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ACCA Strategic Professional · Advanced Financial Management · The role and responsibility of senior financial executive/advisor

A multinational's subsidiary manager is assessed on the subsidiary's own return on investment, and so rejects a project whose return of 14% exceeds the group's cost of capital of 11% but is below the subsidiary's current ROI of 18%. Which problem does this illustrate?

This shows a failure of goal congruence. The project earns 14%, above the group's 11% cost of capital, so it would add value, but the manager rejects it because it dilutes divisional ROI of 18%. Residual income would better align the manager's decisions with group objectives.

  1. AGoal congruence failure, because the performance measure leads to decisions that reduce group valueCorrect
  2. BExchange-rate translation risk in consolidation
  3. CTransfer pricing manipulation to avoid tax
  4. DPecking order theory of financing

Explanation

The project returns 14% against an 11% cost of capital, so it would add group value. The manager rejects it because it would dilute the subsidiary's ROI of 18%. This is a lack of goal congruence between the divisional measure and group objectives; using residual income would help.

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