managment. lecture 7. target setting

balancing problem. how to obtain balance?

1. adapting the 3-legged stool to correct for noise and constrain bias.

2. subjective performance valtuation.

3. combining performance measures

why do we use targets?

• to address the lack of ability problem.

• to address the lack of motivation problem.

• to address the lack of direction problem.

address the lack of ability problem

• sorting/selecting employees: bad ones get removed and only leave good ones.

• matching employees with different roles in firm.

address the lack of motivation problem.

• motivate/incentivize employees.

• provide feedback and learning opportunities.

address the lack of direction problem.

clarify strategy

level threshold

setting targets s.t. below target: regular salary. between minimum and maximum: bonus increases by the amount you're above target. above maximum: maximum you'll get for your bonus.

why is target setting difficutl?

• you need to predict the future and translate your prediction in KPI-realization.

• targets could be used for addressing 3 control problems but usually 'one target does not fit all"

why is target setting a control problem?

• setting a target is an information problem: which information will we use to set the target?

• bad target setting could lead to a situation where the firm is "out of control" (ex:fraud)

target ratcheting

using information about past performance to set targets for the next period.

asymmetric target ratcheting

target ratcheting where upward target adjustments happens in larger magnitures than downward target adjustments

the ratchet effect

restricting output/performance in the current period to receive more attainable future targets to maximize long-term payoffs

how to address the problem of target setting

• no performance-based compensation anymore.

• adding information to the current system: weaken link between last year performance and next year target.

• participative target settting: using information from managers.

• targets based on AI/advanced analytics

• relative performance infomation

extrinsic incentives bias

preople predict that others are more motivated by extrinsic incentives and less instrinsically motivated compared to themselves.