The Sorting Benefits of Discretionary Adjustment to Performance-based Pay
36 Pages Posted: 17 Aug 2015 Last revised: 25 May 2019
Date Written: May 24, 2019
While discretionary adjustment is a salient feature of performance evaluation and influences employee behavior during the evaluation period, we know little about whether and how discretionary adjustment generates sorting effects on desirable employee characteristics. In this study, we develop and test theory suggesting that adding discretionary adjustment to performance-based pay facilitates the attraction of employees that identify more strongly with the organization’s objectives. Results from a laboratory experiment show employees’ preferences for pursuing the organization’s objectives have a stronger positive effect on their preference for performance-based pay when performance-based pay is accompanied by discretionary adjustment than when it is not. Complementing performance-based pay with discretionary adjustment may, therefore, improve sorting on identification with the objectives of the organization. The mechanism behind this sorting effect is that employees anticipate that managers will adjust performance-based pay more (less) favorably when employees reveal a strong (weak) preference for pursuing the organization’s objectives. The documented sorting effect also has value for the organization: employees who reveal a stronger preference for pursuing the organization’s objectives exert more costly effort toward those objectives and this effect is mediated by a preference for performance-based pay when discretionary adjustment is present. We contribute to accounting research and practice by documenting a new and previously unknown consequence of discretionary adjustment that can enrich the tradeoff that managers make when designing their performance evaluation system.
Keywords: discretionary adjustment, contracting, sorting, selection, performance measures, identification
JEL Classification: C92, M40, M41, M52
Suggested Citation: Suggested Citation