The role of subjectivity in mitigating incentive contracting risks

52 Pages Posted: 15 Mar 2021

See all articles by Anne M. Lillis

Anne M. Lillis

University of Melbourne

Mary A. Malina

University of Colorado at Denver - Business School

Julia Mundy

University of Greenwich

Date Written: February 15, 2021

Abstract

We examine how subjectivity in performance measurement and reward systems (PMRS) is used to mitigate incentive contracting risks. Drawing on data from 38 interviews with supervisory and subordinate managers in four firms, we provide a more comprehensive explanation of the role of subjectivity in risk mitigation than is evident in the prior literature. We provide empirical evidence of the importance firms place on the use of subjectivity to mitigate the risk of incentive misalignment and employee sorting errors relative to its well-documented role in mitigating employee compensation risk. We find that incentive misalignment arising from unanticipated behavioral responses to performance measures is a particularly important risk, managed through subjective performance assessments. The extent of subjectivity we observe poses a significant risk of errors and bias. We observe that both vertical and horizontal information gathering and review by calibration panels are key strategies to mitigate the downside risk of subjectivity.

Keywords: subjectivity; incentive alignment; employee sorting; compensation risk; mitigating errors and bias in subjectivity; calibration

JEL Classification: M49, M55, M52, M51

Suggested Citation

Lillis, Anne and Malina, Mary A. and Mundy, Julia, The role of subjectivity in mitigating incentive contracting risks (February 15, 2021). The Accounting Review https://doi.org/10.2308/TAR-2017-0652, Available at SSRN: https://ssrn.com/abstract=3785732

Anne Lillis (Contact Author)

University of Melbourne ( email )

Victoria
Parkville, Victoria 3010
Australia

Mary A. Malina

University of Colorado at Denver - Business School ( email )

1250 14th St.
Denver, CO 80204
United States

Julia Mundy

University of Greenwich ( email )

30 Park Row
Greenwich
London, SE10 9LS
United Kingdom

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