Article2008

Nonfinancial Performance Measures and Promotion‐Based Incentives

152 citations0/0 files storedJournal of Accounting Research

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Accounting and Organizational Management Auditing, Earnings Management, Governance Intellectual Capital and Performance Analysis

Abstract

ABSTRACT In this paper, I examine the sensitivity of promotion and demotion decisions for lower‐level managers to financial and nonfinancial measures of their performance and investigate the extent to which the behavior of lower‐level managers reflects promotion‐based incentives. Additionally, I test for learning versus effort‐allocation effects of promotion‐based incentives. I find that promotion and demotion decisions for store managers of a major U.S.‐based fast‐food retailer (QSR) are sensitive to nonfinancial performance measures of service quality and employee retention after controlling for financial performance. The likelihood of demotion in this organization is also sensitive to nonfinancial performance on the dimension of service quality, while the probability of exit is primarily sensitive to financial performance measures rather than nonfinancial performance measures. I also find evidence that the behavior of lower‐level managers is consistent with the incentives created by the weighting of nonfinancial performance measures in promotion decisions. Managers in locations where there is a higher ex ante probability of promotion and a higher potential reward upon promotion demonstrate significantly higher levels and rates of performance improvement in service quality. Finally, consistent with promotion‐based incentives inducing both effort‐allocation and learning effects, I find that performance‐improvement rates for service quality: (1) are higher in prepromotion periods in markets where promotions occur, (2) decrease immediately after the occurrence of a promotion in the same market area, and (3) remain higher than in markets where promotions do not occur. These findings provide some of the first empirical evidence on an alternative to the explicit weighting of nonfinancial metrics in compensation contracts as a mechanism for generating improvements in nonfinancial dimensions of performance.

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References

1991Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations 2001Econometric Analysis of Cross Section and Panel Data 1992The balanced scorecard : measures that drive performance 1979Moral Hazard and Observability 1997The balanced scorecard: Translating strategy into action 1991Organizational Learning: The Contributing Processes and the Literatures 1995What To Do (and Not to Do) with Time-Series Cross-Section Data 1981Rank-Order Tournaments as Optimum Labor Contracts

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