Register now or log in to join your professional community.
The drawback is that area managers will take inappropriate / suboptimal investment decisions resulting in inefficient use of available funds.
Explanation:
Assume net profits were $800 for last year and the target net profit growth rate is 5%.
To secure his reward, an area manager invested $500 (at the start of year) in new shops and raised the profits to $848 (6% growth).
Return on this new investment is 9.6% (48*100/500).
However, required rate of return (the cost of capital) is 15% for the company. And,
Head office was able to efficiently invest these funds elsewhere.
(All are invited to provide more precise answers that may help readers to grasp the point)
