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The effects of experience and the firm's environment on manager's project selection decisions.

This study is a first attempt to initiate a discussion of how profit center managers' project selection decisions are affected by their experience and the environment in which they make those decisions. Along with other researchers (Scribner, 1986; Wagner and Sternberg, 1986), we contend that the managerial environment affects managers' project selection decisions. Further, we maintain that managers with different levels of experience respond to features of the environment differently. One specific environmental variable is addressed in this paper: the threat of a corporate takeover. A corporate takeover attempt represents a crisis situation for the profit center manager which could result in the manager losing his or her job. The specific research question is, do both inexperienced and experienced managers make the same project selection decisions when faced with the threat of a corporate takeover attempt? While the effects of experience have been extensively researched in the auditing literature (see, for example, Choo, 1989; Colbert, 1989; Davis and Solomon, 1989; Libby and Luft, 1993 for review of this literature), the topic has not been studied at all in a managerial accounting environment. Although the theory of practical intelligence provides the basis for hypothesis development, this study has an exploratory element. A major intention of this research is to provide some direction for researchers who are interested in how managers' environments affect their decisions.

An experiment was conducted which investigated the effects of experience on project selection decisions. In this research, an experienced manager is one who has made project selection decisions for at least two years. An inexperienced manager is one who has never made project selection decisions but has had formal training in the project selection task. Following Shanteau (1988), such an inexperienced manager is referred to here as naive. While no main effects were detected, a first order interaction effect involving experience and knowledge of the takeover attempt was detected. Both the theory developed in the paper and conversations with profit center managers provided possible explanations for our findings.


A recent graduate of a prestigious undergraduate or master of business administration (MBA) program with no prior business experience rarely, if ever, assumes a position of significant managerial responsibility immediately upon graduation. It is generally assumed that the new graduate is not prepared to assume such responsibilities because he or she lacks experience. This paper suggests that experience means, among other things, the ability to adapt to a constantly changing environment (Klemp and McClelland, 1986). This ability to adapt is referred to here as practical intelligence. The purpose of this paper is to present a discussion and a limited empirical test of what happens to a manager as the manager gains experience and learns how to adapt to a changing managerial environment. This paper focuses specifically on profit center managers.

Profit center managers play a substantial, if not decisive role in determining the business strategies in their units, such as where growth should occur and how it should be achieved (Merchant, 1989). Deciding on business strategy means that managers select or reject individual projects that may be pursued in their profit centers. An understanding of the effects of experience is important because in a real-world setting, it seems reasonable to expect that managers' decisions are affected by their past experiences. The reasons and extent to which experience changes these decisions are of interest. Past decision research has largely ignored the effects of the context or business environment on the decision being made. The method employed in much behavioral research about managers requires experimental subjects to respond to an isolated mental task which is cut off from the environment in which that task normally takes place (see, for example, Chow, 1983; Young, 1985). Research that is removed from the actual decision-making environment is very useful in theory building; nonetheless, one must not forget that managers' decisions are likely to be affected by the environment in which they make those decisions.

Learning to Select Projects: The Role of Public Knowledge, Private Knowledge, and Practical Intelligence

Profit center managers select and implement specific projects within their profit centers. The profit center managers' project selection decisions are guided by both public and private knowledge. Public knowledge (also known as academic, formal, declarative or theoretical knowledge) consists of facts, theories, and definitions from textbooks and journals (Scribner, 1986; Bonner et al., 1992). Public knowledge can be acquired in formal educational programs such as undergraduate business or MBA programs. Private knowledge, also known as tacit knowledge (Wagner and Sternberg, 1985) consists of rules of thumb (heuristics) that are developed through direct experience (Bedard, 1989). Scribner refers to private knowledge as "thinking that is embedded in the larger purposive activities of daily life and that functions to achieve the goals of those activities" (1986: 15). Private knowledge is probably disorganized and informal, making it ill-suited for direct instruction. In a managerial setting public knowledge must generally be in place prior to the acquisition of private knowledge, so that private knowledge can be acquired through interpreting public knowledge (Bonner and Walker, 1994). For a profit center manager, private knowledge is frequently acquired as a result of on-the-job experiences.

