BH Tif08

Chapter 8: Organizing to Implement Corporate Diversification137
CHAPTER 8: ORGANIZING TO IMPLEMENT CORPORATE DIVERSIFICATION

TRUE/FALSE QUESTIONS
1.
The most common organization structure for implementing a corporate

diversification strategy is the U-form.
True
False
Answer: False Page: 246
Difficulty: Easy
Chapter Objective: 1
2.
Another name for the M-form is the multidivisional structure.

True
False
Answer: True Page: 246
Difficulty: Easy
3.
In the multidivisional structure, each business that the firm engages in is managed
through a division.
True
False
Difficulty: Easy
4.
The divisions in an M-form organization are true profit-and-loss centers.

True
False
Difficulty: Moderate
5.
All firms that use the multidivisional structure use the same criteria for defining
the boundaries of profit-and-loss centers.
True
False
6.
Divisions in an M-form organization should be large enough to represent

identifiable business entities but small enough so that a division general manager
can manage each one effectively.
True
False
7.
Each division in an M-form organization typically adopts a matrix structure and

the division general manager takes on the role of senior project executive.
True
False
138 Part III

8.
The M-form structure is designed to create checks and balances for managers that
increase the probability that a diversified firm will be managed in ways consistent
with the interests of its equity holders.
True
False
9.
Whenever one party to an exchange delegates decision-making authority to a

second party, an agency relationship has been created between these parties.
True
False
10. In an agency relationship the party delegating the decision making authority is
called the agent.
True
False
Answer: False
Page: 248
11. One common agency problem occurs when managers decide to take some of a
firm's capital and invest it in managerial perquisites that do not add economic value
to the firm but that do directly benefit those managers.
True
False
Answer: True
Page: 248
12. In an M-form organization the role of the Board of Directors is to formulate
corporate strategies consistent with equity holders' interests and to assure strategy
implementation.
True
False
Answer: False
Page: 249
Difficulty: Hard
13. In principle, only the CEO and the President report to the board of directors while
other senior managers report only to the CEO.
True
False
Answer: False
Page: 249
14. Research on outside members of boards of directors tends to show that outside
directors, as compared to insiders, tend to focus less on monitoring a firm's
economic performance than on other measures of firm performance.
True
False
Answer: False
Page: 250
Difficulty: Hard
15. Research has shown that separating the roles of CEO and board chair is positively
correlated with firm performance when firms operated in high-growth and very
complex environments.
True
False
Answer: True
Page: 251
16. To the extent that a board of directors begins to operate a business on a day-to-day
basis, it goes beyond its capabilities.
True
False
Answer: True
Page: 251
17. A board of directors typically consists of 15 to 30 individuals drawn from a firm's
top management group and from individuals outside the firm.
True
False
Answer: False
Page: 250
Difficulty: Hard
18. The title chairman of the board often, but not always, identifies the firm's senior
executive.
True
False
Answer: False
Page: 250
19. Institutional owners are usually pension funds, mutual funds, insurance companies,
or other groups of investors that have joined together to manage their investments.
True
False
Answer: True
Page: 252
20. In 1970, institutions owned 62 percent of the equity traded in the United States; by
1990, institutions owned 48 percent of this equity and by 2002, they owned only 32
percent of this equity.
True
False
Answer: False
Page: 252
Difficulty: Hard
21. The senior executive in an M-form organization has two responsibilities: strategy
formulation and strategy implementation.
True
False
Answer: True
Page: 254
Difficulty: Easy
140 Part III

22. In an M-form organization, the chief executive officer is solely responsible for
strategy implementation.
True
False
Answer: False
Page: 255
23. Only accounting measures of performance can be used in accurately measuring the
performance of divisions within a diversified firm.
True
False
Answer: False
Page: 259
Difficulty: Easy
24. One of the strengths of using a hurdle rate to measure the performance of divisions
in a diversified firm is that if the corporation has a single hurdle rate, there is little
ambiguity about the performance objectives of divisions.
True
False
Answer: True
Page: 259
25. Most accounting measures of divisional performance focus on long-term benefits
and minimize the possibility of a short-term bias.
True
False
Answer: False
Page: 260
26. Economic methods of divisional performance in a diversified firm build on
accounting methods but adjust those methods to incorporate short-term investments
that may generate long-term benefits.
True
False
Answer: True
Page: 260
27. Economic measures of divisional performance in a diversified firm compare a
divisions performance with a firms cost of capital and these measures increase the
potential for gaming, which is generally minimized by accounting measures.
True
False
Answer: False
Page: 260
28. The most popular economically oriented measure of division performance in a
diversified firm is economic value added.
True
False
Answer: True
Page: 260
29. By adjusting for a divisions earning and accounting for the cost of investing in a
division, economic value added is a much more accurate estimate of a divisions
economic performance than are traditional accounting measures of performance.
True
False
Answer: True
Page: 261
30. If a well-managed diversified firm uses both accounting and economic measures it
will be able to unambiguously evaluate divisional performance.
True
False
Answer: False
Page: 261
Difficulty: Hard
31. To the extent that a firm exploits real economies of scope in implementing a
diversification strategy, it will be able to unambiguously evaluate the performance
of individual division in that firm.
True
False
Answer: False
Page: 262
Difficulty: Hard
32. In zero-based budgeting each project has to stand on its own merits each year by
being included among the important projects that a firm can afford to fund and no
project receives funding for the future simply because it received funding in the
past.
True
False
Answer: True
Page: 263
33. Intermediate products or services are those products or services that are produced
in one division of a diversified firm that are used as inputs by another division.
True
False
Answer: True
Page: 263
34. In a diversified firm, market prices are the set by a firms corporate management to
accomplish corporate objectives while transfer prices are determined by the market
forces of supply and demand.
True
False
Answer: False
Page: 263
142 Part III

