Compensation Discretion as Insurance: How Are Targets and Bonuses Affected When Superiors Have a Back-Up Plan?

Abstract

Target setting by superiors and their discretion in compensation decisions are important interrelated pieces in an organization’s control system. Thus, we examine how these processes affect each other and superiors’ decisions therein. We predict, and experimentally find, that superiors with ex post compensation discretion set more aggressive targets and put less effort into the target-setting process, as they rely on their discretion as insurance against setting an overly aggressive target with insufficient effort. This is an important finding, as targets are often used in performance evaluation and compensation decisions, as well as organizational planning, coordination, and resource allocation. We further examine the target-setting process by analyzing the effect of Dark Triad personality traits on superiors’ target-setting decisions. We find that high Dark Triad superiors with ex post discretion set the most aggressive targets, but without ex post discretion they set the least aggressive targets. This facet can be considered in the design of compensation plans and provides insight as to why compensation plans affect individuals differently. In supplemental analyses, we find that superiors’ target setting affects how they use their ex post compensation discretion. Thus, our study illustrates that target setting and compensation discretion influence each other to affect superiors’ decisions concerning subordinates, providing insight into the use of these processes within management control systems.