Performance Measure Properties and Incentives

41 Pages Posted: 15 Mar 2004

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: October 2004

Abstract

We examine the effects of performance measure properties on incentive system design, using data on incentive contracts for auto dealership managers. The data include information on five properties: two indicators of risk; two indicators of distortion; and one indicator of potential manipulation. We find that these properties have important effects on incentive system design. First, firms appear to choose the "best" performance measure available along these dimensions, and use it for the most important (primary) formula bonus. Second, the properties of this primary performance measure are important determinants of the weight placed on the measure for explicit. Third, firms appear to use other performance measures to balance multitask incentives relative to the primary performance measure. Specifically, we find evidence that second and third bonuses are used to provide better incentives for cooperation and to reduce incentives for manipulation. Fourth, we present evidence that subjectivity, through discretionary bonuses based on subjective performance evaluations, and also through implicit incentives for promotions and other rewards, also appear to play the same roles.

Keywords: Incentives, performance measures

JEL Classification: M52, J33, M41, G34, M43

Suggested Citation

Gibbs, Michael and Merchant, Kenneth A. and Van der Stede, Wim A. and Vargus, Mark E., Performance Measure Properties and Incentives (October 2004). IZA Discussion Paper No. 1356. Available at SSRN: https://ssrn.com/abstract=516482

Michael Gibbs (Contact Author)

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

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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