35. In choosing which transfer pricing system to use, a firm should be less concerned
about finding the "right" transfer-pricing mechanism and be more concerned about
choosing a transfer-pricing policy that creates the fewest management problems.
True
False
Answer: True
Page: 265
36. Traditionally, the compensation of corporate managers in a diversified firm has
been only loosely connected to the firms economic performance.
True
False
Answer: True
Page: 266
37. An important study on executive compensation found that differences in CEO cash
compensation is not very responsive to differences in firm performance, even if a
substantial percentage of the CEOs compensation came in the form of stock and
stock options in the firm.
True
False
Answer: False
Page: 266
38. A firm pursuing an international strategy that uses a decentralized federation
structure delegates strategic and operational decisions to those operational entities
that maximize responsiveness to local conditions and international integration.
True
False
Answer: False
Page: 268
Difficulty: Hard
39. A firm pursuing an international strategy that uses a coordinated federation
structure organizes each country as a full profit-and-loss center and delegates
operational decisions to division general mangers or country presidents but
reserving broader strategic decisions for corporate headquarters.
True
False
Answer: True
Page: 268
40. A firm pursuing an international strategy that uses a centralized hub structure
retains strategic and operational decisions at headquarters.
True
False
Answer: True
Page: 270
MULTIPLE CHOICE QUESTIONS

41. The most common organizational structure for implementing a corporate
diversification strategy is the __________ structure.
A. matrix
B. u-form
C. m-form
D. functional
Answer: C
Page: 246
Difficulty: Easy
42. In a multidivisional structure, each business that the firm engages in is managed
through a
A. product line.
B. division.
C. geographic unit.
D. function.
Answer: B
Page: 247
Difficulty: Easy
43. The divisions of an M-form organization are true
A. profit-and-loss centers.
B. functional units.
C. matrix teams.
D. organic structures.
Answer: A
Page: 247
44. The M-form structure is designed to create checks and balances for managers that
increase the probability that a diversified firm will be managed in ways consistent
with
A. the interests of all of its stakeholders.
B. an exclusively short-term perspective.
C. an exclusively long-term perspective.
D. the interests of its equity holders.
Answer: D
Page: 247
45. In an agency relationship, the party that delegates decision-making authority to
another individual is known as the
A. stakeholder.
B. principal.
C. agent.
D. stockholder.
Answer: B
Page: 248
144 Part III

46. Two common agency problems include
A. managers investing some of a firms capital in managerial perquisites that do not
add economic value to a firm and managerial risk aversion.
B. managers not investing enough of a firms capital in managerial perquisites and
managerial risk aversion.
C. managers investing some of a firms capital in managerial perquisites that do not
add economic value to a firm and managerial risk seeking.
D. managers not investing enough of a firms capital in managerial perquisites and
managerial risk seeking.
Answer: A
Page: 248
Difficulty: Hard
47. Which component of the M-form structure evaluates the firms decision making to
ensure that it is consistent with the interests of equity holders?
A. Senior executives
B. Corporate staff
C. Board of directors
D. Division general managers
Answer: C
Page: 249
Difficulty: Easy
48. A board of directors typically consist of
A. 10 to 15 individuals drawn from a firms top management group and from
individuals outside the firm.
B. 10 to 15 individuals drawn exclusively from a firms top management group.
C. 10 to 15 individuals drawn exclusively from individuals outside the firm.
D. 10 to 15 individuals drawn from all stakeholder groups associated with the firm.
Answer: A
Page: 250
49. Which of the following statements regarding outside members of boards of
directors is accurate?
A. Outside directors, as compared to insiders, tend to focus less on monitoring a firms
economic performance than on other measures of firm performance and are more
likely than insider members to dismiss CEOs following poor performance.
B. Outside directors, as compared to insiders, tend to focus less on monitoring a firms
economic performance than on other measures of firm performance and are less
likely than insider members to dismiss CEOs following poor performance.
C. Outside directors, as compared to insiders, tend to focus more on monitoring a
firms economic performance than on other measures of firm performance and are
less likely than insider members to dismiss CEOs following poor performance.
D. Outside directors, as compared to insiders, tend to focus more on monitoring a
firms economic performance than on other measures of firm performance and are
more likely than insider members to dismiss CEOs following poor performance.
Answer: D
Page: 250
Difficulty: Hard
50. In examining the question of whether the roles of CEO and chairman should be
combined, empirical research on this question suggests
A. that combining these roles is always positively related with firm performance.
B. that separating these roles is always positively related with firm performance.
C. that combining these roles is positively correlated with firm performance when the
firm operates in slow-growth and simple competitive environments.
D. that separating these roles is positively correlated with firm performance when the
firm operates in slow-growth and simple competitive environments.
Answer: C
Page: 251
Difficulty: Hard
51. The _________ is the subcommittee of the board of directors that is responsible for
ensuring the accuracy of accounting and financial statements.
A. audit committee
B. finance committee
C. nominating committee
D. personnel and compensation committee
Answer: A
Page: 251
52. The _________ is a subcommittee of the board of directors that maintains the
relationship between the firm and external capital markets.
A. nominating committee
B. audit committee
C. personnel and compensation committee
D. finance committee
Answer: D
Page: 251
53. In the United States, approximately what percent of the firms in the Standard &
Poor's 500 have their founding families still involved in day-to-day management?
A. 50%
B. 66%
C. 33%
D. 25%
Answer: C
Page: 252
Difficulty: Hard
54. In which country are all 20 of the largest 20 firms in the economy family
dominated?
A. the United Kingdom
B. Mexico
C. Argentina
D. New Zealand
Answer: B
Page: 252
146 Part III

