Determinants and Effects of Subjectivity in Incentives
University of Chicago Booth School of Business; Institute for the Study of Labor (IZA)
Kenneth A. Merchant
University of Southern California - Leventhal School of Accounting
Wim A. Van der Stede
London School of Economics & Political Science (LSE)
Mark E. Vargus
University of Texas at Dallas - Department of Accounting & Information Management
Accounting Review, Vol. 79, No. 2, pp. 409-436, April 2004
This study examines two questions: when do firms make greater use of subjectivity in awarding bonuses, and what are the effects of subjectivity on employee pay satisfaction and firm performance? We examine these questions using data from a sample of 526 department managers in 250 car dealerships. First, the findings suggest that subjective bonuses are used to complement perceived weaknesses in quantitative performance measures and to provide employees insurance against downside risk in their pay. Specifically, use of subjective bonuses is positively related to: (1) the extent of long-term investments in intangibles; (2) the extent of organizational interdependencies; (3) the extent to which the achievability of the formula bonus target is both difficult and leads to significant consequences if not met; and (4) the presence of an operating loss. Second, we find that the effects of subjective bonuses on pay satisfaction, productivity, and profitability are larger the greater the manager's tenure, consistent with the idea that subjectivity improves incentive contracting when there is greater trust between the subordinate and supervisor.
Keywords: Incentives, performance evaluation, subjectivity
JEL Classification: M52, J33, M41Accepted Paper Series
Date posted: March 25, 2006
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