Organizational Structure, Aggregation of Performance Measures, and Incentives

42 Pages Posted: 16 Aug 2010

See all articles by Christian Hofmann

Christian Hofmann

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management)

Steffen Reichmann

University of Mannheim

Date Written: August 16, 2010

Abstract

In this paper, we analyze the impact of organizational structure on incentives within a LEN-framework with agents on three hierarchical levels (bottom, middle, top), where the performance measures used for incentive design originate at the bottom-level. Previous literature has shown that with such disaggregated measures, the impact of organizational structure on incentives is limited to midlevel agents. In contrast, we show that with fully aggregated performance measures, organizational structure and incentives are independent. Furthermore, considering partially aggregated measures extends the impact of organizational structure on incentives to all hierarchical levels. The key to our results is that organizational structure affects the quality of aggregated performance measures, whereas the accounting system determines the extent of aggregation. We find that, frequently, the optimal organizational structure on the firm-level is detrimental to at least one hierarchical level. Based on this result we provide a rationale for the empirical lack of the theoretically well established trade-off between risk and incentives.

Keywords: Organizational Structure, Incentives, Aggregation

JEL Classification: D82, J41, M41

Suggested Citation

Hofmann, Christian and Reichmann, Steffen, Organizational Structure, Aggregation of Performance Measures, and Incentives (August 16, 2010). Available at SSRN: https://ssrn.com/abstract=1659915 or http://dx.doi.org/10.2139/ssrn.1659915

Christian Hofmann

Ludwig Maximilian University of Munich (LMU) - Faculty of Business Administration (Munich School of Management) ( email )

Kaulbachstr. 45
Munich, DE 80539
Germany

Steffen Reichmann (Contact Author)

University of Mannheim ( email )

Germany

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