Causes and Effects of Subjectivity in Incentives

U. of Southern California, Leventhal School of Accounting; U. of Chicago, Graduate School of Business

49 Pages Posted: 13 Feb 2002

See all articles by Michael Gibbs

Michael Gibbs

University of Chicago Booth School of Business; Institute for the Study of Labor (IZA)

Kenneth A. Merchant

University of Southern California - Leventhal School of Accounting

Wim A. Van der Stede

London School of Economics & Political Science (LSE)

Mark E. Vargus

University of Texas at Dallas - Department of Accounting & Information Management

Date Written: January 20, 2002

Abstract

This study empirically examines two basic questions. First, where and why do firms make greater or lesser use of subjectivity in the performance evaluations that lead to annual bonuses? Second, what are the effects of greater or lesser use of subjectivity on employee pay satisfaction? We examine these questions using data collected from a sample of 526 department managers in 250 automobile dealerships. Our findings suggest that subjective bonuses are used to complement perceived weaknesses in bonus awards based on quantitative performance measures. Overall, we find that the use of subjective bonuses is positively related to: (1) the extent of departmental interdependencies; (2) the department reporting a net loss; (3) the manager's tenure; and (4) the extent that the achievability of the formula-based bonus is difficult and leads to significant consequences if not achieved. We also find that the use of subjective bonuses is negatively related to the degree to which the formula bonus exhibits a short-term focus. Competition significantly influences the level of subjective bonuses but not the frequency. We also show that the incremental economic effects of these determinants are highly significant. Our results regarding the effects of the use of subjective bonuses on employee pay satisfaction, however, are inconclusive.

Keywords: Incentives; Discretionary bonus; Subjective bonus; Pay satisfaction

JEL Classification: J33, M40, M46, D23

Suggested Citation

Gibbs, Michael and Merchant, Kenneth A. and Van der Stede, Wim A. and Vargus, Mark E., Causes and Effects of Subjectivity in Incentives (January 20, 2002). U. of Southern California, Leventhal School of Accounting; U. of Chicago, Graduate School of Business. Available at SSRN: https://ssrn.com/abstract=297744 or http://dx.doi.org/10.2139/ssrn.297744

Michael Gibbs

University of Chicago Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Institute for the Study of Labor (IZA)

P.O. Box 7240
Bonn, D-53072
Germany

Kenneth A. Merchant

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States
213-740-4842 (Phone)
213-747-2815 (Fax)

Wim A. Van der Stede (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
+44 (0)20 7955 7420 (Fax)

Mark E. Vargus

University of Texas at Dallas - Department of Accounting & Information Management ( email )

2601 North Floyd Road
Richardson, TX 75083-0688
United States
972-883-4772 (Phone)

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