Balancing Difficulty of Performance Targets: Theory and Evidence

53 Pages Posted: 15 Aug 2014 Last revised: 4 Sep 2017

See all articles by Michal Matejka

Michal Matejka

Arizona State University

Korok Ray

Texas A&M University - Mays Innovation Research Center

Date Written: May 15, 2017

Abstract

We examine how firms balance difficulty of performance targets in their annual bonus plans. We present an analytical model showing that managerial allocation of effort is a function of not only relative incentive weights but also the difficulty of performance targets. We find that relative incentive weights and target difficulty can either be complements or substitutes in motivating effort depending on the extent to which managers have alternative employment opportunities. To test the predictions of our model we use survey data on performance targets in annual bonus plans. Our sample of 877 survey respondents consists primarily of financial executives in small- and medium-size private companies where annual bonuses are important both for motivation and retention. Consistent with our model, we find that relative incentive weights are negatively (positively) associated with perceived target difficulty when concerns about managerial retention are high (low). It follows that performance measures included in annual bonus plans have sometimes easy and other times challenging targets depending on their relative incentive weights and retention concerns.

Keywords: Incentives, Targets, Choice of Performance Measures, Labor Market

JEL Classification: M41, M21

Suggested Citation

Matejka, Michal and Ray, Korok, Balancing Difficulty of Performance Targets: Theory and Evidence (May 15, 2017). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2480185 or http://dx.doi.org/10.2139/ssrn.2480185

Michal Matejka (Contact Author)

Arizona State University ( email )

Tempe, AZ 85287-3706
United States
480-965-7984 (Phone)

Korok Ray

Texas A&M University - Mays Innovation Research Center ( email )

4113 TAMU College State
TX 77843-4113
United States

HOME PAGE: http://mays.tamu.edu/directory/korok/

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