The Role of Performance Measure Characteristics in the Design of Incentive Systems: An Empirical Analysis

In this paper, I derive three general performance measure characteristics from the literature that are theoretically related to the use of performance measures, i.e., (1) the impact that a manager has on performance (sensitivity), (2) the impact that uncontrollable factors have on performance (controllability), and (3) the degree to which the performance measure is objective and verifiable (measurement accuracy). I empirically examine the effect of information asymmetry and the performance measure characteristics on the use of three types of performance measures. Furthermore, I examine how two types of uncertainty, i.e., task uncertainty and environmental uncertainty, affect information asymmetry and performance measure characteristics. The major finding of this study is that sensitivity is positively related to the use of all three types of performance measures, while measurement accuracy is positively related to two out of these three types of performance measures. Controllability, on the other hand, does not have the proposed positive effect on any of the performance measures examined. These results suggest that sensitivity and measurement accuracy play an important role in designing incentive systems, while controllability seems to play no role.