Fundamentals of Cost Accounting 3rd Edition by William N. Lanen, Shannon W. Anderson, Michael Maher

Exercise 37

ROI and Management Behavior: Ethical Issues

Division managers at Asher Company are granted a wide range of decision authority. With the exception of managing cash, which is done at corporate headquarters, divisions are responsible for sales, pricing, production, costs of operations, and management of accounts receivable, inventories, accounts payable, and use of existing facilities.

If divisions require funds for investment, division executives present investment proposals to corporate management, which analyzes and documents them. The final decision to commit funds for investment purposes rests with corporate management.

The corporation evaluates divisional executive performance by using the ROI measure. The asset base is composed of fixed assets employed plus working capital, exclusive of cash. The ROI performance of a division executive is the most important appraisal factor for salary changes. In addition, each executive’s annual performance bonus is based on ROI results, with increases in ROI having a significant impact on the amount of the bonus.

Asher adopted the ROI performance measure and related compensation procedures about 10 years ago and seems to have benefited from it. The ROI for the corporation as a whole increased during the first years of the program. Although the ROI continued to increase in each division, corporate ROI has declined in recent years. The corporation has accumulated a sizable amount of short-term marketable securities in the past three years.

Corporate management is concerned about the increase in the short-term marketable securities. A recent article in a financial publication suggested that some companies have overemphasized the use of ROI, with results similar to those experienced by Asher.

Required

a. Describe the specific actions that division managers might have taken to cause the ROI to increase in each division but decrease for the corporation. Illustrate your explanation with appropriate examples.

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b. Using the concepts of goal congruence and motivation of division executives, explain how the overemphasis on the use of the ROI measure at Asher Company might have resulted in the recent decline in the company’s ROI and the increase in cash and short-term marketable securities.

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c. What changes could be made in Asher Company’s compensation policy to avoid this problem? Explain your answer.

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d. Is it ethical for a manager to take actions that increase her ROI but decrease the firm’s ROI?

Step 1 of 4

a.?Most of the specific actions that division managers can take that would result in increasing division ROI and decreasing corporate ROI relate to investment proposals. The division managers have the responsibility to recommend investment opportunities for their divisions. The facts in the problem would suggest that they have been recommending only investments which are a “sure thing” to increase division ROI and screening out investments which would lower division ROI even though improving corporate ROI. In addition, the postponement of capital investments makes the divisional asset base smaller for the calculation of division ROI. Further, the managers are not likely to recommend projects that would improve division ROI in the long run but would depress it in the short run (start-up periods).