdependencies both reduce the influence of delegation of decisions rights to avoid control loss:5 H4: Delegation of strategic decision rights is negatively influenced by (a) the strategic importance for the firm to use assets intensively and (b) interdependencies with other firm units. and avoid local optimization and negative externalities (Abernethy et al. in our specification we follow recent papers (e. as in other studies (e. 2007.e.g. senior management likely prefers to centralize more decisions to ascertain coordinated decision making.. Nagar. and thus interdependence with other units is high. the data requirements to do so properly are very demanding.g. but not the other way around. Instead. To complete our path model. Since units with a broader scope have less negative externalities with other firm units.. Similarly. 5 Although specifying and modeling reciprocal effects between delegation and PM choices may be desirable to obtain a closer test of their causal interrelation (e. Accordingly. The total effect thus should be an offsetting or reduced effect of asset use intensity on the importance of VB measures (i.g.. a reduced importance of the measure in the PM system).. Abernethy et al. Bouwens and Van Lent. Thus. 1999).. more unit interdependencies should both directly (cf. such an analysis would require three adequate instrumental variables that each would have to be significantly and equally related to one dependent variable and be orthogonal to the other two (Wong and Law.some of the decision rights that impact the size and use of the asset base. H3) and indirectly (through reduced decision rights) result in a lower importance of VB measures for evaluation. 2004).. when the scope of the firm’s value chain activities performed within a unit is narrow. 17 . Chung et al. 2002). Indeed. Bouwens and Van Lent (2007) find that units with greater interdependencies receive fewer decision rights than units that face limited interdependencies. Abernethy and Lillis. 2009) that have modeled and found evidence of significant effects of decentralization on PM choices. we also expect that this greater delegation is associated with more emphasis on VB measures for evaluation. 2004. we expect that organizational units performing a broader scope of activities will receive more decision rights than those with a more narrow scope. 2004).

which represents a 17. Respondents generally were high placed managers at the firm level (e. To select an appropriate sampling frame from the CI member list.. In total.. with a link to an online version of the questionnaire. A second reminder was sent by email. division/BU controller. or fill it in online. 454 questionnaires were returned.6% response rate. we only selected respondents who. BU manager. location manager). This provided a sampling frame of 2. corporate controller. CFO. non-respondents were sent a reminder and a new questionnaire.584 potential respondents who were sent a questionnaire with a prepaid return-envelope and an enclosed letter that explained the purpose of the study and the involvement of the CI to stimulate participation in the study.g.1. we used three criteria: (1) the firm the respondent worked for had at least 100 employees. CEO. (2) it was located in the Netherlands. and (3) it was a for-profit firm. In addition. Sample The data used to test the hypotheses were obtained using a large-scale multi-purpose questionnaire administered in 2004-2005 among members of the Controllers Institute (CI. a Dutch institute for Chartered Controllers and Chartered Accountants). corporate controller). to ascertain they could provide knowledgeable responses to the questionnaire items. based on their job title occupy higher positions in their organizations (e. or at the level of business unit/independent location (BU manager.H5: Delegation of operational decision rights is negatively influenced by (a) the strategic importance for the firm to use assets intensively and (b) interdependencies with other firm units. CFO. 3. and were well qualified to answer 18 . Sample and variable measurement 3. In response to this email non-respondents could indicate their reason for not responding to the questionnaire. BU controller). VP. After one month. CEO.g.

we use only the responses from the 130 manufacturing firms in the sample since the nature and impact of value drivers (in particular the one that this study focuses on. 7 failed to answer a question about the organizational structure of the unit. This indicates the imputation does not affect the reported outcomes. while Riceman et al. and the items that we used for the measurement of asset use intensity have a specific meaning for manufacturing firms.all survey questions. benefit less from being evaluated on VB measures as compared to managers in capital-intensive operational functions.24). p=0. while for firms from other industries the amount of missing values was substantial (almost 60%). In addition.43. df=119.4 years of experience in their current position. we omit PM practices in other (e. and production speed and capacity) were included in the questionnaire specifically for manufacturing firms. In the instructions about the questions on performance evaluation. and a total experience in that function of 6. 19 .8 years. respondents were 41 years of age. Thus. For this study. On average. had 3.10). which instead predominantly used the ‘not applicable’ option. (2002) found that managers in service functions.g. we performed a “missing completely at random test” (Little’s MCAR test). 2006). for the responding firms from other industries..7 An early-late respondents analysis between the 30 first responding manufacturing firms and the 30 latest responding manufacturing firms on all model variables shows no significant differences (at p<0.. 7 We used EM (expectation-maximization) imputation to impute values for a few missing values on non-nominal variables (Hair et al. Indeed. such as customer support. which was insignificant (χ2=129.6 Kleiman (1999) reported that VBM is used relatively more often in manufacturing firms. but also add control variables for the sub-industry that firms operate in. To explore the impact of these missing values on the results. the importance of intensive asset use) are typically industry specific. the mean score is significantly lower than it is for manufacturing firms (p<0. we use a homogenous sample from one industry to provide an appropriate test of our hypotheses. we asked respondents to reflect specifically on the manager(s) of the firm’s primary operating units.01). Of the 130 respondents. respondents from these firms provided almost no missing values on these items (less than 5%). resulting in a dataset available for analysis of 123 survey responses. Accordingly. customer service and staff) units. indicating that non- 6 These items (regarding inventory levels.

