ROI and Management Behavior: Notewon Corporation is a highly diversified and decentralized company. Each division is responsible for its own sales, pricing, production, costs of operations, and the management of accounts receivable, inventories, accounts payable, and use of existing facilities. Cash is managed by corporate headquarters. Divisional executives are responsible for presenting investment proposals to corporate management. Proposals are analyzed and documented at corporate headquarters. The final decision to commit funds for investment purposes rests with corporate management. The corporation evaluates division executive performance by 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. Notewon Corporation adopted the ROI performance measure and related compensation procedures about 10 years ago. The corporation seems to have benefited from the program. The ROI for the corporation as a whole increased during the first years of the program. Although the ROI continued to grow 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 the use of ROI was overemphasized by some companies, with results similar to those experienced by Notewon.

Required:

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

b. Explain, using the concepts of goal congruence and motivation of divisional executives, how Notewon Corporation's overemphasis on the use of the ROI measure might result in the recent decline in the corporation's return on investment and the increase in cash and short-term marketable securities.

c. What changes could be made in Notewon Corporation's compensation policy to avoid this problem? Explain your answer.