Strategic Priorities, Relational Contracting Clarity and the Use of Subjectivity in Incentive Contracts

51 Pages Posted: 20 Aug 2012 Last revised: 31 Dec 2015

See all articles by Sara Bormann

Sara Bormann

Washington University in St. Louis - John M. Olin Business School

Date Written: December 15, 2015

Abstract

This paper examines a potential problem associated with the use of subjectivity in incentive contracts: Relational contracting clarity. Clarity refers to the extent to which the terms of a relational contract, or subjective assessment can be communicated and an employee and his superior are able to build a shared understanding on which behavior is desirable and how it translates into rewards (Gibbons and Henderson 2012a, 2012b).

If the terms of a subjective assessment are difficult to communicate, contracting clarity and hence the incentive effect of subjectivity diminish. Accordingly, firms should reduce their reliance on subjectivity. It has been argued that this is the case in complex and multidimensional settings, which arise, for instance, when firms pursue a joint strategy (i.e. follow a differentiation and a low- cost strategy simultaneously). Following a joint strategy has been associated with increased complexity and multidimensionality in the decision making process due to potentially conflicting strategic goals (Dekker et al. 2013; Lillis 2002; Lillis and van Veen-Dirks 2008). My results based on the analysis of survey data of 153 firms are consistent with my expectations. That is, pursuing a joint strategy is associated with a reduced use of subjectivity. However, this relation is not prevalent for all forms of subjectivity. In particular, following a joint strategy is associated with a reduced reliance on subjective formulas, while there is no relation to the use of subjective performance measures.

Keywords: relational contracting clarity, subjectivity, strategic priorities, joint strategies, incentives, survey

JEL Classification: M40, M52, C42

Suggested Citation

Bormann, Sara, Strategic Priorities, Relational Contracting Clarity and the Use of Subjectivity in Incentive Contracts (December 15, 2015). AAA 2013 Management Accounting Section (MAS) Meeting Paper. Available at SSRN: https://ssrn.com/abstract=2132664 or http://dx.doi.org/10.2139/ssrn.2132664

Sara Bormann (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

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