We examine the extent to which firms use past performance as a basis for setting earnings targets in their bonus plans and assess the implications of such targets for managerial incentives. We find that high-profitability firms commonly decrease earnings targets when their managers fail to meet prior-year targets but rarely increase targets. Conversely, we find that low-profitability firms commonly increase earnings targets when their managers meet or exceed prior-year targets but rarely decrease targets. This target-revision process yields a serial correlation in target difficulty—targets remain relatively easy (or difficult) through time. We also find that firms are reluctant to revise earnings targets below zero, resulting in an unusually high frequency of zero earnings targets that are abnormally difficult to achieve. Collectively, our findings suggest that firms incorporate past performance information into targets, yet they do so only to a limited extent. This is consistent with theoretical arguments that highlight the benefits of contractual commitments. Data Availability: Data used in this study cannot be made public due to the confidentiality agreement with the sponsoring organization.

We examine how firms design bonus plans of their CFOs. CFOs participate in decision making much like other executives, but they also have significant fiduciary responsibilities for reporting firms' financial results. Responsibility for financial reporting raises the question of whether it is appropriate to pay CFOs annual bonuses contingent on self-reported financial performance. In this paper, we provide a framework that characterizes CFO bonuses as a tradeoff between CFOs' decision-making responsibilities and their fiduciary duties over financial reporting. This framework yields a number of implications that we examine empirically using a proprietary survey of CFO compensation practices of public and private firms. Our main finding shows that from 2003 to 2007 public entities (relative to private entities) reduced the percentage of CFO bonuses contingent on financial performance. We interpret this result as evidence that firms mitigate misreporting practices in part by deemphasizing CFO incentive compensation. * Ross School of Business, University of Michigan. We acknowledge the support of the American Institute of Certified Public Accountants in this research project. We also wish to thank Merle Erickson (editor) and an anonymous reviewer for suggestions on how to improve the paper as well as numerous colleagues who provided us with feedback on the survey instrument used to collect data. The paper has benefited from comments of workshop participants at the University of

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We use survey data to examine firms' propensity to rely on financial measures in evaluating local business unit managers. We find that firms rely less on financial measures (and more on nonfinancial measures or subjective evaluations) in determining local managers' bonuses when those managers have greater influence over the design of internal accounting systems. At the same time, we find no significant association between the choice of performance measures and local managers' authority to make operating decisions. Instead, we find that local authority to make operating decisions is positively associated with local managers' influence over accounting systems. Taken together, our findings suggest that the design of internal accounting systems is an important dimension of overall organizational design. Our findings also cast doubt on the maintained assumption in prior work that major organizational design choices are complementary. Data Availability: Data used in this study cannot be made public due to confidentiality agreements with participating firms.