An experimental investigation of employer discretion in employee performance evaluation and compensation

Joseph G. Fisher, Laureen A. Maines, Sean A. Peffer, Geoffrey B. Sprinkle

Research output: Contribution to journalArticlepeer-review

43 Scopus citations


Employment relationships provide fertile ground for both employee and employer opportunism. Employers worry about whether employees will devote sufficient effort to work, and employees are concerned about whether employers will compensate them appropriately. In this paper, we examine whether employer discretion over the size of the total employee compensation pool and the allocation of this pool among employees influences employee and employer opportunism. The results of our experiment indicate that firm output and employees' compensation are greater when the employer does not have discretion over total employee compensation, but does have discretion over the allocation of total compensation. We find that the employer's residual profit increases with discretion over the allocation of compensation among employees; however, we find no effect on residual profit of the employer's discretion over the total amount of employee compensation. Our results suggest that firms benefit from a compensation contract that establishes total employee compensation as a predetermined function of public, aggregate measures such as accounting income, but provides the employer at least some discretion to allocate this compensation using private information. However, our results caution that employees and employers may not have similar preferences for the degree of employer discretion over the determination of total employee compensation.

Original languageEnglish
Pages (from-to)563-583
Number of pages21
JournalAccounting Review
Issue number2
StatePublished - Apr 2005


  • Compensation
  • Discretion
  • Double-sided moral hazard
  • Subjective performance evaluation

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics


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