Lost in Translation: The Effects of Incentive Compensation on Strategy Surrogation

Abstract:     
To facilitate managers’ decision-making, firms develop strategic performance measurement systems that translate strategy into performance measures. Ideally, managers see measures for what they are: imperfect proxies for intangible strategic constructs. However, managers may increase their focus on measures to the detriment of their consideration of the strategic constructs the measures are intended to represent. As such, managers may underappreciate the representational role of measures, ultimately losing sight of the global framework in which the measures reside – a phenomenon we label surrogation. In this paper, we investigate whether and how managers’ propensity to exhibit surrogation is affected by the use of strategically-linked performance measures for compensation purposes. We predict that this tendency is most prevalent when managers are compensated on a single measure of a strategic construct, and that this tendency is less prevalent when managers are compensated on multiple measures of a strategic construct. Via an experiment, we find support for these hypotheses. Our paper contributes to the literature on strategic performance measurement systems by highlighting the tendency of managers to use measures as surrogates for strategy. Further, our study speaks to an on-going academic debate regarding the trade-off between the decision-facilitating and decision-influencing roles of performance measures.

JEL Classifications: M41, M40, M49

Working Paper Series