Employee-level Real Activities Management and Managerial Target Setting

Abstract

This study investigates how real activities management (RAM) by employees to meet internal targets set by managers affects their performance, and how managers’ awareness of employees’ opportunity to engage in RAM moderates this effect. Using two experiments, we predict and find that when managers’ awareness is low, employees use RAM to 1) restore their bonus incentives when the current target is set too high, and/or 2) take preemptive actions to hedge against a future target that is ratcheted up too much, resulting in increased employee performance. However, when managers’ awareness of employees’ RAM opportunity is high, managers overestimate employees’ RAM and make less effective target adjustments, resulting in decreased employee performance and less trusting employee-manager relations. Our findings suggest that the opportunity to engage in RAM can have the benefits of motivating higher employee performance, but increasing managers’ awareness of this has negative performance and relational effects.

Keywords: Real Activities Management, Target-Setting, Misattribution, Trust

JEL Classification: D91, M10, M40