This paper suggests that the experienced manager integrates these two types of knowledge with the goal of demonstrating practically intelligent behavior. Practically intelligent behavior is behavior under the control of cognitive processes and employed toward the solution of problems which challenge the well-being and survival of the individual (Charlesworth, 1976). Practically intelligent behavior assists the manager in adapting to changing conditions. Successful adaptation is likely only when the manager's public and private knowledge stores are appropriate for the task at hand (Libby and Luft, 1993).

Public Knowledge

Future profit center managers can acquire public knowledge relating to the project selection task at a college or university. In such a formal educational setting, business fundamentals are conveyed to students through course offerings in the areas of management, accounting, finance, and organizational behavior. One example of public knowledge which is important for this study is knowledge of capital budgeting techniques. In finance and management accounting courses, students learn the principles of net present value (NPV) analysis. Students are taught that projects should be selected based on the NPV of the proposed project. They are also taught that basing a project selection decision on projected accrual accounting earnings may lead the manager to the wrong decision, because accounting measures such as earnings or return on assets do not provide a reliable forecast of the value creating potential of the prospective project (Beaver, 1981). This is due to the fact that the forecasted accrual accounting earnings for a project might appear favorable even though the project actually has a negative NPV. Similarly, the forecasted accrual accounting earnings for a project might not appear favorable even though the project has a positive NPV, Thus, accrual accounting and NPV methods can lead to different decisions. The results of NPV analysis should guide a managers' decisions because accrual accounting projections do not provide an accurate forecast of the value creating potential of different projects or strategies (Brealey and Myers, 1988; Copeland and Weston, 1988).

The public knowledge that students acquire in undergraduate and graduate business programs appears to be largely model-based and abstract. Students are taught models (such as the NPV model) which typically contain a set of limiting assumptions. For example, the NPV model assumes that the amounts and timing of cash flows, as well as the cost of capital, are known with certainty. Managers acquire public knowledge by reading about techniques such as NPV analysis and then working problems which have a single correct solution. Such problem solving is abstract and removed from reality because the solution of the NPV problem is an end in itself (Scribner, 1986). In an actual work setting, the solution of the NPV problem is preliminary to making a decision which incorporates many other variables. A quantitative model such as the NPV model does not capture the complexities of a managerial decision such as the project selection task. Although many finance and accounting textbooks stress the fact that qualitative considerations must be taken into account before making a capital budgeting decision, students are generally not made aware of what those qualitative considerations might be.

Public knowledge is a basis or starting point for functioning as a successful profit center manager. It provides a skeletal framework for certain decisions (Waller and Felix, 1984) such as the project selection decision. The skeletal framework consists of over-simplified rules of evaluation learned from textbooks and classroom instruction (Bedard, 1989). For example, an over-simplified rule is "select all projects with a positive NPV." Although it is the basis for successfully functioning as a profit center manager, public knowledge by itself does not provide a manager with the skills that he or she needs to be a success over the long term.(1)

Private Knowledge

In order to be successful over the longer term, a manager's public knowledge framework is altered as the manager experiences new situations. The public knowledge framework that forms the basis for the project selection decision may become so overgrown with experiential adjustments as to be unrecognizable (Gibbins, 1984). These experiential adjustments are obtained as part of the process of attaining private knowledge and are crucial to managers' successful adaptation to the real world.

Private knowledge is acquired as the manager functions within the firm's management control system. Anthony defines management control as "the process by which managers influence other members of the organization to implement the organization's strategies" (1988: 10). Flamholtz et al. (1985) suggest that a critical part of the management control system is the evaluation-reward element. Evaluation-reward means the administration of extrinsic rewards based upon the evaluation of work performance.

