TY  - JOUR
AU  - Baker,George
AU  - Gibbons,Robert
AU  - Murphy,Kevin J.
TI  - Subjective Performance Measures in Optimal Incentive Contracts
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 4480
PY  - 1993
Y2  - September 1993
UR  - http://www.nber.org/papers/w4480
L1  - http://www.nber.org/papers/w4480.pdf
N1  - Author contact info:
George Baker
Harvard Business School
Morgan Hall 440
Boston, MA 02163
Tel: 617/495-6119
Fax: 617/496-4191
E-Mail: gbaker@hbs.edu

Robert S. Gibbons
MIT Sloan School of Management
100 Main Street, E62-524
Cambridge, MA  02142
Tel: 617/253-0283
Fax: 617/253-2660
E-Mail: rgibbons@mit.edu

Kevin M. Murphy
Booth School of Business
The University of Chicago
5807 S. Woodlawn Ave.
Chicago, IL  60637
Tel: 773/702-7280
Fax: 773/834-3554
E-Mail: murphy@chicagoBooth.edu
AB  - Objective measures of performance are seldom perfect.  In response, incentive contracts often include important subjective components that mitigate incentive distortions caused by imperfect objective measures.  This paper explores the combined use of subjective and objective performance measures in (respectively) implicit and explicit incentive contracts. Naturally, objective and subjective measures often are substitutes, sometimes strikingly so: we show that if objective measures are sufficiently close to perfect then no implicit contracts are feasible (because the firm's fallback position after reneging on an implicit contact is too attractive).  We also show, however, that objective and subjective measures can reinforce each other: if objective measures become more accurate then in some circumstances the optimal contract puts more weight on subjective measures (because the improved objective measures increase the value of the ongoing relationship, and so reduce the firm's incentive to renege).  We also analyze the use of subjective weights on objective performance measures, and provide case-study evidence consistent with our analyses.
ER  -