1998. it is less informative about its relative importance to other (financial) measures.000.response bias is unlikely to be a problem. head (18) or member (12) of a support department to the board (e. A question on whether respondents faced any difficulties completing the questionnaire also supports their ability to do so adequately. For the hypothesis tests. and transportation. These different types of respondents (board members. warehousing and communication. 2003).. The 123 firms included in the final sample have a median number of employees close to 2. in the question we provided two specific examples of VB measures: EVA and CFROI. 20 .2. which is an item measured on a 1-7 Likert scale (1-not important. Malmi and Ikäheimo. Since the inclusion of a capital charge is the distinctive 8 The respondents of these firms are generally high placed and can be classified as board member (44. which may relate to the importance of working capital (inventory) and capital management in these industries. however. To frame respondents towards financial performance measures that include a charge for the cost of capital. staff managers or operational managers) provided similar answers on the questions for our dependent and independent variables. VP). There are no significant differences. Excluding these does not affect our results and inferences. VBa is significantly higher in this industry than in most other sampled industries.g. head (29) or member (7) of a support department to BU management (e. we use two dependent variables.g. while VBa indicates the overall extent to which managers are held accountable for the cost of capital. The first is the importance placed on value-based measures (VBa) in the evaluation of the manager(s) of the firms’ primary operating units. CFO. CEO.g. 9 In line with our rationale to focus only on manufacturing firms and with Kleiman (1999). as only 13% (which were spread over all respondent types) indicated they did. division controller. with firms from trade and financial services. e.. BU manager (8). business controller). Variable measurement Dependent variables Appendix A provides details of all questionnaire items used for analysis.9 While VBa provides information on the absolute importance of VB measures in managerial performance evaluation.8 3. corporate controller). professional services. these are not used fully at the expense of earnings measures. differences can also exist in the extent to which managers are held accountable for financial bottom-line performance. Prior empirical studies have found that when firms adopt VB measures. These are well-known measures in our sample of managers with a financial background. but instead they often combine multiple financial measures (Ittner and Larcker. or head (5) of a BU department.. Thus. 7-very important). including construction.

7-very important): (1) capacity use. computed as the importance of VB measures relative to the importance of profit (Pa) for evaluation: VBa / (VBa + Pa). profit) should increase if including a capital charge increases in importance for the firm. Indeed.. indicating that incentive compensation is typically tied to use of VB performance measures. We rely on this expectation to test for criterion-related validity.element of VB measures. Malmi and Ikäheimo. (2) inventory level.. If this empirically would be common practices. Another way to stimulate and guide VB performance is by holding managers responsible for performance on measures that reflect critical value drivers of the firm. This implies that the importance of such performance measures for performance evaluation should correlate more strongly with VBa than with Pa. In the questionnaire we included an item about whether or not the firm provides performance-based compensation to the manager(s) of its primary operating units. 2006. and 10 As pointed out by a reviewer.g. their importance relative to other financial measures (e. A t-test supports that use of incentive compensation is associated with a greater importance of VB measures (p<0. (3) improvements to production systems. Since profit is included in VB measures. increasing values on VBr indicate that the capital charge is relatively more important in the manager’s performance evaluation. however.g. Malmi and Ikäheimo (2003) and Claes (2006) find that users of VB measures often combine these with non-financial performance measures that are reflective of value drivers. ROI) against a cost of capital to provide incentive for managing value. we also use a relative measure as dependent variable (VBr). this would work against us in finding any results for VBr. 21 .10 Accordingly. firms can also directly compare ‘traditional’ earnings or return measures (e. One way how firms stimulate VB performance is through the provision of financial incentives (Claes. and computed the correlations of VBa and Pa with the importance of four nonfinancial performance measures in managers’ evaluation which more directly capture the intensity of asset use and are leading indicators of VB performance (1-not important.10). 2003).

