Bonus Plan Choices During an Economic Downturn

Abstract

We use survey data to estimate the effect of the 2008–2009 recession on three fundamental bonus plan choices. We find robust evidence that the recession (i) reduced incentive strength, (ii) increased the relative incentive weight on financial performance measures, and (iii) increased the perceived difficulty of financial performance targets, not only in absolute terms but also relative to the perceived difficulty of nonfinancial targets. To assess the extent to which these findings can be explained by standard theoretical explanations, we review prior agency literature and discuss several channels through which an economic downturn can affect firms’ bonus plan choices. Our review highlights that contracting issues rarely examined in prior empirical work such as retention concerns and information asymmetry issues are likely to play an important role during an economic downturn.

Keywords: incentives; choice of performance measures; targets; agency theory

JEL Classification: M41, M52