Cost system and incentive structure effects on innovation, efficiency and profitability in teams

The small number of full-scale adoptions of activity-based costing (ABC) co upled with ABC implementation failures have fueled a debate about the costs and benefits of ABC relative to more traditional volume-based costing (VBC ) systems. ABC differs from VBC by focusing attention on activities and res ources that are under the control of multiple workers, Reducing these costs often requires a coordinated effort. Therefore, incentives that motivate w orkers to cooperate are a prerequisite to successful process improvements b ased on ABC. Alternatively, when competitive incentives are combined with A BC, the result can be unexpected and negative. We examine how accounting co st system and incentive structure choices interact. We find that profits ar e highest when ABC is linked with group-based incentives, which provide hig h motivation to cooperate. In contrast, the lowest level of profit occurs w hen the same information-rich cost system, ABC, is coupled with tournament- based incentives. VBC, a cost system that provides a lower level of cost dr iver information, moderates the incentive effect. Thus, our results demonst rate that the effectiveness of ABC relative to traditional VBC is influence d by its interactive effect with incentive compensation.