Tailoring the Weights on Objective versus Subjective Performance Measures between Top Management and Middle Managers: Evidence from Performance-Based Equity Incentive Plans

Abstract

ABSTRACT This study examines the determinants of performance measurement tailoring between top management and middle managers in compensation contracts. Theoretically, while tailoring potentially enhances the informativeness of performance measures for top management and middle managers respectively, it may reduce the incentives for the two parties to coordinate with each other. We expect a firm's decision to tailor performance measurement between top management and middle managers to be driven by this cost-benefit trade-off. Using hand-collected data from performance-based equity incentive plans from Chinese public firms, we find evidence consistent with the predictions derived from our theoretical framework. Specifically, we find that the likelihood that a firm tailors the weights on objective versus subjective performance measures between top and middle managers increases with competition intensity, non-price competition, environmental uncertainty, and CEO power, and decreases with organizational stability and growth opportunity. Furthermore, we find that suboptimal tailoring decisions are associated with higher management turnover.