EC 5

Question 1

The agency problem - subjectivity

Answer 1

PM are useful to address agency problems but PM
a) can be influenced by uncontrollable factors (noise)
a.1) risk for agent
b) Does not capture all aspect of what a good employee should do (congruence problem)
b.1) risk for principal

Question 2

Observed value of the PM

Answer 2

True value + noise + bias

Question 3

Different types of subjective performance evalutions

Answer 3

Discretionary bonus
Subjective weights

Question 4

Gibbs (2004)
conclusion

Answer 4

• Subjectivity in compensation contracting is used to improve conrgurence and noise problems that are intrinsically linked to the used of PM
• subjectivty increases pay satisfcation, productivity, and profiabiltiy but only when it is applied in a trusting environment
  Important: subjectivity is mainly used in more complex, multi-task, and noisy environments. As
  there is a cost to the use of subjectivity (favoritism and influence costs), there is no real need to
  use subjectivity in ‘easy’ environments.
• Disadvantages
• You open the door for favoritism, supervisor biases, and influence activities
• The appropriate information needs to be collected

Question 5

Ittner (2003

Answer 5

Giving supervisors too much freedom to use subjective performance evaluation will likely not lead to fair performance evaluation

Question 6

Demere (2019)

Answer 6

• A calibration committee is a team of supervisors and higher-level managers which executes
  the subjective performance evaluation
• This study documents that:
• Calibration committees improve consistency, reduce leniency, but increase centrality
• Calibration committees take into account information advantages of supervisors when making
  adjustments and help supervisors to learn about performance expectations

Question 7

Intertemporal choice problem:

Answer 7

managers have a higher preference for
actions from which the benefits are realized at short(er) term

Question 8

What are the benefits of ARMs

Answer 8

1; Correct for the assets/investments one uses to generate a particular result
2; Allows to specify the minimum required rate of return.

Question 9

One reason why the EVa is popular:

Answer 9

• Evaluating managers on ROIC can lead to over-/underinvestment

Question 10

Potential problems of non-financial measures

Answer 10

• Lack of congruence: only a weak link between stock prices and non financial measures (based
  on previous research)
• Relatively short lead times (often within one year)
• Non-linearity: too much employee training can be harmful for firm performance
• Non-verifiability: non financials can also be easily “manipulated” and are more difficult to verify
  by senior management

Question 11

Leniency bias

Answer 11

The leniency bias describes the situation where the manager tends to be more lenient than his or her peers, when rating employees, OR, is more lenient with one employee as compared to another.

Question 12

Centrality bias

Answer 12

Centrality bias is the tendency to rate most items in the middle of a rating scale. Like leniency bias, this can weaken the objectivity of your data.

Question 13

Problems with the individual approach towards subjectivity

Answer 13

The individual approach: your supervisor observes the available performance measures, (maybe) collects
additional information and makes the adjustment if he considers that reasonable
1. Collecting additional information is costly for the supervisor and he may refrain from doing
so, leading to a performance evaluation that is not a better reflection of the employee’s effort
2. Biases in supervisor evaluation: centrality bias and leniency bias
3. Different supervisors factor in different decision criteria leading to inconsistency in
performance evaluations and unfairness perceptions among similar employees
4. Companies often work with flexible teams, implying that an employee works for different
supervisors throughout the evaluation period