The economic demand for and consequences of contracting on measures of the drivers of future performance
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Recent trends in performance evaluation suggest increasing use in practice of measures that reflect drivers of future performance (DFP). These measures include primarily nonfinancial but also forward-looking financial performance measures. There has been relatively little academic research that studies why firms use measures of DFP rather than (or to supplement) traditional performance measures used in incentive contracts. Agency theory offers general insight but does not address specific properties of measures of DFP. This thesis adds specificity to the existing agency literature in presenting a two-period model of the economic conditions that create a demand for measures of DFP both with and without a capital market context. It also explores the economic consequences of variations in both economic conditions and specific properties of the measures of DFP themselves. The central results of this thesis support the view that the use of DFP measures in contracting can be a more cost-effective and timely way in which to reward an agent’s farsighted efforts relative to conventional rewards based on financial performance or the stock price. Further, the use of DFP measures can induce agent effort more efficiently across shortsighted and farsighted activities, which can help mitigate the potential for an agent to engage in short-term myopic behaviour.
Keywords: performance measures, incentive contracts, agency theory, economic determinants