The role of subjectivity in mitigating incentive contracting risks

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 welldocumented 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.

Payoff implications of incentive contracting

In the context of a canonical agency model, we study the payoff implications of introducing optimally structured incentives. We do so from the perspective of an analyst who does not know the agent's preferences for responding to incentives, but does know that the principal knows them. We provide, in particular, tight bounds on the principal's expected benefit from optimal incentive contracting across feasible values of the agent's expected rents. We thus show how economically relevant predictions can be made robustly given ignorance of a key primitive.

Audit firm tenure and perceived audit quality: evidence from CEO incentive contracts

Purpose This paper aims to examine how compensation committees perceive audit quality as indicated by audit firm tenure. Using the contracting weight attached to earnings and cash flows in chief executive officer (CEO) compensation as proxy for the compensation committee’s perception of audit quality, the study examines whether compensation committees perceive performance metric informativeness as being affected by auditor tenure. Design/methodology/approach The paper regresses CEO cash compensation on accounting-based performance metrics and on interactions between auditor tenure and accounting-based performance metrics while controlling for other factors previously shown to affect CEO pay. Auditor tenure is measured using continuous and dichotomous variables. Findings Auditor tenure is associated with a reduced (positive) weight on earnings (operating cash flows), which suggests lower perceived audit quality as tenure lengthens consistent with the auditor closeness argument. This relation is asymmetric, i.e. the negative effect of longer auditor tenure on incentive contracting is more pronounced for positive earnings. The results are robust to using CEO total compensation as the compensation measure, as well as using level and change specifications. Research limitations/implications The inability to control for audit partner tenure in assessing the effect of audit firm tenure on incentive contracting and the potential endogeneity between auditor tenure choice and incentive contracting are the main limitations of this study. Given the lack of information on US audit partner tenure, the study could not control for the audit partner tenure issue. However, the study has attempted to mitigate the endogeneity issue by using a Heckman selection model that includes in the first-stage a regression of auditor tenure on various firm, performance measure and CEO-related governance characteristics, based on existing models (Li et al., 2010). Practical implications Compensation committees view auditor tenure as an indicator of accounting quality in setting CEO pay. Further, long auditor tenure is perceived as detrimental to financial reporting integrity, particularly when earnings numbers suggest positive managerial performance and innovations. Originality/value This study provides empirical evidence that auditor tenure matters in setting executive pay. Further, this study shows evidence on the link between auditor tenure and audit quality from an internal user’s perspective. Prior studies have focused either on external users (investors, creditors) or on the preparer (using measures such as discretionary accruals or meet/beat analysts’ forecasts or forecast guidance).

Multiperiod Contracting and Salesperson Effort Profiles: The Optimality of “Hockey Stick,” “Giving Up,” and “Resting on Laurels”

The authors study multiperiod sales force incentive contracting in which salespeople can engage in effort gaming, a phenomenon that has extensive empirical support. Focusing on a repeated moral hazard scenario with two independent periods and a risk-neutral agent with limited liability, the authors conduct a theoretical investigation to understand which effort profiles the firm can expect under the optimal contract. The authors show that various effort profiles that may give the appearance of being suboptimal, such as postponing effort exertion (“hockey stick”) and not exerting effort after a bad or a good initial demand outcome (“giving up” and “resting on laurels,” respectively) may indeed be induced optimally by the firm. This is because, under certain conditions that depend on how severe the contracting frictions are and how effective effort exertion is in increasing demand, the firm wants to concentrate rewards on extreme demand outcomes. Doing this induces gaming and reduces expected demand but also makes motivating effort cheaper, thus saving on incentive payments. On introducing dependence between time periods, such as when the agent can transfer demands between periods, this insight continues to hold and, furthermore, “hockey stick,” “giving up,” and “resting on laurels” can be optimal for the firm even under repeated short time horizon contracting. The results imply that one must carefully consider the setting and environmental factors when making inferences about contract effectiveness from dynamic effort profiles of agents.

Optimal incentive contract with endogenous monitoring technology

Recent technology advances have enabled firms to flexibly process and analyze sophisticated employee performance data at a reduced and yet significant cost. We develop a theory of optimal incentive contracting where the monitoring technology that governs the above procedure is part of the designer's strategic planning. In otherwise standard principal–agent models with moral hazard, we allow the principal to partition agents' performance data into any finite categories, and to pay for the amount of information the output signal carries. Through analysis of the trade‐off between giving incentives to agents and saving the monitoring cost, we obtain characterizations of optimal monitoring technologies such as information aggregation, strict monotone likelihood ratio property, likelihood ratio–convex performance classification, group evaluation in response to rising monitoring costs, and assessing multiple task performances according to agents' endogenous tendencies to shirk. We examine implications of these results for workforce management and firms' internal organizations.

ANALISIS FAIRNESS DAN INCENTIVE CONTRACTING PADA KINERJA BERBASIS ANGGARAN ATAS PENGUJIAN: EKSPERIMEN (STUDI KASUS PADA MAHASISWA PASCASARJANA DIUNIVERSITAS MALIKUSSALEH TANUN 2017- 2018)

This study aimed to determine the analysis of fairness and incentive contracting on performance-based budget testing experiments. The data used in this research were primary data. The population in this study consisted of 59 postgraduate students who were on Lancang Garam St, postgraduate campus of Malikussaleh University with an observation period starting from 2017-2018. The sampling method was purposive sampling. The number of samples that meet the research criteria based on existing considerations was that all postgraduate students management in science during 2017-2018 as many as 59 respondents. The method used to analyze the relationship between independent variables and the dependent variable was Multiple linear regression analysis and Classical assumption test. The test results showed that the planning variable was accepted because the value was significantly higher, namely the difference between fairness and budget-based performance, while the other side is accepted also because it was seen from a significantly higher value that was with the difference between fairness towards the budget process, which has been studied from 59 students on the postgraduate campus of Malikussaleh University.

Determinants of Earnings Persistence and Predictability for Lodging Properties

Accounting earnings are used extensively in the lodging industry for the purposes of incentive contracting, credit assessment, and valuation but we know little about the attributes of lodging properties’ accounting earnings and their determinants. Two important attributes of accounting earnings are persistence and predictability, which have been identified as key components of sustainable earnings. In this study, we examine a sample for lodging properties over a lengthy time-period to investigate the property-specific determinants of the persistence and predictability of lodging properties’ earnings. We find that barriers to entry, measured by the relative amount of marketing expenditures, have a positive impact on these earnings attributes. We also find that revenue diversification has a positive effect on these attributes, presumably through its impact on earnings stability. Finally, we find that resource rigidity, as measured by operating leverage and labor intensity, have a consistent dampening impact on persistence and predictability.