Week 4 - Target setting

Question 1

Target difficulty and motivation/performance

Answer 1

1. A HARDER target increases INCENTIVE to work harder until a certain point (positive relationship)
   - but motivation/performance dips once the target is too difficult
2. Targets and incentives increase productivity (only on effort tasks) but DECREASE “OUTSIDE-THE-BOX” THINKING (for creative tasks, better to have easier or no targets)

Question 2

Targets are not always set “optimally”
» in practice, companies don’t always reflect theories

Answer 2

EXPERIENCE BIAS
- SUPERVISORS who achieved HIGH PERFORMANCE before being promoted set HIGHER TARGETS than low-performing supervisors, despite having the same information about the employee’s potential
- the biased targets also lead to -ve employee reactions

Question 3

TARGET RATCHETING

Answer 3

ie. using current performance to set future targets
- High performance -> higher targets
» if reach this year’s target, next year’s target will be higher
» this system creates an incentive to reach target but not exceed by too much b/c it means next year’s target will become too difficult

Target ratcheting is thus often “ASYMMETRIC”
ie. negative performance does NOT lead to LOWER future targets
» if don’t achieve target, next year’s target either stays unchanged or doesn’t decrease by the same amount…
» …which means that targets only increase over time
» might cause targets to be too difficult to reach

Question 4

Target ratcheting and effort reduction (Bouwens and Kroos, 2011)

Answer 4

1. Managers with favourable sales performance in the first 3 quarters REDUCE their sales activity in the final quarter
2. Managers who reduce their sales activity in the final quarter are more likely to beat their next-year sales targets than managers who refrain from reducing their final-quarter sales
   - b/c next year’s target is based on current sales

Question 5

What is the condition that incentivises employees to decrease their performance in this period rather than keep going forward?

Answer 5

If increase performance, then next period’s target will be more difficult BUT THIS PERIOD’S BONUS WILL NOT BE HIGHER
-> thus decrease performance this period

Question 6

Alternative incentive scheme - ex ante targets vs ex post payouts
(3 “steps” for meeting threshold, target, maximum <- why capped?)

Answer 6

1. “LINEAR” CONTRACTS CAN LEAD TO “NONLINEAR” PAYOUTS!
   » the value of 1 share already compounds and increases exponentially
2. bonus is capped at the Maximum b/c don’t want to incentivise extreme performance
   - as this would incentivise gamesmanship & adverse behaviour
   » can always pay for extra performance through a SUBJECTIVE bonus

Question 7

Earnings targets and annual bonus incentives
(Indjejikian et al., 2014)
» adjusting targets differently based on employees’ performance

Answer 7

1. Contract commitment:
   - high-performers’ earnings targets rarely increases {& commonly decrease}
   - low-performers rarely decreases {& commonly increase}
2. Pushing high-performers might lead to unrealistic targets (you want to keep these employees)
   » can’t keep on increasing their performance & productivity or might tip them over
3. Low-performers need to increase performance (or leave the firm)

Question 8

What is the US mandatory filing for disclosing information about targets/incentives/pay (incl. executive compensation & director compensation, etc.)?

Answer 8

DEF 14A (“proxy statement”)
- disclosed prior to annual shareholder meeting (typically 6 months after fiscal year ends)

Question 9

TD Canada case
How to formally test links (linkage analysis) in a “STRATEGY MAP”?

Answer 9

Test STATISTICALLY using
1. Factor analysis
- Group data and reduce the no. of dimensions from survey results
2. and Regression analysis

-> now we know where and how to improve