Relative Target Setting and Cooperation

• Date: 01 March 2019
• Published date: 01 March 2019
• DOI: http://doi.org/10.1111/1475-679X.12244
• Author: STEPHAN KRAMER,NICK HOFFMEISTER,MICHAL MATĚJKA,MARTIN HOLZHACKER

DOI: 10.1111/1475-679X.12244

Journal of Accounting Research

Vol. 57 No. 1 March 2019

Printed in U.S.A.

Relative Target Setting and

Cooperation

MARTIN HOLZHACKER,

∗STEPHAN KRAMER,

†

MICHAL MATˇ

EJKA,

‡AND NICK HOFFMEISTER

§

Received 12 July 2017; accepted 8 September 2018

ABSTRACT

A large stream of work on relative performance evaluation highlights the ben-

efits of using information about peer performance in contracting. In contrast,

the potential costs of discouraging cooperation among peers have received

much less attention. The purpose of our study is to examine how the impor-

tance of cooperation affects the use of information about peer performance

in target setting, also known as relative target setting. Specifically, we use data

from an industrial services company where business unit managers need to

share specialized equipment and staff with their peers to manage bottlenecks

in their capacity. Weconstruct several empirical proxies for the costs and ben-

efits of information about peer performance and examine their effects on tar-

get setting. We find robust evidence that the sensitivity of target revisions to

past peer performance is higher when peer group performance has greater

∗Michigan State University; †Erasmus University Rotterdam; ‡Arizona State University;

§Independent.

Accepted by Douglas Skinner. We thank an anonymous reviewer, Martin Artz (dis-

cussant), Alexander Br¨

uggen (discussant), Will Demere, Christoph Feichter, Hans Frimor,

Isabella Grabner, Katlijn Haesebrouck, Joanna Ho, Sylvia Hsingwen Hsu (discussant), Ran-

jani Krishnan, Peter Kroos, Judith K¨

unneke, Edith Leung, Frank Moers, Mathijs van Pe-

teghem, Stefan Reichelstein, Marcel van Rinsum, Karen Sedatole, Naomi Soderstrom and

workshop participants at Emory University, KU Leuven, Maastricht University,Mannheim Uni-

versity, Queen’s University, University of California, Irvine, University of Illinois at Chicago,

University of Southern Denmark, the 2017 AAA MAS meeting, the 2017 ACMAR conference,

the 2016 EIASM conference on New Directions in Management Accounting Research, the

Erasmus University Brown Bag seminar, and the Michigan State University Brown Bag semi-

nar for comments and suggestions.

211

CUniversity of Chicago on behalf of the Accounting Research Center,2018

212 M.HOLZHACKER,S.KRAMER,M.MATˇ

EJKA,AND N.HOFFMEISTER

capacity to filter out noise but lower when the importance of cooperation

among peers is greater.

JEL codes: M21; M41; M52

Keywords: relative performance evaluation; target setting; incentives;

cooperation

1. Introduction

A large stream of literature on relative performance evaluation (RPE) pro-

vides evidence that information about peer performance is used to ex post

filter out noise from compensation decisions (Antle and Smith [1986],

Janakiraman, Lambert, and Larcker [1992], Albuquerque [2009]). In addi-

tion, several recent studies (Aranda, Arellano, and Davila [2014], Bol and

Lill [2015]) show that information about peer performance can also be

used to ex ante revise performance targets, a practice referred to as relative

target setting (RTS). In contrast, there is relatively little empirical evidence

on the costs of using information about peer performance in compensation

contracts even though the theory predicts dysfunctional incentive effects in

settings where managers can strategically interact with peers and reduce

their performance (Lazear [1989], Gibbons and Murphy [1990]).1

Prior studies typically examine compensation contracts of corporate ex-

ecutives in large public companies where the potential for cooperation with

peers is limited (e.g., by antitrust law) and the costs of using information

about peer performance in contracting may be negligible. However, infor-

mation about peer performance is often used at lower organizational lev-

els for performance evaluation of managers who need to cooperate with

their peers (Matsumura and Shin [2006], Casas-Arce and Martinez-Jerez

[2009], Merchant, Stringer, and Shantapriyan [2018]). For example, per-

formance of large multidivisional firms often depends on the extent to

which their business unit (BU) managers are willing to share resources

such as labor, capital equipment, or knowledge with their peers (Gupta and

Govindarajan [1986], Chatterjee and Wernerfelt [1991], Hill, Hitt, and

Hoskisson [1992]). In such settings, facilitating cooperation is at least as

important as filtering out noise from performance evaluations (Bushman,

Indjejikian, and Smith [1995], Keating [1997], Feichter, Grabner, and Mo-

ers [2018]). In other words, what we know about incentive contracts of

corporate executives may provide only partial insights about the relative

costs and benefits of using information about peer performance to evalu-

ate managers at lower organizational levels.

1There are some experimental studies suggesting that RPE encourages sabotage or col-

lusion (Bandiera, Barankay, and Rasul [2005], Charness and Villeval [2009], Harbring and

Irlenbusch [2011], Wang [2017]). There is also some evidence that executive compensation

is less sensitive to peer performance when firms prefer to soften product market competition

(Aggarwal and Samwick [1999], Vrettos [2013]).