Do You Get What You Pay For? An Experimental Analysis of Managers' Decisions and Owners' Expectation
Abstract
We analyze this principle in an experiment in which 'managers' make one-period investment decisions and 'owners' predict these decisions. Three alternative performance measures are considered: earnings, ROI, and residual income. As is well known, neither earnings nor ROI is a goal congruent performance measure with respect to investment decisions, whereas residual income is goal congruent due to its conservation property. We find that, although managers overinvest (underinvest) on average when they are evaluated at earnings (ROI), owners do not get what they pay for from the majority of managers when using earnings or ROI as performance measures. Without information about managers' decisions, owners overestimate these performance measures' effectiveness in inducing individually rational behavior. When confronted with managers' decisions in early rounds, owners consistently revise their beliefs, but their overall estimation quality remains relatively low.
Contact information:
Paolo Perego
Anna Nöteberg