We suggest that much private knowledge is acquired from the evaluation-reward element of the management control system. Managers quickly learn which outcomes are most valued in their firms, because those outcomes are rewarded. There is empirical evidence that profit center managers' annual bonuses are commonly based on measures such as earnings or return on assets in their profit centers (Johnson and Kaplan, 1987; Merchant, 1989; Abowd, 1990). In a study of incentive contracts for managers in twelve different firms, Merchant (1989) found that ten of the twelve contracts tied compensation to some profit based measure. Merchant quotes a profit center manager:

"Operating income is all that's important. We also have goals for return on capital, program accomplishments, accounts receivable, and inventories, but if we don't make our operating income targets, nothing else matters" (1989: 38)

If profit center managers do learn in this way, it seems reasonable to expect that as managers become more experienced, they will in general shift to a short-run "earnings" orientation over time. This is due to the fact that the evaluation-reward element of the planning and control system encourages selection of projects which are earnings enhancing in the short run even if the projects are value eroding in the long run. Often, of course, accrual accounting measures and NPV measures suggest the same decision. However, when accrual accounting measures and NPV measures suggest different decisions, the manager's experience will affect which measure the manager will use.

Experience and The Response to a Corporate Raid

Corporate raiders search for firms where changes in the strategic direction could dramatically increase the value of the firm's stock. These firms typically have a "value gap," which is the difference between the market price of a share of the company's stock and the value of that share if the company were managed for the maximum possible share price (Fruhan, 1988). The value gap exists because incumbent management has selected strategies which fail to exploit the full value creating potential of corporate assets. Undervalued firms (that is, firms where a value gap exists) are prime acquisition targets because there is potential to purchase them and then improve their value. Fruhan states, "A large, sustained discount between actual and potential share price represents an engraved invitation to an unsolicited takeover" (1988: 63).

The possibility of a corporate raid is considered to be an effective tool for disciplining managers (Coughlin and Schmidt, 1985). In this research it represents a crisis situation for incumbent management because that management may be replaced if the firm is taken over. The question addressed here is, what type of projects will profit center managers select in an attempt to increase firm value and thwart a takeover attempt? Specifically, do managers attempt to increase firm value by selecting projects which maximize earnings, or do the managers attempt to increase value by selecting projects having positive NPVs? As discussed above, earnings maximizing projects do not necessarily have a positive NPV. Therefore, managers may have to choose one strategy or the other in their attempt to avoid a takeover.

While there is no empirical evidence about the behavior of managers faced with the possibility of a corporate raid, DeAngelo (1988) provides evidence about incumbent managers' behavior just prior to a proxy contest. A proxy contest is a political campaign in which dissident stockholders seek election to a firm's board of directors. The result of a corporate raid can be similar to the result of a proxy contest: incumbent managers lose their jobs. Empirical evidence suggests that just prior to a proxy contest, managers exercise their accounting discretion to paint as favorable an earnings picture as possible (DeAngelo, 1988). Exercising accounting discretion means using accruals and deferrals to enhance reported profitability. In a study of 102 proxy contests, DeAngelo (1988) concluded that while reported profitability typically increases significantly during an election campaign, real profitability (as measured by operating cash flows) does not. In other words, DeAngelo's study suggests that managers manipulated earnings as a response to the threat of being replaced by new managers. This is an example of managers adapting to a specific environmental condition. We contend that only experienced managers would respond to such a perceived threat by selecting earnings enhancing projects even though those projects are value eroding. They would respond in this way because they have learned from the evaluation-reward element of their firm's planning and control system that earnings are of primary importance. Consistent with DeAngelo (1988), we expect this finding to be especially strong when managerial jobs are threatened.

Predictions are not made about the effects of the manager's level of experience across all environmental factors. The effects of the manager's level of experience can only be predicted when also considering the decision environment. Similarly, predictions are not made about the effect of environmental factors across all experience levels. Rather, the theory developed thus far proposes an interaction between environmental factors and the manager's experience level. Recall that this research is concerned with just one environmental factor: the threat of a corporate takeover. Faced with the possibility of losing their jobs, we hypothesize that experienced managers will select projects which are earnings enhancing, but value eroding. This is consistent with DeAngelo (1988). The following hypotheses, stated in the null form, are proposed:

H1A: (Main Effect of Experience): Subjects' experience levels will not affect their project selection decisions.

