Subjective bonuses can reflect implicit contracts entered at the beginning of the period when certain employees commit to more difficult targets and managers use subjective bonuses at the end of the period to reward this commitment. We examine this prediction in a budget-based incentive systems¿ setting. We argue that the presence of these implicit contracts allows managers to adapt targets to the individual characteristics of employees and their units with the purpose of enhancing the motivational structure of budget-based contracts. Using data from 414 branches of a large travel retailer during a four-year period, we find that managers use their discretion to set targets at different levels of difficulty across branches and subjective bonuses are sensitive to the difficulty of these targets. Branches with more difficult targets relative to their peers receive larger subjective bonuses. We also test the motivational effect of larger subjective bonuses and find that they have a positive effect on future performance. In particular, larger target increases (relative to peers) from current to the next period result in larger performance increase (relative to peers) when the branch is rewarded with higher subjective bonuses in the current period. The evidence indicates that subjective bonuses can fulfill roles beyond addressing performance measurement systems¿ limitations. Managers use them to reward employees¿ commitment to target difficulty and to motivate future performance.

This paper examines organizational learning in a target setting. Organizations commonly set targets-explicit and quantitative reference points-for their operational units that reflect top management aspirations for these units. Targets are commonly the outcome of a subjective process where supervisors combine their explicit and tacit knowledge to set performance expectations for their units. Using a proprietary database from a large European travel company during a period of rapid expansion, we document the effect of organizational learning by studying how targets change as units mature. In particular, we examine managers' experiential learning from branches' past performance and their vicarious learning from branches in the same region in determining performance expectations over the life cycle of branches. Our results indicate that, in setting performance targets, managers increase the weight of a branch's past performance and decrease the weight of comparable branches' performance as the branch matures. Vicarious learning, where managers extrapolate the performance of comparable branches to a new branch, dominates in the early years. Over time, this type of learning is replaced by experiential learning as experience accumulates. We document how early on in the life of branches, these two types of learning interact; this interaction disappears as branches mature. Furthermore, we find that managers learn differently from successes and failures early in the lives of the new units, and this learning is affected by the magnitude of the successes and failures.

Managers use a variety of information to set performance targets. Using data from 376 branches of a large travel retailer over five years, this study documents supervisors considering the relative performance of comparable units in target setting, which we term relative target setting (RTS). We find evidence of RTS after controlling for individual past performance in the form of ratcheting. Our findings also indicate that RTS partially shapes the use of other information on past performance. Specifically, we find that the magnitude of ratcheting decreases (increases) with RTS for favorable (unfavorable) performance variances, and the asymmetry of ratcheting characterized by different ratcheting coefficients for unfavorable than for favorable variances is significant for large absolute magnitudes of RTS. Managers use the flexibility associated with the subjectivity of the target-setting process to weight peer and individual information differently across different units.

The use of variable remuneration systems generally implies the establishment of objectives. Prior literature on management control has identified a phenomenon known as «ratcheting» where objectives defined in the annual budget and that constitute the basis for the incentives system, are ot static, on the contrary, the change depending on the performance achieved in previous periods. Positive (negative) deviations in the performance lead to an increase (reduction) in next period objectives. Important advantages have been attributed to this way of revising the objectives. However, some authors suggest that it can also generate opportunistic behaviours in managers. This paper explains the reasons and consequences of ratcheting and suggests how its limitations can be faced.