No. 236: Timeliness and Bias of Subjective Performance Evaluation

We study the use of objective and subjective performance evaluations in the provision of incentives, with a particular focus on how the timing of subjective performance evaluation affects its role in the cost-minimizing contract. We show that early reporting not only increases reliance on subjective performance evaluation but also increases the likelihood that the optimal contract involves no third-party payments. We derive conditions under which subjective performance evaluation is used, and relate it to the incentive role and confirmatory role of accounting information. Regarding the properties of the performance measures, we find that under early reporting, positive bias in both subjective and objective performance measurement promotes the use of subjective performance evaluation.