H1B: (Main Effect of Knowledge of Corporate Raid): Subject's knowledge of a corporate raid will not affect the subjects' project selection decisions.

H1C: (Interaction Effect of Experience and Knowledge of Corporate Raid): Subjects' experience levels will not modify the effect of their knowledge of a corporate raid on subjects' project selection decisions.

Overview of Experimental Methods


The selection of experimental subjects was driven by a desire for research conclusions which would be as generalizable as possible. This generalizability would be limited if the expermment were conducted using subjects from just one or two firms. Therefore, it seemed appropriate to select subjects from as many different firms as possible. At the same time, it is important to realize that it is difficult to compare managers and managerial experience across different firms. A manager with two years of experience in Firm A may actually possess much more experience than a manager with five years experience at Firm B.

Forty-four executive master of business administration (EMBA) students enrolled part-time at a university in the eastern United States served as experimental subjects. Most students held full-time managerial jobs and could be characterized as actual managers rather than surrogates for managers, although not all of the subjects had made project selection decisions. Nineteen subjects (43.2%) had made project selection decisions, and 25 (56.8%) had not. All had received formal classroom instruction in the principles of NPV analysis. The experiment was conducted at the end of a scheduled class period. A description of the subjects is provided in Table 1.

The Task

All 44 subjects completed the same basic task. Task materials are presented in the appendix. All subjects assumed the role of a profit center manager who was responsible for making project selection decisions in his or her division of a decentralized manufacturer of medical supplies. Subjects read background information relating to the hypothetical firm, Advanced Medical, Inc., prior to reading the information relating to the project selection decision.

The hypothetical project being considered was the manufacture and sale of a new type of hypodermic needle. Subjects were provided with a brief description of the needle project along with projected earnings and cash flow information relating to the manufacture and sale of the needle for the next five years. The case indicated that if the needle project were accepted, earnings and ROA would steadily increase over the next five years. However, the needle project had a negative NPV and an internal rate of return which was less than the cost of capital. Therefore, the needle project was earnings enhancing, but value eroding. Financial theory would suggest that the theoretically correct decision, then, is to reject the needle project, became accepting a project with a net present value less than the cost of capital will decrease the value of the firm (Brealey and Myers, 1988; Copeland and Weston, 1988).

All subjects were informed that if they accepted the needle project, their annual bonus would increase by 25% next year. This means that the annual bonus is tied to increased earnings.

The case might at first appear somewhat complex due to the fact that subjects are provided with five years of projected cash flows, earnings, NPV, and internal rate of return (IRR). This level of complexity seemed warranted given that it was important for all subjects to take the experiment seriously. In a related field research project, one of the authors learned that the amount and type of information provided in the case was the minimum information requirement for actual project selection decisions. Thus, it was felt that a case which provided less information would seem artificial and not elicit the desired response.

Dependent Variables

The dependent variable was the subject's decision to accept or reject the needle project. The intensity of this decision was measured using a three item scale. The scale for each of the three items is a 1 - 6 scale. The dependent variable is measured as the sum of a subject's three responses. These three items are reproduced in Table 2 below. The reason for using multiple indicators is that a single item measurement is typically unreliable. Reliability increases (that is, measurement error decreases) as the number of items in combination increases (Nunnally, 1978). One measure of internal consistency, or reliability, is Cronbach's alpha (Cronbach, 1951). Cronbach's alpha was .86 for the three item scale. Thus, the measurement scale seemed to be highly reliable.
Table 1
Demographic Information about Subjects

Panel A

Age (years) Number of Percent

 Under 25 1 2.3
 25-30 15 34.1
 31-35 12 27.3
 36-40 11 25.0
 41-45 4 9.1
 46-50 1 2.3
 Over 50 0 0.0

 Total: 44 100.0

Panel A provides descriptive statistics about subjects.

