Importance of Measures of Past Performance: Empirical Evidence on Quality of e‐Service Providers*

Abstract

There has been considerable interest in the management accounting research literature in studying how managerial and worker compensation depends on measures of their performance. Stemming from the theoretical analysis of Holmstrom 1982, Banker and Datar 1989, and others, several empirical studies have sought to examine the implicit role and impact of different performance measures (e.g., Antle and Smith 1986; Lambert and Larcker 1987; Bushman, Indjejikian, and Smith 1996; Ittner, Larcker, and Rajan 1997; Banker, Potter, and Srinivasan 2000). Since the economic theory motivating this research stems from a model of moral hazard with unobservable effort from the agent, the only performance measures that appear relevant are those whose distributions are shifted by the agent’s choice of effort level. As a result, the focus of past research has been on measures of future performance that are contingent on agent’s effort. In this paper, we focus on the role of measures of past performance and accomplishments in determining compensation for services provided. Measures of past performance we consider in this study are observable by both the principal and the agent, and differ from the predecision precontract information in Baiman and Evans 1983 that is available only to the agent. Past performance in our study provides a signal on the intrinsic ability or quality of a service provider. In an adverse selection setting where the service provider’s intrinsic ability is not observed directly by the purchaser of the service, measures of past performance and accomplishments are likely to be informative (Darrough and Melumad 1995). The compensation paid for the service, therefore, is likely to depend on the past performance and other signals on the provider’s ability to deliver valuable service. Murphy and Zabojnik (2003), for example, find that as large corporations now tend to hire chief executive officers (CEOs) externally rather than through internal promotions, transferable skills are more important than firm-specific skills. As a