Discussion of Aggregate Performance Measures in Business Unit Manager Compensation: The Role of Intrafirm Interdependencies

Abstract

Bushman, Indjejikian, and Smith consider the role in a firm's compensation practices of the performance of business units to which a manager reports (termed aggregate performance) relative to the performance of the business unit for which the manager has direct responsibility. They model and test the extent to which the relative importance of aggregate and own performance in compensation varies with selected firm characteristics, specifically measures of interdependence. The basic hypothesis is that the more informative aggregate measures are about a manager's effort choice as reflected in interdependent operations, the more important those measures will be in determining the manager's contingent compensation. Using data from a proprietary database developed by Hewitt Associates, Bushman, Indjejikian, and Smith test the implications of a simple model of the link between informativeness and the weight of alternative performance measures in compensation. They find evidence that the more interdependent the units of a firm, the more weight, on average, is given to aggregate performance results. These results tend to hold for both shortand long-term components of compensation, although the results are stronger for the former. Understanding the relative roles of own versus aggregate measures of performance in managers' compensation is important to managerial accounting researchers who want to understand the links among performance, firm characteristics, and compensation. The results in Bushman,