Panel B

Number of Years Making Number of Percent
Project Selection Subjects

 0 19 43.2
 2-3 6 13.6
 4-5 8 18.2
 6-9 10 22.7
 Over 10 1 2.3

 Total: 44 100.0

Panel B provides descriptive statistics regarding the subjects' length of
experience making real-life project selection decisions.

Independent Variables

The experiment used a 2 x 2 between subjects design. Knowledge of a corporate raid was presented at two levels: either subjects were not given any information about a corporate raid or they were told that their firm, Advanced Medical, Inc., was the target of a corporate raid. Further, subjects were informed that if the raid was successful, the managers would probably lose their jobs. While each subject completed the same basic task, each subject made a decision within one, and only one of two possible states of knowledge about the corporate raid.
Table 2
Multi-item Scale Used in the Case

Panel A

Scale Used to Measure Project Selection Decision

 Strongly Strongly
 Disagree Agree

This project should
definitely be accepted. 1 2 3 4 5 6

Most division managers
would accept this project. 1 2 3 4 5 6

If I were actually a
manager at Advanced,
I would select this
project. 1 2 3 4 5 6

This three item scale was used to measure the subjects' decision whether or
not to select the needle project. Each subject's decision was measured as the
sum of his or her responses on the three items.

The two experience levels of subjects were (1) subjects having at least two years experience making project selection decisions (experienced subjects) or (2) subjects having no project selection decision experience (naive subjects). Naive subjects are defined as those who have formal training in making project selection decisions, but have never actually made a project selection decision. This definition of a naive subject is consistent with Shanteau (1988).

Operationalizing experience in this setting is very challenging. Unlike professional auditors, managers cannot be easily classified into experience levels according to job titles. Job rifles in large auditing firms such as audit senior, audit manager, and partner signal fairly distinct levels of experience at the audit task. Managerial titles are not nearly as helpful; a top level manager in a small firm may have made fewer project selection decisions than a lower level manager in another firm. Further, the nature of the profit center managerial task is not as well defined as the auditing task. Thus, our classification of managers into naive and experienced groups is a rough one.

Our assumption is that number of years of project selection decision-making acts as a rough proxy for the level of practical intelligence as a manager. The authors are aware of no literature which suggests the point at which managers can be considered to be experienced at making project selection decisions. It was felt that subjects with less than two years experience making project selection decisions could not be categorized as experienced. However, two years seemed to be a reasonable amount of time to allow managers to be exposed to at least several project selection decisions.

Another concern was the appropriateness of pooling all subjects with two or more years into a single experienced group. This concern was related to the possibility that the two dependent measures varied across different levels of experience. To test the hypothesis of no difference between the dependent measures across the three experience categories (2-3 years, 4-5 years, and over 6 years), both a parametric one-way ANOVA and a nonparametric Kruskal-Wallis ANOVA (Neter et al., 1985) were applied to the data. The hypothesis of no difference in either dependent measures could not be rejected at the .10 level.


A 2 x 2 ANOVA was estimated with two levels of the environmental variable knowledge of the corporate raid and two levels of the experience variable. The results of this analysis are presented in Table 3. In a 2 x 2 ANOVA design, there are four groups of experimental subjects. Two groups of experimental subjects tended to reject the project. The two groups who tended to reject the project were (1) the naive subjects who were informed that Advanced Medical, Inc. was the target of a raid (mean = 6.45) and (2) the experienced subjects who were given no information about the decision environment (5.93). The other two groups tended to accept the project. The two groups who tended to accept the project were (1) the naive subjects who were given no information about the decision environment and (9.13), and (2) the experienced subjects who were informed that Advanced Medical, Inc. was the target of a raid (9.27).

