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Performance Measure Properties and Incentives

  • Gibbs, Michael

    ()

    (University of Chicago)

  • Merchant, Kenneth A.

    ()

    (University of Southern California)

  • Van der Stede, Wim A.

    ()

    (University of Southern California)

  • Vargus, Mark A.

    ()

    (University of Texas at Dallas)

We examine the effects of performance measure properties on incentive system design, using data on incentive contracts for auto dealership managers. The data include information on five properties: two indicators of risk; two indicators of distortion; and one indicator of potential manipulation. We find that these properties have important effects on incentive system design. First, firms appear to choose the “best” performance measure available along these dimensions, and use it for the most important (primary) formula bonus. Second, the properties of this primary performance measure are important determinants of the weight placed on the measure for explicit. Third, firms appear to use other performance measures to balance multitask incentives relative to the primary performance measure. Specifically, we find evidence that second and third bonuses are used to provide better incentives for cooperation and to reduce incentives for manipulation. Fourth, we present evidence that subjectivity, through discretionary bonuses based on subjective performance evaluations, and also through implicit incentives for promotions and other rewards, also appear to play the same roles.

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File URL: http://ftp.iza.org/dp1356.pdf
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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 1356.

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Length: 41 pages
Date of creation: Oct 2004
Date of revision:
Publication status: published in: Industrial Relations, 2009, 48(2), 237-264
Handle: RePEc:iza:izadps:dp1356
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  1. HOLMSTROM, Bengt, . "Moral hazard and observability," CORE Discussion Papers RP -379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  3. Michael Raith, 2003. "Competition, Risk, and Managerial Incentives," American Economic Review, American Economic Association, vol. 93(4), pages 1425-1436, September.
  4. Ichniowski, Casey & Shaw, Kathryn & Prennushi, Giovanna, 1997. "The Effects of Human Resource Management Practices on Productivity: A Study of Steel Finishing Lines," American Economic Review, American Economic Association, vol. 87(3), pages 291-313, June.
  5. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
  6. Joel S. Demski & Hans Frimor & David E. M. Sappington, 2004. "Efficient Manipulation in a Repeated Setting," Journal of Accounting Research, Wiley Blackwell, vol. 42(1), pages 31-49, 03.
  7. 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.
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