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2.2. THEORETICAL BACKGROUND 19
Since RPE has been described in the literature (e.g., Holmstrom 1982), the applicability
of RPE has been associated with uncertainty. More specifically, this argument applies
to uncertainty shared amongst peers because peer performance is only informative to the
extent that the uncertainties are common in nature (Holmstrom 1982, Frederickson 1992,
Matsumura & Shin 2006). Only common events influence both the agent’s performance
and peer performance. On the other hand, individual (or idiosyncratic) uncertainty only
affects the agent’s performance, leaving peer performance unaffected. This reasoning follows
Gibbons & Murphy (1990) and Kren (2002), who explain RPE use with its potential
benefit of specifically filtering out common (as opposed to idiosyncratic) uncertainty 3 .
I hypothesize specifically that RPE can provide insulation for the noise-increasing effects of
common uncertainty. I expect more RPE use under higher levels of common uncertainty.
This expectation results in the following hypothesis:
H1: Common uncertainty has a positive effect on the use of RPE.
2.2.2 RPE and Opportunism-Mitigation; the Use of Internally
vs. Externally Determined Standards
As argued in the introduction of this chapter, it is not only external events that can cause
target-setting problems. Problems that originate from within the business unit can also
cause problems by affecting the difficulty of the performance target. Specifically, this
argument relates to managerial opportunism and the room that managers have to opportunistically
affect (i.e., lower) their performance target level. Murphy’s (2001) findings
imply that managers lower their performance targets if the possibility to do so, presents
itself to them. This reduces the motivational properties of the target, which may lead to
suboptimalization of managerial efforts.
Murphy (2001) shows, both theoretically and empirically that RPE can reduce the room
that managers have to behave opportunistically. This second perspective on RPE relates
to the way in which performance standards are determined. Murphy distinguishes between
two main ways in which standards can be set: 1) they can be determined in some internal,
administrative process; or 2) they can be externally determined. The difference between
these alternatives lies in the extent to which agents can influence the level (or: difficulty)
of the performance standard. Internally determined standards include standards based on
prior-year performance and standards derived from plans or budgets. Such standards are
3 Both Gibbons & Murphy (1990) and Kren (2002) find partial support for this proposition.