The ANOVA results presented in Table 3 indicate that hypothesis 1A and 1B cannot be rejected. This means that no main effect of either knowledge of the raid or experience levels on the subjects' project selection decisions was detected. Failure to reject Hypotheses 1A and 1B is consistent with the theory developed in this research. Hypotheses 1C is rejected at the .05 level. Experienced subjects were more inclined to favor acceptance of the earnings enhancing, value eroding project when they were informed that Advanced Medical, Inc., was the target of a takeover attempt (9.27) than were naive subjects with the same knowledge (6.45). This is consistent with the theory presented above: naive managers (those with only public knowledge) are less likely to select earnings enhancing, value eroding projects as part of an effort to avoid a takeover attempt.


This section begins with a discussion of the results of the experiment in light of (1) the theory developed above and (2) comments about the experiment which were made by experienced managers. This is followed by a presentation of some research questions which are suggested by the theory and empirical results.

The project selection decisions of experienced subjects who were informed that Advanced Medical, Inc., was the target of a takeover attempt indicate a preference for the earnings enhancing but possible value eroding project (mean = 9.27). Consistent with DeAngelo (1988), when incumbent managers' jobs are threatened, those managers portray a favorable picture of their own performance by selecting projects which are earnings enhancing in the short term, but which may be value eroding over the longer term. This is an example of practical intelligence, which means behaving in a way which will increase the likelihood of one's (professional) survival.(2) The experienced managers made a project selection decision which was opposite to that which would result from rote application of the abstract NPV model.

Naive managers who were given information which indicated that Advanced Medical, Inc., was the target of a corporate raid were less inclined to select the project than were the more experienced subjects (6.45). This is consistent with the theory of practical intelligence: this group has not yet learned that painting a favorable picture of oneself as a manager means maximizing short-term earnings. The naive managers who were given information which indicated that Advanced Medical, Inc., was the target of a corporate raid may have rotely applied the NPV model as a response to knowledge of the impending corporate raid.

Experienced managers who were not informed that Advanced was the target of a takeover attempt tended to reject the project (5.93). Discussions with managers following the experiment provided an explanation for this. When there was no threat to their jobs, the experienced managers felt that they could reject the needle project, and wait for a project which had a positive NPV and was expected to result in earnings enhancement. Experienced managers expected that the future would present many potential projects, and absent a threat to their jobs, the experienced group was willing to wait for a more favorable project.
Table 3
Analysis of Variance: Knowledge of Corporate Takeover Attempt (Raid) X
Experience as Independent Variables with Project Selection Decision as the
Dependent Variable

 Sum of Mean
 Source Squares df Square F Probability

Raid (R) 6.279 1 6.279 .330 .569
Experience (E) .056 1 .056 .003 .957
R x E 95.640 1 95.640 5.029 .031
Error 760.713 40 19.018

 Cell Means

Experience Level Environmental Mean

Naive None 9.13 (8)
Naive Raid 6.45 (11)
Experienced None 5.93 (14)
Experienced Raid 9.27 (11)

This table shows the results of ANOVA, the cell means, and the cell sizes. The
independent variables were the subjects' levels of experience (naive vs.
experienced), and whether subjects were informed that their firm was the
target of a takeover attempt. The dependent variable is the subjects' project
selection decision. Higher (lower) values of the dependent variable indicate
the subjects were more (less) strongly in favor of selecting the project.

Naive subjects who were given no environmental information were willing to select the project (9.13). This is inconsistent with our theory which predicts that the naive group is guided by the abstract NPV model and therefore automatically rejects a project with a negative NPV. Conversations with managers provided an explanation for this. Subjects noticed that the project had only a fairly small negative NPV (-$108,000) and an internal rate of return just slightly below the cost of capital. A slight enhancement in the amounts or timing of cash flows or a slight decline in the cost of capital would lead to the conclusion that the project was acceptable from both an earnings perspective and an NPV perspective. Thus, given the fact that their bonus would increase by 25% if they selected this project, naive subjects appeared to look for a reason to select the project. This may suggest that managers will look for reasons to accept projects which may not be in the best interests of the firm if the evaluation-reward element of the planning and control system encourages them to do so. We speculate that managers might go so far as to forget or overlook information which, if considered, would lead to them selecting a project which would decrease their bonus. If the bonus had not been mentioned in the case, the naive subjects might have relied on the abstract NPV model for guidance in making the decision to reject the project.