55. Which of the following statements regarding family owned firms is accurate?
A. The agency problems that exist in professionally managed firms are more
pronounced in family-dominated firms.
B. Family owned firms have a lower sense of loyalty among their employees than
professionally managed firms.
C. Family-dominated firms can make strategic decisions faster than large bureaucratic
firms.
D. Family owned firms tend to respond to short-term fluctuations rather than focusing
on long-term growth.
Answer: C
Page: 252
56. In 1970 institutions owned ______ percent of the equity traded in the United States
and by 2002 they owned _______ percent of the equity traded in the United States.
A. 32; 62
B. 62; 32
C. 48; 62
D. 32; 48
Answer: A
Page: 252
57. Which of the following statements regarding institutional investors is accurate?
A. Institutional investors tend to be more interested in maximizing the short-term
value of their portfolios than in the long-term performance of firms in those
portfolios.
B. High levels of institutional ownership are negatively related to the level of R&D in
a firm.
C. High levels of institutional ownership have a strong, positive relationship with the
level of R&D in a firm.
D. High levels of institutional ownership lead firms to sell strategically unrelated
businesses.
Answer: D
Page: 254
58. The two responsibilities of the senior executive in an M-form organization are
A. strategy formulation and strategy implementation.
B. strategy formulation and strategic control.
C. strategic control and strategy implementation.
D. strategy implementation and differentiation.
Answer: A
Page: 254
Difficulty: Easy
59. Which role in the Office of the President is responsible for strategy
implementation?
A. Chairman of the board
B. Chief executive officer
C. Chief operating officer
D. Chief strategist
Answer: C
Page: 255
60. The primary responsibility of the ________ is to provide information about the
firm's external and internal environments to the firm's senior executive.
A. corporate staff
B. board of directors
C. division general managers
D. shared activity managers
Answer: A
Page: 255
61. The divided loyalties that divisional staff managers have between corporate staff
managers and functional managers is potentially the most problematic in _______
staff functions.
A. marketing
B. accounting
C. logistics
D. production
Answer: B
Page: 256
62. In an M-form organization the management of day-to-day operations is delegated
to
A. divisional general managers and to corporate staff managers.
B. corporate staff managers and to functional managers who report to corporate staff
managers.
C. divisional general managers and to functional managers who report to division
general managers.
D. the board of directors and corporate staff managers who report to the board of
directors.
Answer: C
Page: 257
Difficulty: Hard
63. ____________ have full profit-and-loss responsibility and typically have multiple
functional managers reporting to them.
A. Division general managers
B. Corporate staff managers
C. Senior executives
D. Shared activity managers
Answer: A
Page: 257
64. When compared to the strategy implementation responsibilities of senior executives
in U-form organizations, when implementing strategy division general managers in
M-form organizations
A. tend to have to deal with less conflict.
B. have to compete for external capital funding.
C. tend to have to deal with substantially more conflict.
D. must cooperate with other divisions to exploit corporate economies of scope.
Answer: D
Page: 257
148 Part III

