pdf - Nyenrode Business Universiteit
pdf - Nyenrode Business Universiteit pdf - Nyenrode Business Universiteit
2.5. CONCLUSIONS AND DISCUSSION 49 2.5 Conclusions and Discussion As one of the first empirical studies on the use of Relative Performance Evaluation (RPE) at the middle-management level (see also: Dekker et al. 2012), this research examines why and to what extent RPE has empirical relevance for the performance evaluation praxis of business unit managers. RPE is a means of determining the performance standard by using a peer group benchmark. The performance of an employee (or: business unit manager) is compared with the performance of a peer group. Peer performance functions as an (implicit or explicit) performance target. The peer group typically consists of individuals facing similar tasks and circumstances. The rationale behind this comparison is that the performance of the reference group provides information on the performance potential of the employee. RPE can be used as an explicit performance target or budget based on peer performance. However, RPE can also be used more implicitly in the background, where peer performance is used as a point of reference for the performance evaluation. Prior literature has extensively studied RPE from both analytical and empirical standpoints. Despite ample analytical proof of the benefits of RPE, the empirical support for RPE is scarce. Focusing on the executive level, prior studies provide mixed results concerning organizational reliance on RPE. In contrast to the extant literature, the current study does not examine executive compensation praxis with archival data. Instead, I use detailed survey data to study the use of RPE at the lower echelons. I find that RPE is widely used to evaluate business unit managers, as more than half of the 325 respondents in this study claim to use RPE to a large or very large extent. This study explains the use of RPE along two theoretical lines. The first line of reasoning is the noise-reduction perspective. The noise-reduction perspective on RPE is common in the literature and states that RPE filters out noise due to external events from the overall performance evaluation (Holmstrom 1982). These external events (e.g., rising prices of raw materials or declining market demand) affect not only the performance metrics of the employee but also the performance metrics of the reference group. This effect increases noise in the performance metrics, which no longer reflect only effort. Instead, the metrics also reflect the performance effects of uncontrollable external events. Comparing the performance of a manager to the performance of peers informs the superior about the quality of the employee’s performance, given the external events that have occurred. This comparison reduces the noise levels in the performance evaluation. This study finds support for this noise-reducing effect of RPE by analysing whether increased levels of common uncertainty (as a proxy for shared external events) positively affect the reliance on RPE. The second explanation for RPE use is its ability to reduce the evaluated manager’s room for opportunistic behaviour. This opportunism-mitigating perspective has received little
50 CHAPTER 2. RPE AT THE BUSINESS UNIT MANAGER LEVEL attention in the empirical literature. Following Murphy (2001), I argue that RPE can reduce the risk of managerial opportunism because RPE determines the difficulty of the manager’s performance target outside his own sphere of influence. Murphy (2001) argues that managers can try to lower their performance targets if this lies within their reach. Managers can do so if, for example, the performance targets are based on prior-year performance or internal negotiations. However, if the target-setting process lies outside the manager’s sphere of influence, the target is better insulated against such opportunistic behaviour. This is the case with RPE, where the performance target is based on the performance of a peer group and not on some internal process. According to this reasoning, RPE mitigates the room for managerial opportunism. I analyse whether information asymmetry (as a proxy for room for opportunism) combined with sufficient comparability to other organizations (as a necessary condition for relevant comparisons) positively affects the reliance on RPE. However, I find only marginal and mixed support for the opportunism-reducing effect of RPE. In chapter 4 of this thesis, I analyse in greater detail the opportunism-mitigating properties of RPE use to further study this perspective on RPE use. This study suggests that RPE is used in practice to reduce noise in the performance evaluation of managers. Noise reduction improves the quality of the performance evaluation and the efficiency of the performance contract between the principal and agent. Albeit more carefully because of the inconsistency in the findings of this study, the findings suggest that RPE may help to reduce the room that managers have to opportunistically influence their performance targets. This function is important because the presence of room for opportunism potentially harms the realization of organizational goals. However, the evidence for this application of RPE is inconsistent and requires further research. In the remainder of this thesis, I study whether RPE is effective at reducing noise and opportunism to further examine these perspectives on RPE. As with any study, this research is subject to a number of limitations. For instance, this study does not assess implications that RPE use may have on incentive compensation (Dekker et al. 2012). Also, there are several data-related limitations. For example, the data are cross-sectional, which limits the research to analysing the associations between reliance on RPE and the drivers of noise and opportunism. Instead, a study of the longitudinal effects of RPE adoption would allow one to more directly observe the causality between these factors. Additionally, the data limit further exploration of the marginal evidence for the opportunismreducing characteristics of RPE. The marginal evidence for the opportunism perspective may be caused by the risk of collusion amongst the evaluated managers. Holmstrom (1982) argues that RPE is vulnerable for collusion amongst agents. If agents collude, they collectively reduce their efforts, resulting in a lowered performance benchmark. This possibility
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50 CHAPTER 2. RPE AT THE BUSINESS UNIT MANAGER LEVEL<br />
attention in the empirical literature. Following Murphy (2001), I argue that RPE can<br />
reduce the risk of managerial opportunism because RPE determines the difficulty of the<br />
manager’s performance target outside his own sphere of influence. Murphy (2001) argues<br />
that managers can try to lower their performance targets if this lies within their reach.<br />
Managers can do so if, for example, the performance targets are based on prior-year performance<br />
or internal negotiations. However, if the target-setting process lies outside the<br />
manager’s sphere of influence, the target is better insulated against such opportunistic<br />
behaviour. This is the case with RPE, where the performance target is based on the<br />
performance of a peer group and not on some internal process. According to this reasoning,<br />
RPE mitigates the room for managerial opportunism. I analyse whether information<br />
asymmetry (as a proxy for room for opportunism) combined with sufficient comparability<br />
to other organizations (as a necessary condition for relevant comparisons) positively<br />
affects the reliance on RPE. However, I find only marginal and mixed support for the<br />
opportunism-reducing effect of RPE. In chapter 4 of this thesis, I analyse in greater detail<br />
the opportunism-mitigating properties of RPE use to further study this perspective on<br />
RPE use.<br />
This study suggests that RPE is used in practice to reduce noise in the performance evaluation<br />
of managers. Noise reduction improves the quality of the performance evaluation and<br />
the efficiency of the performance contract between the principal and agent. Albeit more<br />
carefully because of the inconsistency in the findings of this study, the findings suggest that<br />
RPE may help to reduce the room that managers have to opportunistically influence their<br />
performance targets. This function is important because the presence of room for opportunism<br />
potentially harms the realization of organizational goals. However, the evidence for<br />
this application of RPE is inconsistent and requires further research. In the remainder of<br />
this thesis, I study whether RPE is effective at reducing noise and opportunism to further<br />
examine these perspectives on RPE.<br />
As with any study, this research is subject to a number of limitations. For instance, this<br />
study does not assess implications that RPE use may have on incentive compensation<br />
(Dekker et al. 2012).<br />
Also, there are several data-related limitations. For example, the data are cross-sectional,<br />
which limits the research to analysing the associations between reliance on RPE and the<br />
drivers of noise and opportunism. Instead, a study of the longitudinal effects of RPE adoption<br />
would allow one to more directly observe the causality between these factors. Additionally,<br />
the data limit further exploration of the marginal evidence for the opportunismreducing<br />
characteristics of RPE. The marginal evidence for the opportunism perspective<br />
may be caused by the risk of collusion amongst the evaluated managers. Holmstrom (1982)<br />
argues that RPE is vulnerable for collusion amongst agents. If agents collude, they collectively<br />
reduce their efforts, resulting in a lowered performance benchmark. This possibility
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