Performance evaluation and the use of transfer pricing in Maltese divisionalised organisations

Abstract

Purpose: The purpose of this dissertation is to analyse the performance evaluation measures implemented within divisionalised organisations. The dissertation also aims to evaluate the use of the controllability principle when evaluating performance. Additionally, this research assesses the transfer pricing system within such organisations, specifically, the process by which such transfer prices are determined, and the objectives of the transfer pricing system implemented. Design: Due to the nature of the objectives, a qualitative approach was adopted. Following an analysis of the current literature, nine semi-structured interviews were held with the Chief Financial Officers of organisations that adopt a divisionalised structure. Findings: This research reveals that participants adopt a ‘hybrid’ organisational structure, with the degree of decentralisation varying from one group to another, often depending on its size. Investment and strategic decisions are vested with top management, meaning that control remains centralised within upper management and that divisional managers have limited autonomy. Additionally, it was established that most participants apply the controllability principle to a certain extent when evaluating managerial performance. This is mainly dependent on whether the uncontrollable factor is an internal or external factor. The study reveals that even though all participants implement, or are in the process of implementing a formal Performance Measurement System (PMS), in most cases the PMS applies only to top management and divisional managers. Furthermore, the research revealed that participants implement either the cost-based method or the market price method to establish the transfer price for intra-divisional transactions, and the transfer price is determined by top management. Additionally, the findings indicate that goal congruence and the facilitation of fair divisional performance evaluation are often high on the agenda when determining the transfer pricing policy, in contrast with divisional autonomy, which tends to be given less importance. Conclusions: The study clearly shows that control remains centralised within top management, even though the participants recognise the benefits of increased decentralisation. Additionally, it was concluded that it would be beneficial to the organisation if the PMS is applied to all the employees within the organisation as this will improve motivation which will subsequently improve performance. Lastly, it was established that the increased transfer pricing regulations and the threats of tax audits have rendered transfer pricing an expensive compliance issue, bringing about a change in the priority of transfer pricing objectives. Value: The divisionalised organisational structure has become increasingly popular since it allows for a higher degree of specialisation and diversification. This research is expected to be a reference point for organisations that plan on adopting a divisionalised organisational structure by providing an in-depth analysis of the performance evaluation measures and the transfer pricing systems implemented by organisations that adopt a similar organisational structure.