65. Rather than having profit-and-loss responsibilities, _______ are assigned a budget
and manage their operations to that budget.
A. profit centers
B. cost centers
C. operation centers
D. functional centers
Answer: B
Page: 258
66. When the cost of services from a shared activity is ________ the cost of
comparable services provided by a division itself or by an outside supplier than the
division, general managers have a strong incentive ________.
A. less than; to use the services of shared activities
B. greater than; to use the services of shared activities
C. less than; to use the services of an outside supplier
D. equal to; to use the services of an outside supplier
Answer: A
Page: 258
67. ______ is an economic measure of divisional performance.
A. Return on assets
B. Return on a division's sales
C. Economic value added
D. A division's growth rate
Answer: C
Page: 260
68. Which of the following is a weakness of using a hurdle rate as a standard of
evaluating the performance of a division?
A. The process is time-consuming.
B. The process is fraught with political intrigue.
C. This approach lets other firms determine what is and what is not excellent
performance for a division within a diversified firm.
D. The use of such a single standard ignores important differences in performance that
might exist across divisions.
Answer: D
Page: 259
Difficulty: Hard
69. Most accounting measures of divisional performance have a common limitation in
that they
A. have a short-term bias.
B. are costly to implement.
C. are difficult to interpret.
D. have a long-term bias.
Answer: A
Page: 260
70. If a division of a multi-divisional firm has adjusted accounting earnings of $10

million, a weighted average cost of capital of 10% and a total capital employed by
the division of $50 million, the division has an EVA of
A. $25 million.
B. $5 million.
C. $15 million.
D. $20 million.
Answer: B
Page: 260
Difficulty: Hard
71. When adjusting a division's accounting earnings for use in the economic value
added calculations, R&D spending is usually
A. subtracted from the division's performance.
B. depreciated over the life of the average R&D projected and subtracted from the
division's performance.
C. amortized over the life of the average R&D projected and added back to the
division's performance.
D. added back into the division's performance.
Answer: D
Page: 260
72. In ________ budgeting, corporate executives create a list of all capital allocation
requests from divisions in a firm, rank them from "most important" to "least
important" and then fund all the projects a firm can afford, given the amount of
capital that is available and no project receives funding simply because it was
funded in the past.
A. cost-plus
B. activity-based
C. zero-based
D. revenue-based
Answer: C
Page: 263
73. In a multidivisional company, one division "sells" its products or services to a
second division for a(n) ________ which is set by a firm's corporate management
to accomplish corporate objectives.
A. allocation price
B. transfer cost
C. market price
D. transfer price
Answer: D
Page: 263
150 Part III

74. Under which transfer pricing scheme is the transfer price set equal to the selling
division's actual cost of production, or set equal to the cost of production if the
selling division were operating at maximum efficiency?
A. Exchange autonomy
B. Mandated full cost
C. Mandated market based
D. Dual pricing
Answer: C
Page: 265
75. Which of the following statements regarding CEO compensation is accurate?
A. Differences in CEO cash compensation are very responsive to differences in firm
performance.
B. If a substantial percentage of a CEO's compensation comes in the form of stock and
stock options in the firm, changes in compensation are closely linked with changes
in firm performance.
C. If a substantial percentage of a CEO's compensation comes in the form of stock and
stock options in the firm, changes in compensation are not closely linked with
changes in firm performance.
D. If a substantial percentage of a CEO's compensation comes in the form of salary,
changes in compensation can be expected to be closely linked with changes in firm
performance.
Answer: B
Page: 266
76. A(n) __________ occurs when a large, typically diversified firm divests itself of a
business in which it has historically been operating and the divested business
operates as an independent unit.
A. harvest
B. liquidation
C. initial public offering
D. corporate spin-off
Answer: D
Page: 267
77. A business unit within a diversified firm may be sold to the public through a(n)
A. corporate spin-off.
B. liquidation.
C. IPO.
D. harvest strategy.
Answer: C
Page: 267
78. In the __________ organizational structure, each company in a country in which a

firm operates is organized as a full profit-and-loss division headed by a divisional
general manager who is typically the president of the company in that particular
country.
A. decentralized federation
B. coordinated federation
C. centralized hub
D. transnational structure
Answer: A
Page: 268
79. In the ___________ organizational structure each country operation is organized as
a full profit-and-loss center but strategic operational decisions are delegated to
division general managers but broader strategic decisions are made at corporate
headquarters.
A. transnational structure
B. centralized hub
C. decentralized federation
D. coordinated federation
Answer: D
Page: 268
80. If the importance of local responsiveness is low, and the importance of global
integration is high, a firm should use a ________ approach to managing its
international strategy.
A. transnational structure
B. centralized hub
C. coordinated federation
D. decentralized federation
Answer: B
Page: 271
Difficulty: Hard
SpandoCorp is a diversified firm that makes industrial, military and consumer products from
Spandex. SpandoCorp manages each of the businesses that it operates in as a separate division
and treats each as a true profit-and-loss center. In this organization, Grace McKenna is
responsible for deciding which set of businesses SpandoCorp will operate in and for encouraging
behavior that is consistent with this strategy, Wells Tucker provides information to McKenna
about the internal and external environments that she uses in her decision making, and Kelly Rae
is one of the individuals who is responsible for evaluating the firms decision making to ensure
that it is consistent with the interests if equity holders.
81. Which organizational structure is SpandoCorp using?
A. U-form
B. Matrix
C. M-form
D. Functional
Answer: C
Page: 247
152 Part III

