Subjective Adjustments to Objective Performance Measures

Abstract

Using proprietary and survey data of 276 objective performance measures for 69 audit managers from 12 divisions of a large internal audit organization, I investigate factors that cause supervisors to subjectively adjust managers' objective performance measures. The organization introduced a pay-for-performance incentive plan that allows supervisors to subjectively adjust audit managers' objective performance measures to correct imperfections in these measures. Empirical evidence documents both benefits and costs of subjective adjustments. Specifically, I find that while supervisors subjectively adjusted objective performance measures they perceived to be noisy, incomplete, non-verifiable, and manipulable, suggesting incentive contracting benefits, they also subjectively adjusted objective performance measures based on managers' influence activities, their own personal preferences, and their own division managers' adjustment tendencies, suggesting incentive contracting costs.

Keywords: Subjectivity, performance measurement, incentive compensation, subjective adjustments

JEL Classification: M49, L84