Performance Standards in Incentive Contracts
Kevin J. Murphy
University of Southern California - Marshall School of Business; University of Southern California - Department of Economics; USC Gould School of Law
Research in incentives has focused on performance measures and pay-performance sensitivities but has largely ignored a third significant dimension: the performance standard. Performance standards generate important incentives whenever plan participants can influence the standard-setting process. I describe management bonus contracts and the role of performance standards, distinguishing between "internally determined" standards that are directly affected by management actions in the current or prior year, and "externally determined" standards that are less easily affected. I show that companies choose external standards when prior-year performance is a noisy estimate of contemporaneous performance. In addition, companies using budget-based and other internally determined performance standards have less-variable bonus payouts, and are more likely to smooth earnings from year to year, than companies using externally determined standards.
Number of Pages in PDF File: 43
JEL Classification: J33, J44, M41, M43, G30working papers series
Date posted: November 26, 1999
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo6 in 0.516 seconds