pdf - Nyenrode Business Universiteit
pdf - Nyenrode Business Universiteit pdf - Nyenrode Business Universiteit
2.2. THEORETICAL BACKGROUND 17 The remainder of this chapter is organized in four sections. Section 2.2 provides the theoretical background of RPE, the theoretical model and the development of the hypotheses. The measurement is described in section 2.3, and the analyses and results in section 2.4. Section 2.5 addresses the findings, and the conclusions. 2.2 Theoretical Background and Development of the Hypotheses As described in the introduction of this chapter, RPE can reduce two types of target-setting problems: 1) problems that arise from outside the business unit (external problems), and 2) problems that arise within the business unit (internal problems). Based on prior literature, I argue that the presence of both types of problems can induce RPE use. The conceptual relations between target-setting problems and RPE are presented in figure 2.1. This section describes the nature of the two types of target-setting problems in terms of their relation to noise in the performance evaluation and room for managerial opportunism, and operationalizes these factors as common uncertainty and information asymmetry, respectively. These antecedents of RPE (common uncertainty and information asymmetry) are assumed to increase the noise and opportunism-levels which drive organizational reliance on RPE 2 . This section develops three research hypotheses based on these antecedents and ends with the introduction of control variables. External Target Setting Problems Internal Target Setting Problems Figure 2.1: Conceptual Model Positive Positive RPE use 2 In addition to common uncertainty and information asymmetry, other factors exist that influence noise and opportunism, including ’uncommon’ or idiosyncratic uncertainty. The current chapter focuses on common uncertainty because, unlike idiosyncratic uncertainty, it can be reduced by RPE use. Chapters 3 and 4 assess a more comprehensive list of noise and opportunism drivers. ❄ ✻
18 CHAPTER 2. RPE AT THE BUSINESS UNIT MANAGER LEVEL 2.2.1 RPE and Noise Reduction: Reducing the Effect of External Factors on the Performance Evaluation This section describes how RPE can reduce target-setting problems that originate from outside of the business unit. These external factors include events that occur in the environment of the business unit. Examples include rising prices and declining demand. External factors affect the performance of the business unit and thus the difficulty of the performance target. Windfall gains can cause the target to be achieved easily. This reduces the motivation of the business unit manager to provide maximum effort; his performance target is achieved due to good luck, and requires less effort. On the other hand, bad luck can make the target impossible to achieve. This also reduces the motivation of the manager, who cannot achieve his target, even when providing his maximum effort. External events increase the ‘noisiness’ of the performance metrics. Measured performance is the result not only of effort, but also of uncontrollable factors. This reduces the informativeness of the performance metrics about the agent’s performance. Overall, noise reduces the quality of the performance evaluation, which aims to reward the agent for the provision of effort, not for uncontrollable events. However, RPE can reduce the noise in the performance evaluation, insulating the performance evaluation from the effects of external events. In the literature, noise reduction is the primary explanation for RPE use (see Holmstrom 1982). RPE reduces noise in the evaluation by incorporating information about peer performance into the performance contract between the principal and the agent (Holmstrom 1982). Because the agent and his peers have partially similar exposure to uncontrollable external events, their performance is similarly affected by these events. Comparing the agent’s performance to the performance of his peers provides the principal with more information about what performance level is achievable under the current circumstances. Thus, by judging the agent’s performance relative to his peers, the principal is informed about the quality of the agent’s performance under the (often uncontrollable) external circumstances. This reduces the effects of external uncontrollable factors on the performance evaluation. Due to this noise reduction and increased informativeness, RPE can improve the quality of performance evaluation. 2.2.1.1 Common Uncertainty The noise-reduction perspective on RPE informs my model with the effect of uncertainty on the use of RPE. Uncertainty is a widely researched antecedent for many control instruments (Chenhall 2003). Uncertainty can introduce noise in the performance evaluation if uncertainty is uncontrollable for the evaluated agent, and influences his performance.
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2.2. THEORETICAL BACKGROUND 17<br />
The remainder of this chapter is organized in four sections. Section 2.2 provides the theoretical<br />
background of RPE, the theoretical model and the development of the hypotheses.<br />
The measurement is described in section 2.3, and the analyses and results in section 2.4.<br />
Section 2.5 addresses the findings, and the conclusions.<br />
2.2 Theoretical Background and Development of the<br />
Hypotheses<br />
As described in the introduction of this chapter, RPE can reduce two types of target-setting<br />
problems: 1) problems that arise from outside the business unit (external problems), and<br />
2) problems that arise within the business unit (internal problems). Based on prior literature,<br />
I argue that the presence of both types of problems can induce RPE use. The<br />
conceptual relations between target-setting problems and RPE are presented in figure 2.1.<br />
This section describes the nature of the two types of target-setting problems in terms of<br />
their relation to noise in the performance evaluation and room for managerial opportunism,<br />
and operationalizes these factors as common uncertainty and information asymmetry, respectively.<br />
These antecedents of RPE (common uncertainty and information asymmetry)<br />
are assumed to increase the noise and opportunism-levels which drive organizational reliance<br />
on RPE 2 . This section develops three research hypotheses based on these antecedents<br />
and ends with the introduction of control variables.<br />
External Target<br />
Setting Problems<br />
Internal Target<br />
Setting Problems<br />
Figure 2.1: Conceptual Model<br />
Positive<br />
Positive<br />
RPE use<br />
2 In addition to common uncertainty and information asymmetry, other factors exist that influence<br />
noise and opportunism, including ’uncommon’ or idiosyncratic uncertainty. The current chapter focuses<br />
on common uncertainty because, unlike idiosyncratic uncertainty, it can be reduced by RPE use. Chapters<br />
3 and 4 assess a more comprehensive list of noise and opportunism drivers.<br />
❄<br />
✻
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