Studying the Effects of Managerial Experience

This study attempts to initiate a discussion of how profit center managers' project selection decisions are affected by their experience and the environment in which they make those decisions. The fact that the effects of experience have not been studied in a managerial context seems to be due to the difficulty of operationalizing experience across firms and industries. The researcher is vulnerable to the charge that experience has not been operationalized properly. In spite of this difficulty, the effects of experience and the interaction of experience with environmental features are important topics for study. A research program which addressed this topic may have to begin by studying managers' behavior at a single firm and then attempt to generalize this knowledge to other firms and industries.

A particularly interesting research question would be the main and interactive effects of environment and experience on managers' use of accounting reports. That is, as managers become more experienced, do they rely more or do they rely less on accounting reports in making decisions such as the project selection decision? Further, what environmental factors would lead to greater or less use of accounting reports?

Another issue which is worthy of study is how the evaluation-reward system interacts with managers' experience and environment. That is, when are managers willing to forgo immediate financial reward? As Merchant (1989) points out, very little is known about the mix of incentives that is attractive to profit center managers. This lack of knowledge is due to the fact that most of the compensation research to date has focused on top executives. It cannot be assumed that incentives which are effective for top executives will also be effective for profit center managers. Merchant (1989) suggests that, compared with top executives, profit center managers are probably more interested in protecting their autonomy and in improving their promotion possibilities.

A limitation of this research is the fact that the bonus system could not be operationalized in any real sense. Subjects were told their bonus was based on earnings maximization; they were not actually given a real bonus. This is due to the fact that providing a meaningful incentive to subjects who hold well paying managerial jobs is prohibitively expensive.

The results of this research may provide a partial explanation for the observation that some people who are highly successful in formal schooling are often unsuccessful managers and some people who are not successful in formal schooling are successful managers. Part of the explanation lies in the fact that the intellectual demands of schooling are but a subset of the intellectual demands of real-world pursuits (Neisser, 1976). In the environment of this research, public knowledge is a subset of the knowledge that provides practical intelligence.

The practical usefulness of this research to many managers may be found in the discussion of public knowledge, private knowledge, and practical intelligence. Specifically, the discussion implies how managers with various levels of experience may be assigned to different divisions of a multidivision firm. Recall that the person with practical intelligence has the ability to respond appropriately to changing conditions. Therefore, divisions which operate in rapidly changing environments should be managed by the most experienced managers. Less experienced managers may be assigned to areas of the firm that do not encounter such rapidly changing business conditions. Under these more stable conditions, less experienced people will come to know when their abstract, model-based knowledge may be usefully applied to business decisions. Thus, the best manager for a division experiencing rapid change is a person with the most experience in that division or with a particular product, rather than the person with the most formal education.

Much work needs to be done to formulate a comprehensive theory of practical intelligence in real-world pursuits. Such a theory would be very helpful to accounting researchers who are interested in the subject surrogation issue as well as to those who are interested in developing competent managers. Such a theory will encompass general aptitudes, public knowledge, and private knowledge that is used in managing oneself, others, and one's career (Wagner and Sternberg, 1985).

1 Several writers have addressed the gap between professional knowledge and the demands of real-world practice. See Simon (1972); Schein (1973); Neisser (1976); and Schon (1982).

2 Loyalty to the business entity or to its employees may explain experienced managers' willingness to choose a project which is earnings enhancing in the short term, but possibly value eroding over the longer term. If the experienced manager believes that this type of earnings enhancing project will be useful in averting the takeover attempt, the experienced manager may select the project in an effort to preserve the business entity and the jobs of current employees. Our experimental design does not allow a clear interpretation of the motives of the experienced managers.


