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On the Use of Nonfinancial Performance Measures in Management Compensation

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Dirk Sliwka

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Abstract

It is often claimed that (i) managers work too hard on operational issues and do not spend enough effort on strategic activities, and (ii) something can be done about this by introducing nonfinancial performance measures, as for instance with a balanced scorecard. We give an explanation for both claims in a formal model. The distortion toward operational effort arises because with financial performance measures strategic effort can only be rewarded in the future. But renegotiation-proof long-term compensation plans entail too weak variable components in the future. This problem can be reduced by introducing performance measures that help to disentangle strategic and operational effects. Copyright (c) 2002 Massachusetts Institute of Technology.

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Article provided by Blackwell Publishing in its journal Journal of Economics & Management Strategy.

Volume (Year): 11 (2002)
Issue (Month): 3 (09)
Pages: 487-511
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Handle: RePEc:bla:jemstr:v:11:y:2002:i:3:p:487-511

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  1. Hermalin, Benjamin E & Katz, Michael L, 1991. "Moral Hazard and Verifiability: The Effects of Renegotiation in Agency," Econometrica, Econometric Society, vol. 59(6), pages 1735-53, November. [Downloadable!] (restricted)
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  2. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
  3. Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation, Yale University. [Downloadable!]
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  4. Narayanan, M P, 1985. " Managerial Incentives for Short-term Results," Journal of Finance, American Finance Association, vol. 40(5), pages 1469-84, December. [Downloadable!] (restricted)
  5. Fudenberg, Drew & Tirole, Jean, 1990. "Moral Hazard and Renegotiation in Agency Contracts," Econometrica, Econometric Society, vol. 58(6), pages 1279-1319, November. [Downloadable!] (restricted)
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  6. Ma, Ching-To Albert, 1994. "Renegotiation and Optimality in Agency Contracts," Review of Economic Studies, Blackwell Publishing, vol. 61(1), pages 109-29, January. [Downloadable!] (restricted)
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  7. Stein, Jeremy C, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, MIT Press, vol. 104(4), pages 655-69, November. [Downloadable!] (restricted)
  8. Schmidt, Klaus M. & Schnitzer, Monika, 1995. "The interaction of explicit and implicit contracts," Economics Letters, Elsevier, vol. 48(2), pages 193-199, May. [Downloadable!] (restricted)
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  9. Bushman, Robert M. & Indjejikian, Raffi J. & Smith, Abbie, 1996. "CEO compensation: The role of individual performance evaluation," Journal of Accounting and Economics, Elsevier, vol. 21(2), pages 161-193, April. [Downloadable!] (restricted)
  10. Chen, Yongmin, 1994. "Conflicting interests in information disclosure and short-term orientation of firms," International Journal of Industrial Organization, Elsevier, vol. 12(2), pages 211-225, June. [Downloadable!] (restricted)
  11. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Dutta, Sunil & Reichelstein, Stefan J., 2004. "Stock Price, Earnings and Book Value in Managerial Performance Measures," Research Papers 1873, Stanford University, Graduate School of Business. [Downloadable!]
  2. Jens Robert Schöndube, 2007. "Early versus late effort in dynamic agencies with learning about productivity," FEMM Working Papers 07026, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management. [Downloadable!]
  3. Dutta, Sunil & Reichelstein, Stefan J., 2002. "Leading Indicator Variables, Performance Measurement and Long-Term versus Short-Term Contracts," Research Papers 1756, Stanford University, Graduate School of Business. [Downloadable!]
  4. Brem Markus & Tucha Thomas, 2005. "On Transfer Pricing: Conceptual Thoughts on the Nature of the Multinational Firm," IIMA Working Papers 2005-11-03, Indian Institute of Management Ahmedabad, Research and Publication Department. [Downloadable!]
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