Normative decision making with multiattribute performance targets

Abstract

Abstract Many companies set multiple performance targets for their managers and reward them on meeting a threshold value for each target or goal. Examples of such incentive structures abide in the managerial literature and in organizational settings. We show that this incentive structure, while popular, has two main problems: (i) it can induce managers who try to maximize the probability of meeting their performance targets to make decisions that are not compatible with expected utility maximizing decisions, and (ii) it may lead to trade‐offs among the performance objectives that are inconsistent with the corporate value function. In this paper, we propose a method to remedy these two problems, while retaining a target‐based incentive scheme. We define a multiattribute target as a deterministic region in the space of multiattribute outcomes that has two properties: (1) the probability that the outcome of a multiattribute lottery lies within the target region is equal to the expected utility of the lottery, and (2) all outcomes within the target region are preferred to all outcomes outside it. These two properties lead to a new quantity; which we call the ‘value aspiration equivalent’ that leads managers who maximize the probability of meeting their targets to simultaneously maximize the expected utility, and it also induces trade‐offs that are consistent with the decision maker's value function. Copyright © 2009 John Wiley & Sons, Ltd.