The role of subjectivity in mitigating incentive contracting risks
The Accounting Review https://doi.org/10.2308/TAR-2017-0652
52 Pages Posted: 15 Mar 2021
Date Written: February 15, 2021
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 well-documented 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.
Keywords: subjectivity; incentive alignment; employee sorting; compensation risk; mitigating errors and bias in subjectivity; calibration
JEL Classification: M49, M55, M52, M51
Suggested Citation: Suggested Citation