82. Grace McKenna is best described as a(n) __________ in SpandoCorp.
A. senior executive
B. corporate staff member
C. division general manager
D. institutional investor
Answer: A
Page: 254
83. Wells Tuckers position in SpandoCorp is best described as
A. a division general manager.
B. a member of the corporate staff.
C. the senior executive.
D. a member of the board of directors.
Answer: B
Page: 255
Difficulty: Hard
84. Kelly Raes position is SpandoCorp is best described as a(n)
A. institutional investor.
B. senior executive.
C. division general manager.
D. member of the board of directors.
Answer: D
Page: 249
85. If Todd Hienz was the Chief Operating Officer for SpandoCorp, his responsibilities
would include
A. supervision of the board of directors in its monitoring role.
B. strategy implementation.
C. strategy formulation.
D. strategy control.
Answer: B
Page: 255
86. If SpandoCorp wanted to measure the performance of its divisions with a method
that would minimize any potential short-term bias, they should use a(n)
A. hurdle rate based measure of divisional performance.
B. divisional budget based measure of performance.
C. economic value added measures of divisional performance.
D. measure of performance based on the average level of profitability of firms in a
divisions industry.
Answer: C
Page: 260
Difficulty: Hard
87. If SpandoCorp used a ________ budgeting process it would assume that no project
would received funding for the future simply because it was funded in the past and
required each project to stand on its own merits each year to be included in a list of
important projects that the firm can afford to fund.
A. zero-based
B. cost plus
C. dynamic
D. traditional
Answer: A
Page: 263
88. If the bulk materials division of SpandoCorp sold its reams of Spandex to the
military division and set the transfer price of these reams equal to the bulk
materials actual cost of production, SpandoCorp would be using the _______
transfer pricing scheme.
A. exchange autonomy
B. mandated full cost
C. mandated market based
D. dual pricing
Answer: B
Page: 265
89. If SpandoCorps Board of Directors wanted to ensure that changes in the CEO's
compensation would be closely linked to changes in the firms performance they
should
A. use a compensation package that includes only a salary for the CEO.
B. use a compensation package that includes a salary and a cash bonus for the CEO.
C. use a compensation package the includes a salary, a cash bonus and stock options
that represent only a relatively small percentage of for the CEOs total
compensation package.
D. use a compensation package that includes a salary and stock options that represent
only a relatively substantial percentage of for the CEOs total compensation
package.
Answer: D
Page: 266
90. If SpandoCorp wanted to implement an international strategy and was not
especially concerned with global integration but wanted to be sure to choose the
organizational structure that was the most locally responsive, the company should
use a
A. decentralized federation.
B. transnational structure.
C. centralized hub.
D. coordinated federation.
Answer: A
Page: 271
Difficulty: Hard
154 Part III