64 indicates sufficient reliability. and (3) high production speed. Pa correlates only significantly with inventory level (r=0. The items are measured on a 1-5 scale anchored as 1) headquarters. Indeed. these four non-financial measures also correlate positively and significantly with asset use intensity. Independent variables Table 1 reports the factor analysis results (based on principal axis factoring and Oblimin rotation) for the constructs that are measured using multiple items. supporting the homogeneity of the construct across different sub-industries. 3) location manager. While strategic choices aimed at competitive advantage may not always be aimed at enhancing shareholder value as implied in VBM. results in a variance explained of only 26. These results confirm that when firms rely on value-based measures.(4) expansion of production capacity. and 5) team leader. (2) optimal utilization of production capacity. [Insert Table 1 about here] Asset use intensity is measured by three items specific to manufacturing firms reflecting the strategic importance for the firm to use assets intensively (ASSINT). this is often in conjunction with non-financial measures that reflect critical value drivers (i. the reported factor solution is robust against a sequence of alternative estimations in which we successively leave out the observations for each of the sub-industries. as enhanced shareholder value may follow from a competitive advantage. In addition.13 Delegation of decision rights is measured with a scale that captures the lowest management level in the organization that has the right to make a variety of strategic and operational decisions. including non-manufacturing firms.e.12 Factor analysis shows that these items load on one factor that explains 59% of the items’ variance.11 While VBa correlates significantly with all four performance measures (r ranges between 0. intensive asset use). The Cronbach alpha of 0. 2) business unit manager.22 and 0..7% and item loadings and Cronbach alpha are significantly lower.37). This construct reflects how important the following items are to achieve a competitive advantage: (1) low inventory levels. and support criterion-related validity for VBa by indicating that this measure is distinctively different from Pa. This supports the assertion that asset use intensity has different meanings across industries and our choice to limit the analysis to manufacturing firms. in general these perspectives can be expected to converge. 13 A similar factor analysis for all responses on these items.22). 12 11 22 . 4) department manager.

they can strongly impact the intensity of use of existing assets and working capital and through that VB performance.Accordingly. delivery performance and inventory levels. higher values on these items indicate more delegation of decision rights. Strategic decision rights include rights to develop and introduce new products. The factor solution explains 53% of the variance in all items. we excluded an item about the rights to determine bonuses for direct production personnel as many sample firms did not have a bonus system for this level. hiring production personnel. Respondents were asked to indicate whether or not the following activities take place within the unit: production. For instance. and only 8% delegates decision rights to attract loans below the headquarter level. purchasing and/or sales. and is measured as the sum of the number of different primary operating value chain activities performed by the focal unit. The count measure of scope of the value chain (SCOPE) thus varies from one (if the unit performs only one operational activity) to seven (if all are performed). and hiring qualified production personnel can improve operations and asset use. and to explore new markets. 23 . These observations are consistent with Bouwens and Van Lent (2007). marketing.83 for OPDR indicate adequate reliability. logistics. setting adequate production priorities can enhance capacity use.14 As expected.73 for STRDR and 0. Operational decision rights include rights such as selecting suppliers. Only 15% of the firms in the sample delegates decision rights for making large investment decisions to the business unit level (and 0% below this level). factor analysis on the 11 items extracts two clear dimensions that reflect strategic decision rights (STRDR) and operational decision rights (OPDR). Unit interdependence is reflected by the scope of value chain activities under the unit’s control. selecting adequate suppliers can affect quality. research and development. The Cronbach alpha of 0. determining production capacity. In addition. These decisions typically are associated with investments in new assets. service delivery. setting production priorities. and provision of after-sales service. and setting prices. Units that include a 14 Two items are excluded from the analysis since they show very little variation and are generally not delegated to management levels below the headquarter level. While the discretion to invest in new assets may be limited with these rights.

managers in firms with a product-market structure should have more influence on VB performance than managers operating in other structures. with product-market structures providing the lowest degree of interdependence. which relates to the information characteristics of its organizational units and the decisions taken by managers. and allow firms to (partly) delegate real authority. product and functional structures. firm size.15 Firms are structured as more independent decision making units when the benefits of local decision making are higher than the cost of upward communication and for coordination between units (Jensen and Meckling. and can react relatively swiftly to changes in customer preferences and competitive circumstances. which differ in their ability to employ local knowledge. Accordingly. organizational structure is reflective of unit interdependencies.broader scope of activities should be less dependent on other firm units and be better able to influence asset use and working capital. 1997). we control for the firm’s organizational structure. Product-oriented structures (where functions are clustered around one product or product group) and functional structures (where responsibilities are divided over functional groups) build to a lesser extent on local knowledge and are relatively less able to respond quickly to environmental changes. Thus. this proxies for information asymmetries and for managers’ ‘real authority’ (Aghion and Tirole. We use two variables that 15 A product-market structure builds on both local product and market knowledge in deciding on which products to produce and sell. As argued before. respondent level. our measurement of decision rights may not fully capture the different types of decisions delegated and managers’ ‘real authority’ . Control variables We control for four variables that may influence delegation choices and the importance of VB measures for evaluation: organizational structure. and subindustry membership. In addition. 1995). 2007). since VB measures may induce parochial behavior. 24 . they are ill-suited to incorporate the effects of decisions made in other units (Bouwens and Speklé. We distinguish between product-market. Since organizational structure affects managers’ opportunity to make decisions based on local knowledge. First.

