Performance Measures and Intra-Firm Spillovers: Theory and Evidence

We revisit the question of how performance measures are used to evaluate business unit managers in response to intra-firm spillovers. Specifically, we are interested in variation in the relative incentive weightings of aggregated above-level measures (e.g., firm-wide net income), own-level business unit measures (e.g., business unit profit), and specific below-level measures (e.g., R&D expenses) in response to spillover arising from either the focal unit's effect on other business units or the other units' effect on the focal unit. Our theory highlights complementarity between above- and below-level measures and the existence of an interaction between the two directions of spillovers. Based on a survey of 122 business unit managers, we report evidence consistent with an interaction effect and with complementarity between above- and below-level measures. In particular, we show that firms increase the weighting on both above- and below-level measures when they are coping simultaneously with high levels of spillovers on other units and spillovers from other units.