ESSAY QUESTIONS
91. Describe the multi-divisional, or M-form structure and how it is used to implement a
corporate diversification strategy.
The most common organizational structure for implementing a corporate diversification
strategy is the M-form, or multidivisional, structure. The M-form structure is designed to
create checks and balances for managers in a firm that increase the probability that a
diversified firms will be managed in ways consistent with the interests of its equity holders.
In the multidivisional structure, each business that the firm engages in is managed through a
division, which is treated as true profit-and-loss center in that the profits and losses are
calculated at the level of the division in these firms. Divisions in an M-form organization
typically adopt a U-form structure and are large enough to represent identifiable business
entities, but small enough so that a division general manager can effectively manage each one.
Pages: 246-247
92. Define what constitutes an agency relationship, the roles of the principal and the agent,
and discuss how the agency relationship is reflected in the context of corporate
diversification, when the agency relationship can be effective, and identify two common
agency problems.
An agency relationship exists whenever one party to an exchange delegates decision-making
authority to a second party. In the agency relationship the party delegating the decision making
authority is called the agent and the party to whom the authority is delegated is called the
agent. In the context of corporate diversification, an agency relationship exists between a
firms outside equity holders (as principals) and its managers (as agents) to the extent that
equity holders delegate the day-to-day management of their investment to those managers.
The agency relationship between equity holders and managers can be very effective as long as
managers make investment decisions in ways that are consistent with equity holders interests.
Thus, if equity holders are interested in maximizing the rate of return on their investment in a
firm, and if managers make their investment decisions with this objective in mind, then equity
holders will have few concerns about delegating the day-to-day management of their
investments to managers. Unfortunately, in numerous situations the interests of a firms
outside equity holders and its managers do not coincide. When parties in an agency
relationship differ in their decision-making objectives, agency problems arise. Two common
agency problems have been identified including:
1. Managers can decide to take some of a firms capital and invest it in managerial perquisites
that do not add economic value to the firm but do directly benefit those managers.
2. To the extent that very risky investments may jeopardize a firms survival and thus
management's compensation and positions, managers to be more risk averse in their
decision making than equity holders would prefer them to be.
Page: 248
93. Describe the nature and role of the board of directors in an M-form organization,
discuss who generally serves on the board, the role of outside members on a board of
directors and when the roles of CEO and Chairman of the Board should be combined
or separated.
In an M-form organization the board of director's primary responsibility is to monitor decision
making in the firm, to ensure that it is consistent with the interests of outside equity holders. In
principle, all of a firms senior managers report to the board. A board of directors typically
consists of 10 to 15 individuals drawn from a firms top management group and from
individuals outside the firm. A firms senior executive (often identified by the title president or
chief executive officer or CEO), its chief financial officer (CFO), and a few other senior
managers are usually on the boardalthough outsiders typically outnumber managers on the
board. The firms senior executive is often but not always the chairman of the board (a term
used here to denote both female and male senior executives). The task of managerial board
membersincluding the board chairis to provide other board members information and
insights about critical decisions being made in the firm and the effect those decisions are likely
to have on a firms equity holders. The task of outsiders on the board is to evaluate the past,
current, and future performance of the firm, and of its senior managers, to ensure that the
actions taken in the firm are consistent with equity holders interests. Outside directors, as
compared to insiders, tend to focus more on monitoring a firms economic performance rather
than other measures of firm performance. Outside board members are also more likely than
inside members to dismiss CEOs following poor performance. Also, outside board members
have a stronger incentive than inside members to maintain their reputation as effective
monitors. This incentive by itself can lead to more effective monitoring by outside board
members. Moreover, the monitoring effectiveness of outside board members seems to be
substantially enhanced when they personally own a substantial amount of a firms equity.
There is currently some debate about whether the roles of board chair and CEO should be
combined or separated, and if separated, what kinds of people should occupy these positions.
Empirical research on this question suggests that whether these roles of CEO and chairman
should be combined or not depends on the complexity of the information analysis and
monitoring task facing the CEO and chairman. Some researchers have found that combining
the roles of CEO and chairman is positively correlated with firm performance when firms
operate in slow-growth and simple competitive environmentsenvironments that do not
overtax the cognitive capability of a single individual. This finding suggests that combining
these roles does not necessarily increase conflicts between a firm and its equity holders. This
research also found that separating the roles of CEO and board chair is positively correlated
with firm performance when firms operate in high-growth and very complex environments. In
such environments, a single individual cannot fulfill all the responsibilities of both CEO and
chairman, and thus the two roles need to be held by separate individuals.
Pages: 249-251
Difficulty: Hard
156 Part III