17 We control for firm size instead of unit size since the underlying arguments concerning agency costs and performance measurement system costs relate to firm size instead of unit size. Second. Therefore. publishers and printers (n=13). Ely.16 The indicator variable (LEVEL) is coded 1 for headquarter-level respondents. VB measures have also been argued to be more relevant for managers at higher levels as they may better understand how to influence VB measures and value drivers (Ittner and Larcker. (3) chemicals and chemical products (n=23).g. and 0 for BU/location-level respondents. we control for the firm’s membership of one of the following six sub-industries: (1) food. the managers of operating units reflected on by headquarter respondents may be at a relatively higher level than those reflected on by BU/location level respondents. 1998. for instance. we control for firm size. (5) basic metals and fabricated metal products (n=15). Larger firms.indicate whether (1) or not (0) the firm has a functional structure (FUNC). we control for respondent level as a proxy for the level of the managers the respondents reflect on. have been argued to have higher agency costs because they have higher risks of cross-subsidizing unprofitable units and consuming perks (Garvey and Milbourn. which likely influences firms’ use of VBM. 2000. the cost of introducing a VBM system may be more easily covered by larger firms (Garvey and Milbourn.17 We measure firm size (SIZE) as the log of the number of employees working in the firm. Malmi and Ikäheimo. Finally. In addition. (4) electrical and optical equipment and instruments (n=11). (2) pulp. 1991). Lovata and Costigan. or a product structure (PROD). 2002). paper and paper products.. In particular. Third. 25 . 2003). which could affect the extent to which they are held accountable for VB performance. prior studies suggest that the choice between alternative accounting measures is often industry specific (e. with product-market structure as reference group. Rajan (2000) further suggests that firms may simply adopt VB measures because industry leaders have done so. 2000). using indicator variables. Although this 16 While effects relating to differences in decision rights should be captured by STRDR and OPDR. beverage and tobacco products (n=27). and (6) machinery and equipment (n=13) (the reference group is “other” (n=21)).

18 Table 3 reports the correlation coefficients between all model variables (based on mean scores for multi-item constructs).00) and chemical & pharmaceutical producers (µ=4. Further.91). 25 provided a score of 1.21. [Insert table 3 about here] Table 3 shows that VBa and VBr are strongly correlated (r=0.67. µ(VBr)=0. On the other hand. The data further confirm that operational decision rights are delegated more frequently (µ=2.study purposefully focuses only on manufacturing firms. in many cases they appear to be important measures for evaluation. these indicators control for potential differences at the sub-industry level.14). VBa and VBr are highest in chemical and pharmaceutical firms (µ(VBa)=4. Results 4. Consistent with expectations.53. 4.50 would indicate equal importance).96).46.05).45) and lowest in paper product producers & publishers (µ(VBa)=2. SD=1. where 0. VB measures are less important than profit (mean VBr=0.1. Thus.28). 31 firms provide a score of 6 or 7 indicating substantial importance of the measures for evaluation.95). p<0. although (as expected) the average extent to which managers of primary operating units are evaluated on VB measures is not high. 26 . Descriptive statistics and variable correlations Table 2 reports descriptive statistics for all variables.07). Of the 123 respondents.36. there is substantial variation in the importance of intensive asset use to achieve a competitive advantage (µ=4. which means that the VB measures are not at all important. Although the sample data are collected within one industry. On average. the importance of VB measures for evaluation is below the mid-point of the scale (4). VBa increases when intensive asset use is more important for competitive 18 Sub-industry comparisons show that while the delegation of decision rights hardly differs between subindustries. the variation is substantial (SD=2.84. [Insert Table 2 about here] With a mean of 3. µ(VBr)=0. and lower among paper product producers & publishers (µ=3.57) than strategic decision rights (µ=1. however. importance of intensive asset use is relatively high among metal (products) producers (µ=5.

µ f=3. Results are also qualitatively similar when using maximum likelihood estimation in LISREL. p<0. The correlations of the antecedent variables with VBr are of similar magnitude. p<0. p<0. Delegation of strategic decision rights further varies significantly across firms with different organizational structures. Appendix B reports loadings of 19 To estimate the measurement model. the delegation of both types of decisions rights also differs significantly for respondents across different organizational levels.27. and is highest for firms with product-market structures (p<0. and an ANOVA test shows it differs significantly across firms with different organizational structures.15.16. r=0.75.32. VBa also increases with firm size (r=0.54.10. We obtain similar structural model estimates when instead of estimating a measurement model.000).28. and when more operational and strategic decision rights are delegated (r=0. Multivariate results Given the sample size of this study (N=123). Both decision rights also do not correlate significantly with the scope of activities performed by the unit. 2005). 4. p<0. the correlation with delegation of strategic decisions rights is insignificant. While asset use intensity correlates negatively with delegation of operational decision rights (r=-0. we use partial least squares (PLS) to estimate the two structural models with absolute and relative importance of VB measures as dependent variables. µ p = 2.05). when the unit performs a broader scope of value chain activities (r=0.10).2. with the highest (lowest) mean for firms with a product-market (product) structure (µ pm=4. despite the limited sample size. PLS bases on principal components analysis and orthogonal rotation. and bootstrapping to compute t-values of coefficients (n=1. p<0.01).05).05).27. 27 . p<0. The correlations between the independent variables cause no concerns about multicollinearity.15.19 We use SmartPLS (version 2.advantage (r=0. we use factor scores (based on principal axis factoring with Oblimin rotation reported in Table 1)..0) for the analysis (Ringle et al. Not surprisingly. p<0.10).05).

