Additional Information in Accounting Reports: Effects on Management Decisions and Subjective Performance Evaluations Under Causal Ambiguity

Abstract

Organizations have often been criticized for reliance on a single item of accounting information (e.g., profit) in evaluating performance, because of its incompleteness. We provide theory-based experimental evidence that under frequently occurring performance-evaluation conditions (subjective performance evaluation, causal ambiguity, and individual differences in cognitive ability, knowledge, and/or motivation that lead to different interpretations of information), reliance on a single item of accounting information (profit), rather than profit plus additional (e.g., nonfinancial or external) information, can provide two potential benefits which offset the costs of information incompleteness. First, subordinates are more likely to make the management decisions that superiors will evaluate and reward highly-that is, there are fewer coordination failures in management decisions. Second, even after controlling for the presence or absence of coordination failures, subordinates experience less negative surprise about their performance evaluations. * Accepted l'information suppl ementaire (non financi ere ou externe, par exemple), est susceptible d'offrir deux avantages qui compensent les coûts associ es a l'incompl etude de l'indicateur. En premier lieu, les subordonn es sont davantage susceptibles de prendre les d ecisions de gestion que leurs sup erieurs evalueront et r etribueront g en ereusementde sorte que l'on observera moins de discordance dans les d ecisions de gestion. En second lieu, même une fois contrôl ee la pr esence ou l'absence de discordance, les subordonn es s'exposent a moins de surprises d esagr eables dans l' evaluation de leur performance. 1.Causal ambiguity is defined as uncertainty about the relations among actions, outcomes, and information (Barney 1991; King and Zeithaml 2001); see section 2 for an extended formal definition. 2.A coordination failure occurs when actions which would be expected to benefit two or more parties do not occur (Black, Hashimzade, and Myles 2008), for example because the parties do not have the information or communication opportunities that would have enabled them to take these actions. In our setting, both subordinates and superiors expect higher benefits when there is a match (coordination) between the management decisions subordinates make and the management decisions which their superiors will evaluate and reward highly. Failures can occur when subordinates make incorrect judgments about what these decisions are.

The Role of Subjectivity in Mitigating Incentive Contracting Risks

“…Given the subjective overlay on objective performance measures, subordinates wanting to choose actions to maximize their bonus or promotion prospects would need to anticipate the way two successive subjective rating processes would either alter or confirm their performance rating. This substantially dilutes the decision influence of objective performance measures (Luft et al 2016). These observations are unlikely to be unusual, with meta analyses in the personnel psychology literature suggesting that the correlation between performance ratings and objective measures is approximately 27 to 39 percent (Heneman 1986;Bommer, Johnson, Rich, Podsakoff, and Mackenzie 1995).…”

“…However, subjectivity also has a well-established downside risk. Subjective assessments are potentially riddled with errors and bias (Bol 2008;Moers 2005;Luft et al 2016). When managers make subjective evaluation decisions they weigh up personal costs and benefits, and they may lack incentives to invest in information acquisition to support accurate subjective assessments (Bailey, Hecht, and Towry 2011;Maas et al 2012;Bol 2011).…”

“…While subjectivity is introduced into PMRS to enhance incentive alignment and employee sorting and to reduce compensation risk, it also introduces its own risk of errors and bias associated with unverifiable subjective assessments (Moers 2005;Bol 2008;Luft, Shields, and Thomas 2016). We investigate the relative salience of incentive misalignment, employee sorting errors and compensation risk as rationales for the use of subjectivity (the upside of subjectivity).…”

Me vs. We: The Effect of Incomplete Team Member Feedback on Cooperation of Self-Regarding Individuals

“…Individuals often underestimate the difference between their own and others' beliefs (Marks & Miller, 1987;Luft, Shields, & Thomas, 2016). Proselfs can therefore believe that others will behave or interpret information in a similar manner to themselves, and this belief will affect how they interpret and react to others' actions (Kanagaretnam et al, 2009).…”

“…As individuals often underestimate the difference between their own and others' beliefs, proselfs expect that others have the same self-regarding nature and will behave or interpret information in a similar manner as themselves (Marks & Miller, 1987;Kanagaretnam et al, 2009;Luft et al, 2016). Thus, higher team contributions from a fellow team member can be surprising to proselfs, leading them to consider the motivation behind this action and whether this positive action from the team member is strategic or self-regarding.…”