Determinants and Effects of Subjectivity in Incentives

Accounting Review, Vol. 79, No. 2, pp. 409-436, April 2004

Posted: 25 Mar 2006

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

Abstract

This study examines two questions: when do firms make greater use of subjectivity in awarding bonuses, and what are the effects of subjectivity on employee pay satisfaction and firm performance? We examine these questions using data from a sample of 526 department managers in 250 car dealerships. First, the findings suggest that subjective bonuses are used to complement perceived weaknesses in quantitative performance measures and to provide employees insurance against downside risk in their pay. Specifically, use of subjective bonuses is positively related to: (1) the extent of long-term investments in intangibles; (2) the extent of organizational interdependencies; (3) the extent to which the achievability of the formula bonus target is both difficult and leads to significant consequences if not met; and (4) the presence of an operating loss. Second, we find that the effects of subjective bonuses on pay satisfaction, productivity, and profitability are larger the greater the manager's tenure, consistent with the idea that subjectivity improves incentive contracting when there is greater trust between the subordinate and supervisor.

Keywords: Incentives, performance evaluation, subjectivity

JEL Classification: M52, J33, M41

Suggested Citation

Gibbs, Michael and Merchant, Kenneth A. and Van der Stede, Wim A. and Vargus, Mark E., Determinants and Effects of Subjectivity in Incentives. Accounting Review, Vol. 79, No. 2, pp. 409-436, April 2004. Available at SSRN: https://ssrn.com/abstract=516462

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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