[Insert Table 4 and Figure 2 about here] Consistent with hypothesis 1. which factor is also significantly associated with VBa and VBr (which are highest in product-market combinations). gain importance when there are fewer interdependencies with other firm units. 28 . One reason for this may be that these decisions are monitored more directly and overruled when not in line with firm strategy (Aghion and Tirole. is slightly lower than the ‘rule of thumb’ that it should be higher than 0.87. 20 In addition.g. in the appendix we report the composite reliability and average variance extracted (AVE) of each construct. 1998). The AVE for operational decision rights. delegation is highest in firms organized by product-market combinations). The AVE’s range between 0.20 Table 4 and Figure 2 reports the results for both models.. A closer inspection. which reinforces that these are three separate constructs and thus further supports discriminant validity. In line with hypothesis 3. Thus.66. Composite reliability ranges between 0. asset use intensity has a positive and significant influence on VBa and VBr. Inconsistent with hypothesis 2a (and in contrast to the positive correlation in Table 3). Delegation of operational decision rights also has a positive and significant influence on VBa and VBr. shows that delegation of strategic decision rights is significantly associated with organizational structure (i. cf. This test also indicates common method bias is unlikely to be a problem.50. This supports that VB measures. which supports hypothesis 2b. Fornell and Larcker (1981). which facilitates the use of VB measures for evaluation (Bromwich and Walker. the scope of value chain activities under managerial control has a positive influence on both VBa and VBr. we also factor analyzed all items of ASSINT. we discuss these simultaneously. 1981). 1997)..81 and 0. Finally. supporting that the constructs have good discriminating validity (Fornell and Larcker. and in particular the capital charge included.46 and 0. Thus.all items from the measurement models. however. managers with a broader scope of influence over the firm’s value chain activities are not only held more accountable for aggregate financial performance measures as found in prior studies (e. a more nuanced interpretation is that delegation of strategic decision rights is associated with organizational structures that provide units relatively greater independence. however. Since the results are very similar for VBa and VBr. OPDR and STRDR simultaneously. however. which is higher than all squared correlations between constructs. delegation of strategic decision rights has no impact on VBa and VBr. and the manager has greater influence on the capital charge. indicating that internal consistency reliability is satisfactory.e.

.19*0. but also more specifically for the capital charge included in these measures. These are decision rights that have impact on investments in fixed assets. To analyze which types of operational decision rights are more often centralized when asset use intensity increases. We find no support for hypotheses 4b and 5b that greater unit interdependencies. a more narrow scope of value chain activities under the unit’s control). The total effect.Abernethy et al. suppliers and price setting (all p<0. working capital (e. (i. however. Keating. greater importance of intensive asset use is associated with greater importance of VB measures for managerial evaluation. however. on the one hand VB measures gain importance. The results for the control variables.. 29 . For manufacturing firms. and not for strategic decision rights (H4a).10). for operational decision rights (H5a).20=-0.17). the unit’s asset base likely is also larger.04).. and thus are less likely to be delegated to middle-level managers when these assets are strategically important to the firm. is positive (0. Thus. consisting of the positive direct effect of asset use intensity on importance of VB measures (0. involves less delegation of operational and strategic decision rights. in total. this should also provide the unit manager relatively greater independence in influencing asset use. Together with the support for H1. 2004. 1997). but on the other hand top management also retains more direct control over decisions that impact asset use. asset use intensity evokes more centralization of choices of production methods/systems.01). In addition.e.21) and the negative indirect effect via operational decision rights (-0. these results suggest that when asset use intensity becomes more important.21 The delegation of decision rights is influenced negatively by asset use intensity. 21 Even though with a greater scope of activities. supplier choices affecting inventory management) and the margin earned on products. This effect is only significant. Using the same model specification. capacity choices are typically associated with significant investments in fixed production-related assets. we additionally analyze each decision right individually.g. we find that asset use intensity is most strongly related to the centralization of production capacity choices (p<0.

First.69.. 2007. p<0. 5. Nagar. As noted above. who found that firms with a more complex organizational structure delegate more decision rights (although they did not differentiate between types of decision rights). this finding also can be connected to prior accounting studies that find a positive association between information asymmetry and delegation (e. prior studies have focused on explaining the use of or weight on performance measures primarily by variables reflecting the operating context of the firm.10.22 Thus. 2002). as noted earlier. This finding partially converges with the results of Colombo and Delmastro (2004).indicate that while organizational structure has no influence on the delegation of operational decision rights. 2004. 2007.10). 2004. 22 Positive significant coefficients on VBa and VBr are found for chemical & pharmaceutical firms (t-value=1.g. Abernethy et al. information asymmetries and delegation of decision rights (Abernethy et al. firms with a product-market structure delegate significantly more strategic decision rights.78. 30 . Nagar. VB measures are also more important in firms with a product-market structure than in those with a product structure. Bouwens and Van Lent. but has no influence on VBa and VBr. Keating. their inclusion does not change the influence of the hypothesized variables. These appear to be particularly suitable contexts for VBM given the high capital intensity of these firms.. Bouwens and Van Lent.g. and t-value=2.. Since organizational structure proxies for local knowledge and information asymmetry. respondent level is negatively associated with the delegation of both types of decision rights. Consistent with Table 3. p<0. consistent with arguments of higher agency costs and the better covering of the costs of VBM. although the difference with firms with a functional structure is not significant. Discussion Several of our results merit further discussion. such as interdependencies.. the results are unlikely to relate to structural sub-industry differences (e.05) and on VBa for basic and fabricated metals firms (t-value=1. While the controls for sub-industry membership (untabulated) show some significant effects. in asset use intensity). Firm size has a positive and significant influence on both VBa and VBr. p<0.44. 1997.

