Use of residual income to evaluate the performance of divisions may lead to a reduction in suboptimizing behavior by managers, compared to the use of return on investment to evaluate performance.

Question

Quizplus · Accepted Answer

Using residual income to evaluate performance encourages managers to focus on earning profits above a certain minimum level, rather than maximizing return on investment by minimizing investment. This reduces the possibility of suboptimizing behavior in which managers sacrifice long-term profitability to meet short-term targets.

Use of Residual Income to Evaluate the Performance of Divisions