Performance Measure Aggregation, Career Incentives, and Explicit Incentives

Abstract

ABSTRACT: We examine a setting in which managers have differential career concerns and firm performance is publicly observed using disaggregated measures that are incrementally informative but costly to contract upon. In such a setting, when do firms contract on aggregated rather than disaggregated performance measures? We show that at intermediate levels of managerial career concerns contracting on an aggregate measure can be welfare-enhancing. In this case, the net cost of both contracting directly on an aggregate measure and exploiting career incentives based on disaggregated measures is smaller than the cost of contracting directly on disaggregate measures. Our findings also imply that detailed performance disclosures will be accompanied by lower incentive weights based on aggregate performance when career incentives mitigate distortions caused by aggregation. Further, if performance measures become noisier due to transient shocks, we find that contractual incentive weights on aggregate performance can be either increasing or decreasing, depending on the magnitude of a manager’s career incentives.

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