by adjusting inventory levels). This supports arguments in the strategic PM literature that PM choices should reflect the outcomes of value driver analysis to induce behavior congruent with firm strategy (Ittner and Larcker.g. it is not per se imperative to provide them with investment or divestment rights. filling capacity. Since our data come from a relatively homogenous sample of manufacturing firms and the analyses control for sub-industry membership. The data further indicate that decision rights to make new significant investments are rarely taken at levels below top management (as also observed by Bouwens and Van Lent (2007)). Our results with respect to the delegation of operational decision rights and scope of value chain activities under the unit’s control support the influence of these variables on the importance of VB measures for managerial evaluation. we find that middle-level managers in firms organized by product-market combinations (who on average have more delegated rights to develop and introduce new products and explore new markets) are also held more accountable for value-based performance. we find that this importance is not only a function of managers’ opportunity to affect VB performance. These decision rights enable managers to influence the intensity of asset use (e. 31 . 2001). we find a complex set of relationships between the decision rights managers receive and the importance of VB measures. but also of their firm’s incentives to do so. by scheduling production. However. While the delegation of strategic decision rights has no significant direct effect. as reflected by the importance of a specific value driver.g. Second.. Of the two types of decision rights that we examine.2002).. only the delegation of operational decision rights is directly associated with the importance of VB measures. our finding indicates that also within one industry variation in the importance of a value driver explains variation in PM choices. selecting high quality suppliers) and working capital (e. since through the delegation of other decision rights they appear to be sufficiently able to influence the cost of capital in other ways. This implies that when managers are evaluated on VB measures.

firms may also 32 . 2007). a balance needs to be found between the delegation of decision rights and the extent to which managers are held accountable for VB performance for the decision rights that they do receive. in particular since VB measures already include profit. conditional on asset use intensity. the negative effect of asset use intensity on delegation of these rights suggests that senior management relies on both incentive provision through VB measures and centralization of particular decisions to mitigate incentive loss. and the importance relative to profit. VB measures gain importance for evaluation. a risk of VB measures identified in the literature is that they can create ‘parochial behavior’ by incentivizing managers to improve their performance without considering externalities of their decisions on other units (Bouwens and Speklé.Third. One explanation is that PM system changes are slowly implemented and that firms are reluctant to dispose old practices (Malmi and Ikäheimo. We find that the model variables help explaining both the absolute importance of VB measures. We indeed find that when the scope of activities in the unit is broader. The overall effect is a reduced but still positive influence of asset use intensity on importance of VB measures for managerial evaluation. which limits interdependencies with other units. 2003). Alternatively. these results suggest that. Fourth. While the delegation of operational decision rights is positively associated with importance of VB measures. The observation that VB measures and profit measures are used in combination raises the question why firms use multiple financial measures simultaneously. Finally. we find support that in the context of high asset use intensity delegation of decision rights and VB measures are used as alternative ways to increase control. our data indicate that middle-level managers are often evaluated on both profit and VB measures. which similarly are characterized by greater unit independence. Such behavior should be less problematic when units include a broader scope of the firm’s value chain activities. We also find that these measures are more important in firms organized as product-market structure. Thus.

Conclusion and limitations In this study. Our basic tenet is that these managers are held more responsible for valuebased measures when it strategically becomes more important for their firm to intensively manage the cost of capital and when their influence over these capital costs increases. While our control variable for respondent level indeed supports differences exist in use of value-based measures across firm levels. 6. an interesting direction for future 33 . when managers receive more operational decision rights. We find that the importance of value-based measures for managerial performance evaluation increases when intensive asset use is an important value driver for the firm. First. the overall influence of asset use intensity on use of valuebased measures remains positive. we build on strategic and economic arguments to predict conditions that influence the importance of value-based measures for the performance evaluation of middlelevel managers. the level of analysis is at the manager(s) responsible for the primary operating activities of an organizational unit. who found that the most important reason to adopt VB measures in their sample was that managers simply are not sufficiently aware of the costs involved with capital use. Our results should be interpreted within several limitations. This is in line with survey evidence of Haspeslagh et al. and when they have control over a broader set of activities of the firm’s value chain.deliberately add a measure with a capital charge to earnings measures to increase managers’ awareness of the cost of capital used. Although we also find that firms delegate less operational decision rights when it strategically is more important to use assets intensively. limiting the interdependencies with other firm units. Although this is an advantage because within the firm only some managers might be evaluated on value-based measures and others not. it also implies we have less information on whether such measures are used firm-wide and on their importance at other levels. and it thus allows us to examine the influence of factors that affect the relevance of VB measures for evaluation. (2001).

