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Inter-Departmental Cost Allocation and Investment Incentives

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  • Donna Wei

    (INSEAD)

Abstract

This paper endeavors to demonstrate that fixed cost allocation can align investment incentives in a multi-period and multi-division setting. In a decentralized firm, a divisional manager can make an investment that benefits both his own and the operations of a downstream division. The relative budgeted activity (RBA) cost allocation method assigns fixed cost charges according to the ratio of a division’s budgeted activity in proportion to that of the firm, and thereby resolves the hold-up problem created by the decentralized setting. Internal accounting rules can be designed to give managers strong incentives to internalize the firm’s objective regarding efficient investment levels, and alleviate the tension between ex ante investment efficiency and ex post production efficiency. This paper examines how much the fixed charges should be in order to achieve the optimal level of investment.

Suggested Citation

  • Donna Wei, 2004. "Inter-Departmental Cost Allocation and Investment Incentives," Review of Accounting Studies, Springer, vol. 9(1), pages 97-116, March.
    • Handle: RePEc:spr:reaccs:v:9:y:2004:i:1:d:10.1023_b:rast.0000013630.18838.04
    DOI: 10.1023/B:RAST.0000013630.18838.04
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    References listed on IDEAS

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    1. Tai-Yeong Chung, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(5), pages 1031-1042.
    2. Reichelstein, Stefan J. & Dutta, Sunil, 2001. "Controlling Investment Decisions: Depreciation and Capital Charges," Research Papers 1722, Stanford University, Graduate School of Business.
    3. Rogerson, William P, 1997. "Intertemporal Cost Allocation and Managerial Investment Incentives: A Theory Explaining the Use of Economic Value Added as a Performance Measure," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 770-795, August.
    4. RAMJI BALAKRISHNAN & DOUGLAS V. DeJONG, 1993. "The Role of Cost Allocations in the Acquisition and Use of Common Resources," Contemporary Accounting Research, John Wiley & Sons, vol. 9(2), pages 395-414, March.
    5. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    6. Tim Baldenius, 2000. "Intrafirm Trade, Bargaining Power, and Specific Investments," Review of Accounting Studies, Springer, vol. 5(1), pages 27-56, March.
    7. Baiman, S & Noel, J, 1985. "Noncontrollable Costs And Responsibility Accounting," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 23(2), pages 486-501.
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    Cited by:

    1. Sunil Dutta & Stefan Reichelstein, 2010. "Decentralized capacity management and internal pricing," Review of Accounting Studies, Springer, vol. 15(3), pages 442-478, September.
    2. Alwine Mohnen & Moshe Bareket, 2007. "Performance measurement for investment decisions under capital constraints," Review of Accounting Studies, Springer, vol. 12(1), pages 1-22, March.
    3. Alexander Nezlobin & Stefan Reichelstein & Yanruo Wang, 2015. "Managerial performance evaluation for capacity investments," Review of Accounting Studies, Springer, vol. 20(1), pages 283-318, March.

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