Project Selection Study


We are very interested in the decisions you make as managers. To better understand your decision process, we would like you to complete a short management decision case for a hypothetical firm, Advanced Medical, Inc. (hereafter referred to as Advanced).

This exercise should take no more than 20 minutes; all the necessary financial information is provided and you do not have to make any calculations.

The exercise materials follow this introduction. Since this research concerns individual decision making, please complete the exercise on your own.

After you have completed the case, please return it to me. Your responses are strictly confidential.

Overview of Advanced Medical, Inc.

Advanced is a decentralized firm engaged in the manufacture and sale of a broad range of products in the health care field. Each division has a general manager who is responsible for identifying and implementing appropriate projects.

As a division general manager at Advanced, you are considering a number of projects that could be implemented over the next several years. Each project is independent of all other projects; that is, each project does not affect any other project. Each project under consideration satisfies all nonfinancial criteria equally well.

Levels of the Environmental Variable

One level of the environmental factor independent variable was a control group. This group did not receive any information about the corporate takeover attempt. The control group immediately began work on the case, "Needle Project."

The second level of the contextual factor independent variable was the threat of a corporate raid. This level is indicated below as, "Advanced Medical Target in Corporate Raid." Subjects who received this experimental treatment read the three indicated paragraphs and then began reading the case, "Project Selection Study."

Advanced Medical Target in Corporate Raid

There is evidence that a large health care firm, National Therapeutic, is considering a takeover attempt of Advanced. Advanced is a prime takeover candidate because its stock is thought to be undervalued.

Stock analysts feel that the undervaluation is due to poor asset management at Advanced, and that the takeover may still be avoided if Advanced's managers immediately begin to manage assets more effectively. More effective asset management, especially cash management, should drive Advanced's market value to appropriate levels.

If National Therapeutic is successful in its takeover attempt, a new manager would be assigned to your division. There is a high likelihood that you would be dismissed.

Needle Project

In this case, you are given information about the possible manufacture and sale of a new type of hypodermic needle in your division. This needle would be used when drawing blood samples from patients. Due to constantly improving technology in the industry, the needle would probably be obsolete at the end of five years.

Certain financial projections related to the needle project are:

* Initial expenditure for equipment to manufacture the needle: $6,500,000.

* Salvage value of equipment at end of year 5: $1,600,000.

* Increase in inventories required if project is accepted.

* Increase in receivables required if project is accepted.
Financial Projections: Needle Project

(in thousands of dollars, except EPS amounts)

 Year 1 Year 2 Year 3 Year 4 Year 5

Needle Sales $5,250 $5,400 $5,575 $5,880 $6,145
Operating Profit $ 540 $ 559 $ 564 $ 580 $ 583
Incremental Earnings Per Share
(EPS) for Project $ .10 $ .10 $ .10 $ .11 $ .11
ROA for Project .10 .12 .16 .22 .36
Cost of Capital .12 .12 .12 .12 .12
Increase in Receivables $ 850 $ 15 $ 15 $ 25
Decrease in Receivables $ 905
Increase in Inventories $1,500
Decrease in Inventories $1,500
Summary of Projected Cash Flows

 Year 1 Year 2 Year 3 Year 4 Year

Annual Cash Flows (*)($7,330) $1,524 $1,529 $1,536
$5,568 Cash Flows Discounted at 12%
Cost of Capital (*)($6,546) $1,215 $1,089 $ 977
$3,157 Total (Nondiscounted)
Cash Flows $2,827
Net Present Value of Project (NPV): -$108
Internal Rate of Return (IRR): 11.39%

* Refers to negative amounts


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Jack M. Ruhl Assistant Professor of Accountancy Western Michigan University

Larry M. Parker Associate Professor of Accountancy Case Western Reserve University
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Author:Ruhl, Jack M.; Parker, Larry M.
Publication:Journal of Managerial Issues
Date:Sep 22, 1994
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