Dipankar Ghosh

Incentive Instruments and the Weighting of Performance Measures

Understanding an organization’s incentive design requires that researchers collectively examine all forms of incentive instruments, namely, bonus, merit raise, and promotion, since these are common components of an incentive structure. Prior research on the weighting of performance measures tends to examine only one incentive instrument at a time (usually annual bonus) and provides somewhat mixed findings regarding the relevance of nonfinancial performance measures used to evaluate and reward the performance of long-term time horizon employees. Using proprietary data from a car-dealership organization, our results show that for long-term time horizon employees, the firm assigns significant weights to nonfinancial measures for bonuses, raises, and promotions in its incentives structure (H1). Next, we show that in incentive contracts, financial measures are weighted more than nonfinancial measures for bonus than they are weighted for merit raise and promotion (H2a); however, nonfinancial measures are weighted more than financial measures for merit raise and promotion (H2b). That is, the duration of the performance measures is reflected in the time horizon of the incentive instruments. And lastly, for bonuses (H3a), the influence of performance measures do not differ between junior managers and senior managers, for merit raises (H3b), the influence of both financial measures and nonfinancial measures is greater for junior managers than they are for senior managers, whereas for promotions (H3b), the influence of nonfinancial measures is greater for junior managers than for senior managers; the influence of financial measures is insignificant. The results for H3b and H3c taken together suggest that for senior managers nonfinancial measures are used differently for their evaluations and determining their raise and promotion.

Strategy, Incentive Design and Performance: Empirical Evidence

Firms pursuing different business strategies should align these strategies to incentive design. This study uses both archival and survey data on 110 stores of a Japanese high-end bakery chain to provide empirical evidence that misalignment between an organization’s business strategy and incentive design (i.e., weights for financial and non-financial performance measures) adversely affects firm performance. Our results suggest that a decline in the firm performance may be caused by managers’ shifting their focus toward financial measures that are inconsistent with a customer-oriented strategy. Although the firm requires the exclusive usage of non-financial measures in determining promotions, as expected, our results show that financial measures affect managers’ promotions. Additional analyses show that the influence of non-financial measures in promotion decisions becomes less pronounced after the firm shifts to a primarily financial-focused bonus plan.

Contemporaneous and Forward-Looking Measures: Implications for Incentive Structure for Long-Horizon Employees

Using car dealership data, we examine the relevance of forward-looking (FL) and contemporaneous (CO) measures for pay-for-performance incentives (bonus, annual raise, promotions) for long-horizon employees. Economic models suggest that while contracts with FL performance measures mitigates the shortsighted efforts of employees whose employment horizons are not aligned with the firms profitability horizons, these measures have no influence on effort as employment horizons approach the firms long-term profitability horizon. We predict and show for long-horizon employees that: their incentive contracts weights FL measures significantly more and are assigned greater weights than CO measures; and, compared to CO measures, the weights on FL measures increase as the time horizon of the incentives increase (bonus to raise to promotion).