Better Safe Than Sorry: Subsidiary Performance Feedback and Internal Governance in Multiunit Firms

Abstract

This paper explores the link between subsidiary performance feedback and internal governance mechanisms in multiunit firms. A central premise of performance-feedback models is that performance below aspirations is associated with increased risk tolerance and thereby with a higher likelihood of taking excessive risks in resource allocation decisions. Building on this observation, we contend that the headquarters of multiunit firms take this association into account in the design of internal (i.e., headquarters-subsidiary) governance mechanisms. Accordingly, a subsidiary’s performance-aspiration gap (below aspirations) is positively associated with the headquarters’ oversight of its resource allocation decisions and negatively associated with the provision of incentive schemes that promote risk taking. Regression results, using data on subsidiaries in France between 1998 and 2004, support our hypotheses and show that subsidiaries performing below historical and social aspirations are less likely to be given discretion in investment decisions and incentivized by cash bonuses. In the supplementary analyses, we also provide suggestive evidence that subsidiary performance problems in multiunit firms trigger structural adaptation in the internal governance mechanisms in pursuit of regaining fit.