94. Discuss the role of institutional investors in an M-form organization. In addressing this
question be sure to identify who institutional investors are, discuss trends in
institutional ownership, and the whether institutional investors encourage managers to
act in ways that are consistent with the interests of equity holders, or if institutional
investors are overly myopic.
Institutional owners are usually pension funds, mutual funds, insurance companies or other
groups of individual investors that have joined together to manage their investments. In 1970,
institutions owned 32 percent of the equity traded in the United States. By 1990, institutions
owned 48 percent of this equity. In 2002, they own 62% of the equity traded in the U.S.
Institutional investors can use their investment clout to insist that a firms management behaves
in ways consistent with the interests of equity holders. Observers who assume that institutional
investors are interested more in maximizing the short-term value of their portfolios than in the
long-term performance of firms in those portfolios fear that such power will force firms to
make only short-term investments. Recent research in the United States and Japan, however,
suggests that institutional investors are not unduly myopic. Additionally, other researchers
have shown that high levels of institutional ownership leads firms to sell strategically unrelated
businesses. This effect of institutional investors is enhanced if, in addition, outside directors on
a firms board have substantial equity investments in the firm.
Page: 252-254Difficulty: Moderate
95. Identify the responsibilities of the senior executive in an M-form organization and
discuss the three different roles in the office of the president and the responsibilities of
each role.
The senior executive (the president or CEO) in an M-form organization has two
responsibilities: strategy formulation and strategy implementation. Strategy formulation
entails deciding in which set of businesses a diversified firm will operate. At the broadest
level, deciding which businesses a diversified firm should operate in is equivalent to
discovering and developing valuable economies of scope among a firms current and potential
businesses. If these economies of scope are also rare and costly to imitate, they can be a source
of sustained competitive advantage for a diversified firm. The senior executive is uniquely
positioned to discover, develop, and nurture valuable economies of scope in a diversified firm
but the senior executive in an M-form organization should involve numerous other divisional
and functional managers in strategy formulation to ensure complete and accurate information
as input to the process and a broad understanding of and commitment to that strategy once it
has been formulated. Strategy implementation focuses on encouraging behavior in a firm that
is consistent with this strategy and almost always involves resolving conflicts within and
between each of the major managerial components of the M-form structure: corporate staff,
division general managers, and shared activity managers.
It is often the case that the roles and responsibilities of the senior executive in an M-form
organization are greater than what can be reasonably managed by a single individual. This is
especially likely if a firm is broadly diversified across numerous complex products and
markets. In this situation, it is not uncommon for the tasks of the senior executive to be
divided among two or three people: the chairman of the board (responsible for the supervision
of the board of directors in its monitoring role), the chief executive officer (responsible for
strategy formulation), and the chief operating officer (responsible for strategy implementation).
Together, these roles are known as the office of the president.
Pages:
254-255
96. Discuss the role of division general managers in an M-form organization and compare
and contrast this role with that of senior executives in U-form organizations.
Division general managers in an M-form organization have primary responsibility for
managing the day-to-day operations of a firms businesses. Division general managers have
full profit-and-loss responsibility and typically have multiple functional managers reporting to
them. As general managers, they have both strategy formulation and strategy implementation
responsibilities. On the strategy formulation side, division general managers choose strategies
for their divisions, within the broader strategic context established by the senior executive of
the firm. Many of the analytical tools described in Parts I and II of this book can be used by
division general managers to make these strategy formulation decisions.
The strategy implementation responsibilities of division general managers in an M-form
organization parallel the strategy implementation responsibilities of senior executives in Uform organizations. In particular, division general managers must be able to coordinate the
activities of often conflicting functional managers in order to implement a divisions strategies.
In addition to their responsibilities as a U-form senior executive, division general managers in
an M-form organization have two additional responsibilities: to compete for corporate capital
and to cooperate with other divisions to exploit corporate economies of scope. Division
general managers compete for corporate capital by obtaining high rates of return on capital
invested in previous periods by the corporations in their business. In most firms, divisions that
have demonstrated the ability to generate high rates of return on earlier capital investments
gain access to more capital, or to lower-cost capital, compared to divisions that have not
demonstrated a history of such performance. Division general managers cooperate to exploit
economies of scope by working with shared activity managers, corporate staff managers, and
the senior executive in the firm to isolate, understand, and use the economies of scope around
which the diversified firm was originally organized. Division general managers can even
become involved in discovering new economies of scope that were not anticipated when the
firms diversification strategy was originally implemented but nevertheless may be both
valuable and costly for outside investors to create on their own.
Page: 257
97. Discuss the role of accounting measures of divisional performance, identify three
different standards of comparison that can be used when evaluating the accounting
performance of a division along with the strengths and weaknesses of each standard,
and the potential weaknesses of accounting measures of divisional performance.
Common accounting measures of divisional performance include the return on the assets
controlled by a division, the return on a divisions sales, and a divisions sales growth. These
158 Part III

accounting measures of divisional performance are then compared with some standard to see if
a divisions performance exceeds or falls short of that standard. Diversified firms use three
different standards of comparison when evaluating the performance of a division: (1) a hurdle
rate that is common across all the different business units in a firm, (2) a divisions budgeted
level of performance (which may vary by division), and (3) the average level of profitability of
firms in a divisions industry.
Each of these standards of comparison has their strengths and weaknesses. For example, if a
corporation has a single hurdle rate of profitability that all divisions must meet or exceed, there
is little ambiguity about the performance objectives of divisions. On the other hand, such a
single standard ignores important differences in performance that might exist across divisions.
Comparing a divisions actual performance to its budgeted performance allows the
performance expectations of different divisions to vary, but the budgeting process is time
consuming and fraught with political intrigue. Finally, while comparing a divisions
performance with the average level of profitability of firms in a divisions industry also allows
performance expectations to vary across divisions within a diversified firm, this approach lets
other firms determine what is and is not excellent performance for a division within a
diversified firm. This approach can also be manipulated: By choosing just the right firms
with which to compare a divisions performance, almost any division can be made to look like
its performing better than its industry average.
No matter what standard of comparison is used to evaluate a divisions accounting
performance, most accounting measures of divisional performance have a common limitation.
All these measures have a short-term bias. This short-term bias reflects the fact that all these
measures treat investments in resources and capabilities that have the potential for generating
value in the long run and costs during a particular year.
Pages: 259-260
98. Discuss the relationship between accounting methods of measuring divisional

performance and economic methods, identify the formula used for calculating economic
value added, and discuss methods for adjusting accounting earnings and the
importance of making these adjustments.
Economic methods build on accounting methods, but adjust those methods to incorporate
short-term investments that may generate long-term benefits. Economic methods also compare
a divisions performance with a firms cost of capital. This avoids some of the gaming that can
characterize the use of other standards of comparison in applying accounting measures of
divisional performance.
Perhaps the most popular of these economically oriented measures of division performance is
known as economic value added or EVA. EVA is calculated by subtracting the cost of capital
employed in a division from that divisions earnings in the following manner:
EVA =
adjusted accounting earnings - (weighted average cost of capital x total capital

