Targets, Standards and Performance Expectations: Evidence from Annual Bonus Plans

Abstract

This paper studies the role of performance standards in executive annual bonus plans. We find that earned bonuses exceed pre-determined target bonuses (on average), implying that standards do not reflect performance expectations in a statistical sense. We also find that target bonuses are adjusted upward (downward) in response to performance above (below) standard in a prior year. However, these adjustments do not appear to fully incorporate past performance information since our evidence also suggests that "abnormal" bonuses (earned bonus less target bonus) are positively serially correlated. Finally, we find that the magnitude of the abnormal bonus is related to proxies for the existence of information asymmetry between managers and their superiors. Overall, our results are consistent with the predictions and insights of the participative budgeting literature.

JEL Classification: J33, L22, M41, M46