research is to explicitly disentangle variation in the use of value-based measures at the individual manager level from variation across firms in the use of VBM systems. and how these measures are embedded within the firm’s broader package of controls. to a comprehensive system where VB measures are used company-wide in planning. to satisfy shareholders. and the effects on value creation in particular. Future research may examine whether the ‘appropriate’ use (‘fit’) of VB measures in response to strategy. we lack information regarding how comprehensive the VBM system is in supporting managers to improve value-based performance. Second. which may include other dimensions such as uncontrollable external factors that generate noise in the performance measure. A similar comment holds for the factors that affect managers’ opportunity to affect VB performance. from mere rhetoric use. decision making.. Since we only asked respondents about the importance of value-based measures for managerial evaluation. Related to this issue is that we have little information in our measurement about what specific type of VB measure is used. and with use of non-financial measures that reflect the firm’s value drivers. Third. how it is calculated. value drivers and managerial influence enhances value creation as compared to 34 . Drazin and Van de Ven. 1985). data limitations preclude us from testing the performance implications of this use. target setting and rewarding processes. Malmi and Ikäheimo (2003) documented that firms use VBM systems in many different ways. we examine the influence of one key value driver (intensity of asset use) on the importance of value-based performance measures. as a package) can shed light on how the broader package of control stimulates and facilitates the achievement of value-based performance. a more systematic analysis of the interrelations between different control elements (i. while we explain variation in the importance of VB measures (following the logic of ‘selection fit’. Fourth. ignoring the influence of other potentially relevant value drivers. cf.e. While we do find that use of VB measures is typically associated with the use of incentive compensation. and how the cost of capital that it includes is determined.

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Figure 1: Representation of the research model Asset use intensity Delegation of strategic & operational decision rights Unit interdependence Importance of VB measures Control variables 38 .

PROD. Panel B: PLS model estimations for the effects on the relative importance of VB measures 1 The effects of the control variables FUNC. Panel A: PLS model estimations for the effects on the absolute importance of VB measures1 Figure 2. LEVEL and SIZE are not reported in these graphs.Figure 2. 39 .

66 0.75 0.43 Eigenvalue (incr.69 0.78 0. variance explained) Cronbach α Panel B: Delegation of decision rights Operational decision rights Selecting suppliers Determining production capacity Hiring production personnel Setting production priorities Setting product/service prices Determining personnel salary Choosing production methods/systems Organizing marketing campaigns Strategic decision rights Introducing new products/services Developing new products/services Exploring new markets Factor loadings 0.71 0.58 0.77 (59%) 0. 40 .52 0.50 1.45 0.64 0. variance explained) 4.74 0.64 1 0.Table 1: Results of factor analyses on the multi-item scales (N=123) Constructs/items Panel A: Asset use intensity Optimal utilization of production capacity High production speed Low inventory levels Eigenvalue (incr.83 0.48 0.13 (38%) 1.73 1 Factor loadings are based on principal axis factoring with Oblimin rotation.95 0.67 (15%) Cronbach α 0.

STRDR = delegation of strategic decision rights (mean score on 3 items).86 1.70 7 0.00 4.67 0.37 1.13 0.13-0.36 Min Max Variable definitions: VBa = absolute importance of value-based measures for evaluation.57 0.53 2.14 0.68 1.57 1.13 1 1. OPDR = delegation of operational decision rights (mean score on 8 items).36 4. dev.02 1-7 0. ASSINT = importance of intensive asset use (mean score on 3 items).63 0. FUNC = indicator variable whether or not the firm has a functional structure.96 2.48 2.46 0. 41 .15 1.88 7 4.00 1 0 0 0 1. LEVEL = respondent level (BU/location vs.53 3. SCOPE = sum of indicator variables reflecting value chain activities performed by the unit.00 7 1 1 1 5.Table 2: Descriptive statistics of the model variables (N=123) Mean St. SIZE = log of the number of employees working in the firm. PROD = indicator variable whether or not the firm has a product-oriented structure.88 1-7 1-5 1-5 1-7 0-1 0-1 0-1 1-∞ 1 0. Theoretical range VBa VBr ASSINT OPDR STRDR SCOPE FUNC PROD LEVEL SIZE 3.07 0. headquarters). VBr = importance of value-based measures relative to profit.

