Performance Measure Properties and Incentive System Design

Abstract

We analyze effects of performance measure properties (controllable and uncontrollable risk, distortion, and manipulation) on incentive plan design, using data from auto dealership manager incentive systems. Dealerships put the most weight on measures that are “better” with respect to these properties. Additional measures are more likely to be used for a second or third bonus if they can mitigate distortion or manipulation in the first performance measure. Implicit incentives are used to provide ex post evaluation, to motivate the employee to use controllable risk on behalf of the firm, and to deter manipulation of performance measures. Overall, our results indicate that firms use incentive systems of multiple performance measures, incentive instruments, and implicit evaluation and rewards as a response to weaknesses in available performance measures.