Management Accounting Section Midyear Meeting

Target Ratcheting and Commitment: The Role of Alternative Target Functions

• In Event: Determinants of Firm Performance

Abstract

Targets set for performance evaluation are often revised based on past performance, commonly referred to a as target ratcheting. Prior work suggests that the extent of target ratcheting may vary depending on firm’s commitment to share rents with managers. In this study, we suggest that firms may commit via incentive function design choices (i.e., ex-ante target bonus levels) instead of target level revisions if committing via target level revisions is (too) costly. Specifically, not adjusting performance targets to next-period expectation levels due to commitment may limit the use of performance targets for corporate planning or capital market guidance. Using earnings targets from executive bonus plans, we find evidence consistent with our expectations. For performance targets that represent ex-ante expectation levels, we find performance target revisions are more positively associated with past performance, ex-ante target bonuses are positively associated with performance target revisions (based on past performance), and performance target revisions based on past performance are less positively associated with future performance. Combined, these results suggest contractual commitments in target setting are prevalent in corporate practice, even if a high extent of target ratcheting can be observed.

Authors

• Martin Artz, University of Münster

• Silvan Kindinger, Institute of Management Accounting & Control