18** 0.04 -0.05 -0.03 1.06 1.17* 0.09 1.03 -0.00 0. respectively (two-tailed).22** 0.02 0.15* 0.44*** -0.17* -0.01.19** 0.07 -0.15 0.15* 0.00 0.13 0.**.28*** 1.00 0.09 0.05 and 0. Variables definitions are provided below Table 2.35*** 0.02 -0.07 1.06 0.28*** 1.07 1.15* 0.84*** 0.Table 3: Pearson correlation coefficients (N=123) VBa VBa VBr ASSINT OPDR STRDR SCOPE FUNC PROD LEVEL SIZE 1.16* 0.00 0.20** -0.04 VBr ASSINT OPDR STRDR SCOPE FUNC PROD LEVEL ***.25*** 1.00 -0.14 -0. 0.* indicate significance at p<0.10.00 -0.22*** -0.01 0.27*** 0.00 -0.17* 0.02 -0.30*** 0.01 -0.07 -0.14 0.02 0.27*** -0.09 0.00 -0.00 0. 42 .

43 . The estimates of the standardized coefficients on OPDR and STRDR in Model 2 are similar as in Model 1 (since PLS uses bootstrapping to compute t-values.51) (1.78. metals on VBa.08) SIZE 0.68) (-0.18) (-0.12) PROD -0.07)** STRDR 0.19 0.25 -0.99)** (2.32) SCOPE 0.42)** (2.69.38)** (2.12 0.20 (1.24 (2.05 -0.05 0.02)*** (-1.07 (-2. respectively (two-tailed).15 -0.10.29) (0.27 -0.03)** (1.Table 4: Partial least squares model estimations (N=123) Model 1 Variables ASSINT OPDR1 -0.73) (0.05 and 0. Cell Coefficients are the standardized coefficients.01.10.01 (-0.50)** (-2.05).02 -0.21 0.73) (-3. p<0. ***.32 Model 1 estimates the effects on the absolute importance of value-based measures and Model 2 estimates the effects on the relative importance of value-based measures.22 (0.01) (2. and chemicals on VBa and VBr.19 0.06 -0.81)* (-1. t=1.02 (0..22 -0. Three of these are significant (i.21 0. Six indicator variables are included in all equations to control for sub-industry membership.03 (0. and t=2.46) VBa Model 2 VBr 0.13 0.10.13 (-0.10 -0. p<0. **.75) (2. t=1.14 (1.15 0. these differ marginally between both models).79)* STRDR1 0.76)* LEVEL -0.e.19 (-1. 0.62)*** R2 0.02 0.23)** (2.12)** (-0.44. p<0.05 0.32 0. and t-values (between brackets).07)** FUNC -0.* indicate significance at p<0.20 0.00 0.82)*** OPDR 0.31) (-2.

Determining salaries of direct production personnel . 2-department manager.Low inventory levels .Management level at firm headquarters . 3-location manager.My organization(al unit) has a product structure: functional departments that work on one product (or product group) are united in one unit .Value-based measures.Exploring new markets .Attracting loans .Determining production capacity (in people and machines) . production.Introducing new products and services in the market .Determining bonuses for direct production personnel . sales and after sales service . 7-very important) .Developing new products and services (R&D) .Choosing production methods and systems . 5headquarters) (reverse coded) .Determining sales prices for products and services . assembly.My organization(al unit) has a functional organizational structure.Profit Asset use intensity How important are the following elements for the firm to achieve a competitive advantage over its competitors? (1-not important.Appendix A: Questionnaire items This appendix details the measurement of the different questionnaire items used in the study.Setting priorities in production (which products first) Respondent level I have filled in this questionnaire from the position of: .Optimal utilization of production capacity (people and machines) . such as EVA and CFROI . 7-very important) . 4-business unit manager.High production speed Organizational structure Which of the following organizational structures best fits your organization(al unit)? .Hiring production personnel . the responsibilities are divided based on functions. Importance of value-based measures for managerial performance evaluation How important is each of the following performance indicators for the evaluation of the managers(s) of the primary operating units in your organization(al unit)? (1-not important.Organizing marketing campaigns .Selecting suppliers .My organization(al unit) has a product-market structure: functional departments are united per product-market combination Delegation of decision rights What is the lowest management level that has the authority to take the following decisions in your organization? (1-team leader.Management of a business unit . such as marketing.Management of an independent location 44 .Making large investment decisions .

65 0. publishers and printers .Marketing .Food.Research and Development .Chemicals and chemical products .Unit interdependence Which type of primary operating activities are performed within your organizational unit? .Production .Service provision .69 0.63 0.Purchasing and/or sales .46 45 .72 0.Basic metals and fabricated metal products .81 AVE 0.59 0.64 0.90 0.72 0.69 0.82 0.68 0. paper and paper products.Logistics activities .66 0.After-sales service Sub-industry membership In which industry does your firm or organizational unit operate? .87 0.Electrical and optical equipment and instruments .85 0.83 0.81 0.78 0. beverage and tobacco products .Pulp.Manufacture of machinery and equipment .Other Appendix B: Partial least squares loadings of multi-item constructs Items Asset use intensity High production speed Optimal utilization of production capacity Low inventory levels Operational decision rights Selecting suppliers Setting production priorities Determining production capacity Setting product/service prices Hiring production personnel Organizing marketing campaigns Determining personnel salary Choosing production methods/systems Strategic decision rights Introducing new products/services Developing new products/services Exploring new markets Loadings Composite reliability 0.57 0.

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