Relative Target Setting : Performance-dependent Asymmetry and Real Driving Power

Abstract

Firms use various sources of information in target setting. Since target setting functions as a management control mechanism, differences in firm environments should cause cross-sectional variation in firms target setting practices. While peer information is a primary source of valuable information, we still do not know the detailed landscape of how it is used in relative target setting(RTS). I conjecture that the use of peer information shows asymmetry, depending on relative performance. Upon empirical investigation, I find evidence supporting the performance-dependent asymmetry in RTS. Outperforming firms more actively exploit the peer information in target setting than poor performing firms. Next, I investigate a traditional assumption in target setting literature – the optimal contracting assumption. I examine determinants of serial correlation in target deviation, and find evidence inconsistent with optimal contracting view. That is, positive association between RTS and serial correlation is mediated by greater CEO power and financial distress, but not by manager ability, indicating separating contracts hypothesis needs re-examination.