Testing for Distortions in Performance Measures: An Application to Residual Income Based Measures Like EVA
Journal of Economics and Management Strategy, Forthcoming
Tinbergen Institute Discussion Paper No. TI 2014-056/V
29 Pages Posted: 9 Nov 2014
Date Written: 2014
Abstract
Distorted performance measures in compensation contracts elicit suboptimal behavioral responses that may even prove to be dysfunctional (gaming). This paper applies the empirical test developed by Courty and Marschke (2008) to detect whether the widely used class of Residual Income based performance measures — such as Economic Value Added (EVA) — is distorted, leading to unintended agent behavior. The paper uses a difference-in-differences approach to account for changes in economic circumstances and the self-selection of firms using EVA. Our findings indicate that EVA is a distorted performance measure that elicits the gaming response.
Keywords: Residual Income, Economic Value Added, Distortion, Performance Measurement
JEL Classification: D21, G35, J33, L21, M12, M40, M52
Suggested Citation: Suggested Citation
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