Target Ratcheting and Investment in Productivity Improvements

Abstract

In this study we examine how target ratcheting affects employees’ tradeoff between short-term output and long-term investments. We hypothesize that while using past performance information in setting new targets (i.e. target ratcheting) decreases individuals’ short-term output, it increases investments in future productivity improvements by mitigating the negative consequences of the horizon problem. We test our prediction in a multi-period experiment, where we manipulate in a nested between subjects design the target setting procedure and within subjects the individuals’ time horizon. The results support our hypotheses that as individuals’ time horizon decreases the exogenously determined target groups lower their investment and put more attention to the short-term output task, while participants in the target ratcheting condition keep their initial strategy and invest relatively more in future productivity improvements. Therefore, this study provides a plausible explanation for the widespread use of an alleged dysfunctional practice, i.e., target ratcheting.