The Influence of Target Setting on Employees’ Investment Behavior

In this study we examine whether increasing targets based on past performance information or on exogenous information affects employees' trade-off between short-term output and long-term investments differently. Both mechanism are supposed to increase long-term investments, while also achieving the short-term output targets. Archival data do not allow disentangling these mechanisms, so we examine this question in a multi-period experiment in which participants can spend their time on either maximizing short-term output or investing in long-term productivity improvements. The results show little difference in the initial investment levels. However, as the time horizon decreases, participants in the exogenously increasing target condition start reducing their investments and focus on short-term output, while participants in the target ratcheting condition keep their initial high-level of investment. This outcome is consistent with our theory that target ratcheting decreases the horizon problem of individuals and thereby leads to higher long-term investments. This study helps to reconcile seemingly disparate findings of prior literature and provides a plausible explanation for the widespread use of an alleged dysfunctional practice, that is, target ratcheting