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Discretionary bonus adjustments allow managers to restore the alignment of employee effort and compensation when bonus amounts are based on noisy objective performance measures. The implications of discretionary adjustments for employees' future efforts and fairness perceptions present important trade‐offs for managers to consider. Adjustments may be used to motivate different types of effort in future periods, but may also create perceptions of unfairness among employees who are not affected by negative events. This study examines the joint influence of the likelihood of future negative uncontrollable events and compensation interdependence (i.e., the extent to which one employee's compensation influences others' compensation) on managers' willingness to make adjustments for the effect of a negative uncontrollable event on a single employee. In our experiment, we manipulate the likelihood of future uncontrollable events and whether bonuses are determined individually or are drawn from a shared bonus pool. Results show that managers are less willing to adjust when the likelihood of future events is high to avoid setting a precedent, thereby motivating employees to adapt to changing conditions. We also find that managers are less willing to adjust, regardless of event likelihood, when compensation interdependence is high, to avoid demotivating unaffected employees. Finally, we find that participants' general attitudes toward compensation significantly influence their adjustment decisions beyond the effects of our independent variables. Our results highlight the unique nature of discretionary adjustments, help explain findings from previous research, and demonstrate important considerations managers must make when using the flexibility provided to them in pay‐for‐performance contracts.

Strategic performance measurement systems operationalize firm strategy with a set of performance measures. A consequence of such alignment is the tendency for managers to lose sight of the strategic construct(s) the measures are intended to represent, and subsequently act as though the measures are the constructs of interest, a phenomenon referred to as surrogation . We investigate how involvement in strategy selection affects managers’ propensity to exhibit surrogation. We predict and find that strategy selection reduces surrogation. Surprisingly, we do not find that engaging in strategy deliberation, a key process underlying strategy selection, reduces surrogation. Thus, managers’ involvement in the actual choice of strategy appears to be both a necessary and sufficient condition to mitigate surrogation. Our paper broadens understanding of factors that influence surrogation, such as the effects of different aspects of managers’ strategic involvement and buy‐in. Further, by documenting how managers behave within (as opposed to simply with ) strategic performance measurement systems, we highlight the potential for managers to endogenously influence the effectiveness of such systems.

We investigate managers’ propensity to engage in strategic promotion behavior. Strategic promotion behavior occurs when managers pursue personal economic interests when contributing to employee promotion decisions, such that the probability that relatively lower performing employees are selected for a promotion is increased. We develop theory about how two important organizational characteristics—transparency about individual performance levels and the presence of group incentives—jointly affect managers’ tendency to strategically influence promotion decisions. Using a stylized lab experiment, we find that transparency about individual performance levels decreases strategic promotion behavior when group incentives are absent but not when group incentives are present. We discuss how our findings contribute to our understanding of management accounting and control systems.

Conventional wisdom suggests that frequent performance reporting is beneficial for decision making, as it can enhance timeliness and usefulness of the reported information for decision making. We investigate a potential motivational cost of frequent performance reporting. Using goal orientation theory, we predict and find that frequent performance reporting has negative motivational and performance implications when employees know or assume that the information they report will be used to evaluate their task-related skill. Our theory and results suggest that organizations need to balance the informational benefits and motivational costs of frequent reporting when designing their performance reporting systems. In addition, our theory and results can help organizations begin to design solutions that take advantage of the informational advantage of frequent reporting while minimizing its motivational costs.

We analyze the effect of social norms and enforcement on the dynamics of taxpayer compliance. Specifically, we develop two models to evaluate the movement between classes of compliant and noncompliant taxpayers. Our analysis suggests that the effect on compliance of changing enforcement levels depends on whether the taxpayer population is initially compliant or noncompliant. Compliant populations are insensitive to changes in enforcement policies until enforcement becomes sufficiently lax, when we observe a sudden shift to high levels of noncompliance in equilibrium. In contrast, relatively noncompliant populations respond to increased enforcement by gradually increasing compliance. Then, when enforcement becomes sufficiently harsh, we find a sudden shift in equilibrium to very high levels of compliance. After the taxpayer population shifts from compliance to noncompliance, or vice versa, our models predict that returning to the previous enforcement policy will not cause the population to return to its previous state. On the whole, our models' results help explain why taxpayer compliance varies across time and across geographic regions, even under similar enforcement regimes.

To facilitate managers' decision-making, firms develop strategic performance measurement systems that translate strategy into performance measures. Ideally, managers see measures for what they are—imperfect proxies for intangible strategic constructs. However, managers may fail to fully appreciate the fact that measures are merely representations of the strategic constructs, and act as though the measures are the construct of interest—a phenomenon we label surrogation. In this paper, we investigate whether and how the use of strategically linked performance measures for compensation purposes affects managers' propensity to exhibit surrogation. In accordance with the attribute substitution framework (Kahneman and Frederick 2002), we predict incentive compensation exacerbates surrogation, and that this effect is more prevalent when managers are compensated on a single measure of a strategic construct than when managers are compensated on multiple measures of a strategic construct. Via two experiments, we find support for these hypotheses. Our paper contributes to the literature on strategic performance measurement systems by highlighting the tendency of managers to use measures as surrogates for strategy. More generally, we identify a by-product of contracting on imperfect performance measures not previously considered in extant literature, and establish when consideration of costs of this by-product are likely to be critical.

Performance measure noise can be a critical barrier to employees' learning. Using an experiment, we examine whether the effects of performance measure noise on employees' learning depends on the type of learning in which employees engage: experiential versus vicarious. We predict and find performance measure noise has a more deleterious effect on learning when such learning occurs experientially rather than vicariously. Specifically, we find experiential learners demonstrate less learning as performance measure noise increases, but vicarious learners show no such effect of performance measure noise. Collectively, our findings suggest performance measure noise and learning type play important roles in the extent to which firms realize the decision-facilitating benefits of performance measurement systems. In particular, since much of the learning in modern organizations occurs vicariously, our findings suggest performance measure noise may not be as detrimental to employees' learning as previously thought.

Employee contracts often allow for managerial discretion, such that the manager decides after observing an employee's performance how that employee will be rewarded or penalized. Importantly, the effects of such evaluation outcomes can extend beyond the employee(s) directly affected, because such outcomes can be observed by other employees within the firm. The net effect of such vicarious learning as an indirect control depends on the inferences employees make after observing a peer's evaluation outcome. In this study, we use an experiment to investigate whether the inferences observer-employees make about how managers evaluate and reward employee behavior depend on whether the valence of the observed outcome is positive or negative. Using the setting of a strategic performance measurement system, we test and find support for a causal model, in which the valence of the observed outcome influences observer-employees' inferences and subsequent behavioral focus via their psychological distance from, and their construal of, the observed outcome. Our results suggest that how observer-employees respond after observing a peer employee's evaluation outcome is asymmetric. Specifically, when contemplating their own behavior, employees who observe positive outcomes focus on the performance measures within the strategic performance measurement system, whereas those who observe negative outcomes focus on the underlying strategic construct.