Target Ambiguity and Ratchet Effect

Abstract

Prior literature documents that the subordinate has an incentive to reduce the effort level when current performance affects future target performance, which is known as the ratchet effect. The ratchet literature, however, assumes that the superior can discern the true (desired) level of target performance in the short run, and it does not explicitly explain how the ratchet effect varies along the process of identifying the true target performance. This study analytically investigates the impact of target ambiguity on the magnitude of the ratchet effect. The analysis shows stronger ratchet effect when the superior possesses limited prior knowledge about the indubitable target performance. With higher ambiguity that the superior faces in setting target performance, the superior must depend largely on the subordinates actual performance. As a consequence, the subordinate becomes more reluctant to exert effort for the best level of current performance because it will influence the future standard to be substantially tough. It also shows that the subordinates effort reduction following a highly ambiguous performance target can be alleviated when the subordinate actively participates in the target setting process and when performance measures are adequately noisy.