employed by a division)
The calculation of economic value added begins with a divisions adjusted accounting
earnings. These are a divisions traditional accounting earnings, adjusted so that they
approximate what would be a divisions economic earnings. Several adjustments to a
divisions accounting statements have been described in the literature. For example, traditional
accounting practices require R&D spending to be deducted each year from a divisions
earnings. This can lead division general managers to underinvest in longer-term R&D efforts.
In the EVA measure of divisional performance, R&D spending is added back into a divisions
performance, and R&D is then treated as an asset and depreciated over some period of time.
By adjusting a divisions earnings, and accounting for the cost of investing in a division,
economic value added is a much more accurate estimate of a divisions economic performance
than are traditional accounting measures of performance.
Pages:
260-261
99. Discuss the role of transfer pricing systems in a M-form organization, identify
difficulties with setting optimal prices, and identify four alternative transfer pricing
schemes.
The transfer of products or services produced in one division that are used as inputs for
products or services produced by a second division of a multidivisional firm is usually
managed through a transfer-pricing system in which one division sells its product or service
to a second division for a transfer price. Unlike a market price, which is typically determined
my market forces of supply and demand, transfer prices are set by a firms corporate
management to accomplish corporate objectives.
From an economic point of view, the rule for establishing the optimal transfer price in a
diversified firm is quite simple: The transfer price should be the value of the opportunities
forgone when one divisions product or service is transferred to another division. Setting
transfer prices equal to opportunity costs sounds simple enough, but it is very difficult to do in
real diversified firms. Establishing optimal transfer prices requires information about the value
of the opportunities forgone by the selling division. This, in turn, requires information about
this divisions marginal costs, its manufacturing capacity, external demand for its products, and
so forth. Much of this information is difficult to calculate. Moreover, it is rarely stable. As
market conditions change, demand for a divisions products can change, marginal costs can
change, and the value of opportunities forgone can change. Also, to the extent that a selling
division customizes the products or services it transfers to other divisions in a diversified firm,
the value of the opportunities forgone by this selling division become even more difficult to
calculate.
Even if this information could be obtained and updated rapidly, division general managers in
selling divisions have strong incentives to manipulate the information in ways that increase the
perceived value of the opportunities forgone by their division. These division general
managers can thus increase the transfer price for the products or services they sell to internal
160 Part III

customers and thereby appropriate for themselves profits that should have been allocated to
buying divisions.
Four alternative transfer pricing schemes that firms use in practice include:
Exchange autonomy in which buying and selling division general managers are free to
negotiate transfer price without corporate involvement and the transfer price is set
equal to the selling division's price to external customers.
Mandated full cost in which the transfer price is set equal to the selling division's actual
cost of product, or to the selling division's standard cost.
Mandated market price in which the transfer price is set equal to the market price in the
selling division's market.
Dual pricing in which the transfer price for the buying division is set equal to the
selling division's actual or standard costs, and the transfer price for the selling division
is equal to the price to external customers or the market price in the selling division's
market.
Pages:
263-265
100. Discuss the importance of compensation policies in diversified firms and identify the
CEO compensation package that most closely aligns the interests of the CEO with those
of stockholders.
A firms compensation policies constitute a final set of tools for implementing corporation
diversification. To the extent that compensation in diversified firms gives managers
incentives to make decisions consistent with stockholders interests, they can be an important
part of the process of implementing corporate diversification. Traditionally, the
compensation of corporate managers in a diversified firm has been only loosely connected to
the firms economic performance. Research indicates that differences in CEO cash
compensation (salary plus cash bonus) are not very responsive to differences in firm
performance but if a substantial percentage of a CEOs compensation came in the form of
stock and stock options in the firm, changes in compensation would be closely linked with
changes in the firm performance. These and similar findings reported elsewhere have led
more and more diversified firms to include stock and stock options as part of the
compensation package for the CEO to more closely align the interests of the CEO with those
of stockholders.
Page: 266
Difficulty: Easy

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Chapter 8: Organizing to Implement Corporate Diversification137

CHAPTER 8: ORGANIZING TO IMPLEMENT CORPORATE DIVERSIFICATION

The most common organization structure for implementing a corporate

Another name for the M-form is the multidivisional structure.

The divisions in an M-form organization are true profit-and-loss centers.

Divisions in an M-form organization should be large enough to represent

Each division in an M-form organization typically adopts a matrix structure and

138 Part III

Whenever one party to an exchange delegates decision-making authority to a

Chapter 8: Organizing to Implement Corporate Diversification139

140 Part III

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Chapter 8: Organizing to Implement Corporate Diversification143

MULTIPLE CHOICE QUESTIONS

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70. If a division of a multi-divisional firm has adjusted accounting earnings of $10

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78. In the __________ organizational structure, each company in a country in which a

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Chapter 8: Organizing to Implement Corporate Diversification153

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Chapter 8: Organizing to Implement Corporate Diversification157

158 Part III

98. Discuss the relationship between accounting methods of measuring divisional

Chapter 8: Organizing to Implement Corporate Diversification159

adjusted accounting earnings - (weighted average cost of capital x total capital

160 Part III

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