Incentive Instruments and the Weighting of Performance Measures

Abstract

Understanding an organization’s incentive design requires that researchers collectively examine all forms of incentive instruments, namely, bonus, merit raise, and promotion, since these are common components of an incentive structure. Prior research on the weighting of performance measures tends to examine only one incentive instrument at a time (usually annual bonus) and provides somewhat mixed findings regarding the relevance of nonfinancial performance measures used to evaluate and reward the performance of long-term time horizon employees. Using proprietary data from a car-dealership organization, our results show that for long-term time horizon employees, the firm assigns significant weights to nonfinancial measures for bonuses, raises, and promotions in its incentives structure (H1). Next, we show that in incentive contracts, financial measures are weighted more than nonfinancial measures for bonus than they are weighted for merit raise and promotion (H2a); however, nonfinancial measures are weighted more than financial measures for merit raise and promotion (H2b). That is, the duration of the performance measures is reflected in the time horizon of the incentive instruments. And lastly, for bonuses (H3a), the influence of performance measures do not differ between junior managers and senior managers, for merit raises (H3b), the influence of both financial measures and nonfinancial measures is greater for junior managers than they are for senior managers, whereas for promotions (H3b), the influence of nonfinancial measures is greater for junior managers than for senior managers; the influence of financial measures is insignificant. The results for H3b and H3c taken together suggest that for senior managers nonfinancial measures are used differently for their evaluations and determining their raise and promotion.