When one size does not fit all: Using ex post subjective ratings to provide parity in risk-adjusted compensation

Posted: 13 Nov 2017 Last revised: 26 Jun 2020

See all articles by Shannon W. Anderson

Shannon W. Anderson

University of California, Davis - Graduate School of Management

Henri C. Dekker

VU University Amsterdam

Karen Sedatole

Goizueta Business School

Eelke Wiersma

VU University Amsterdam - Department of Accounting

Date Written: May 9, 2020

Abstract

Firms typically use a ‘one-size-fits-all’ (OSFA) compensation contract that specifies a common formulaic relation between performance and compensation (i.e., a performance bonus) for nonexecutive managers in similar jobs. However, a contract that is appropriate on average, may be suboptimal for individual managers if heterogeneity in the operating environment creates varying compensation risk. We use field data from a retail firm that introduced an OSFA bonus compensation plan for its store managers. The common bonus formula is based on a weighted sum of objective measures of performance and a subjective rating made by supervisors. The firm intended the supervisors’ discretionary subjective rating to evaluate performance on dimensions that are difficult to measure (e.g., store appearance). We test and find that supervisors give uniformly higher subjective ratings to managers whose objective measure of sales performance is measured with greater noise, and to managers who face higher performance target difficulty, the latter assessed both prior to (ex ante) and subsequent to (ex post) the evaluation period. These results obtain after controlling for manager ability and performance, and for alternative mechanisms to mitigate differences in compensation risk (e.g., salary changes, sales target changes, and bonus adjustments). The evidence suggests that supervisors use discretion in subjective ratings to provide manager-specific risk premiums for non-executive managers who are subject to an OSFA contract.

Keywords: subjective evaluation, performance measurement, compensation risk, subjectivity

JEL Classification: M40, M52

Suggested Citation

Anderson, Shannon W. and Dekker, Henri C. and Sedatole, Karen and Wiersma, Eelke, When one size does not fit all: Using ex post subjective ratings to provide parity in risk-adjusted compensation (May 9, 2020). Management Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3065970 or http://dx.doi.org/10.2139/ssrn.3065970

Shannon W. Anderson

University of California, Davis - Graduate School of Management ( email )

One Shields Avenue
Apt 153
Davis, CA 95616
United States

Henri C. Dekker

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands

Karen Sedatole

Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

Eelke Wiersma (Contact Author)

VU University Amsterdam - Department of Accounting ( email )

De Boelelaan 1105
Amsterdam, 1081 HV
Netherlands

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