An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Stanley Baiman
University of Pennsylvania

Tim Baldenius
Columbia University

Abstract: This paper investigates the use of non-financial performance measures (NPMs) to encourage cooperation across divisions. The implementation of a project often requires joint efforts by multiple divisions. However, privately informed division managers tend to forgo some profitable joint projects and underinvest in relationship-specific assets. We show that paying those managers discrete bonuses tied to project implementation improves firmwide profit. The optimal implementation bonus trades off distortions in implementation and upfront investments. We then consider specific investments in learning-by-doing in a dynamic setting. We develop a “fast-track” theory of bonuses: conditional on a project being implemented successfully in period 1, the implementation bonus in period 2 should be raised. Our results suggest that firms can augment divisional performance evaluation with NPMs to improve incentives for cooperation while avoiding the problems associated with firm-wide profit sharing.

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