An International Meeting of the American Accounting Association American Accounting Association 2006 Annual Meeting August 6–9, 2006 Washington, D.C.

Jasmijn C. Bol
IESE Business School

Abstract: This paper examines how subjective performance measures and discretional adjustments by supervisors affect the incentive provision of a compensation contract. I investigate a compensation plan for low-level employees that includes both objective and subjective measures and that allows supervisors to make discretional adjustments to financial rewards. After establishing that the performance ratings are subject to leniency and centrality bias, I examine how the biases and the adjustments affect posterior performance. Contrary to what is generally assumed, the results show that incentives are not just negatively affected by biased performance ratings. I provide evidence indicating that leniency bias positively affects performance improvement, while centrality bias has a negative effect on it. I also find that upwards discretional adjustments have a positive effect on the performance of those employees that receive them, while it does not influence those employees who do not.

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