Essays on behavioral aspects of the design and disclosure of compensation contracts

This thesis consists of four essays on the design and disclosure of compensation contracts. Essays 1, 2 and 3 focus on behavioral aspects of mandatory compensation disclosure rules and of contract negotiations in agency relationships. The three experimental studies develop psychology- based theory and present results that deviate from standard economic predictions. Furthermore, the results of Essay 1 and 2 also have implications for firms’ discretion in how to communicate their top management’s incentives to the capital market. Essay 4 analyzes the role of fairness perceptions for the evaluation of executive compensation. For this purpose, two surveys targeting representative eligible voters as well as investment professionals were conducted. Essay 1 investigates the role of the detailed ‘Compensation Discussion and Analysis’, which is part of the Security and Exchange Commission’s 2006 regulation, on investors’ evaluations of executive performance. Compensation disclosure complying with this regulation clarifies the relationship between realized reported compensation and the underlying performance measures and their target achievement levels. The experimental findings suggest that the salient presentation of executives’ incentives inherent in the ‘Compensation Discussion and Analysis’ makes investors’ performance evaluations less outcome dependent. Therefore, investors’ judgment and investment decisions might be less affected by noisy environmental factors that drive financial performance. The results also suggest that fairness perceptions of compensation contracts are essential for investors’ performance evaluations in that more transparent disclosure increases the perceived fairness of compensation and the performance evaluation of managers who are not responsible for a bad financial performance. These results have important practical implications as firms might choose to communicate their top management’s incentive compensation more transparently in order to benefit from less volatile expectations about their future performance. Similar to the first experiment, the experiment described in Essay 2 addresses the question of more transparent compensation disclosure. However, other than the first experiment, the second experiment does not analyze the effect of a more salient presentation of contract information but the informational effect of contract information itself. For this purpose, the experiment tests two conditions in which the assessment of the compensation contracts’ incentive compatibility, which determines executive effort, is either possible or not. On the one hand, the results suggest that the quality of investors’ expectations about executive effort is improved, but on the other hand investors might over-adjust their prior expectations about executive effort if being confronted with an unexpected financial performance and under-adjust if the financial performance confirms their prior expectations. Therefore, in the experiment, more transparent compensation disclosure does not lead to more correct overall judgments of executive effort and to even lower processing quality of outcome information. These results add to the literature on disclosure which predominantly advocates more transparency. The findings of the experiment however, identify decreased information processing quality as a relevant disclosure cost category. Firms might therefore carefully evaluate the additional costs and benefits of more transparent compensation disclosure. Together with the results from the experiment in Essay 1, the two experiments on compensation disclosure imply that firms should rather focus on their discretion how to present their compensation disclosure to benefit from investors’ improved fairness perceptions and their spill-over on performance evaluation. Essay 3 studies the behavioral effects of contextual factors in recruitment processes that do not affect the employer’s or the applicant’s bargaining power from a standard economic perspective. In particular, the experiment studies two common characteristics of recruitment processes: Pre-contractual competition among job applicants and job applicants’ non-binding effort announcements as they might be made during job interviews. Despite the standard economic irrelevance of these factors, the experiment develops theory regarding the behavioral effects on employees’ subsequent effort provision and the employers’ contract design choices. The experimental findings largely support the predictions. More specifically, the results suggest that firms can benefit from increased effort and, therefore, may generate higher profits. Further, firms may seize a larger share of the employment relationship’s profit by highlighting the competitive aspects of the recruitment process and by requiring applicants to make announcements about their future effort. Finally, Essay 4 studies the role of fairness perceptions for the public evaluation of executive compensation. Although economic criteria for the design of incentive compensation generally do not make restrictive recommendations with regard to the amount of compensation, fairness perceptions might be relevant from the perspective of firms and standard setters. This is because behavioral theory has identified fairness as an important determinant of individuals’ judgment and decisions. However, although fairness concerns about executive compensation are often stated in the popular media and even in the literature, evidence on the meaning of fairness in the context of executive compensation is scarce and ambiguous. In order to inform practitioners and standard setters whether fairness concerns are exclusive to non-professionals or relevant for investment professionals as well, the two surveys presented in Essay 4 aim to find commonalities in the opinions of representative eligible voters and investments professionals. The results suggest that fairness is an important criterion for both groups. Especially, exposure to risk in the form of the variable compensation share is an important criterion shared by both groups. The higher the assumed variable share, the higher is the compensation amount to be perceived as fair. However, to a large extent, opinions on executive compensation depend on personality characteristics, and to some extent, investment professionals’ perceptions deviate systematically from those of non-professionals. The findings imply that firms might benefit from emphasizing the riskiness of their managers’ variable pay components and, therefore, the findings are also in line with those of Essay 1.

Potential of information technology in dental education

The use of information technology (IT) in dentistry is far ranging. In order to produce a working document for the dental educator, this paper focuses on those methods where IT can assist in the education and competence development of dental students and dentists (e.g. e-learning, distance learning, simulations and computer-based assessment). Web pages and other information-gathering devices have become an essential part of our daily life, as they provide extensive information on all aspects of our society. This is mirrored in dental education where there are many different tools available, as listed in this report. IT offers added value to traditional teaching methods and examples are provided. In spite of the continuing debate on the learning effectiveness of e-learning applications, students request such approaches as an adjunct to the traditional delivery of learning materials. Faculty require support to enable them to effectively use the technology to the benefit of their students. This support should be provided by the institution and it is suggested that, where possible, institutions should appoint an e-learning champion with good interpersonal skills to support and encourage faculty change. From a global prospective, all students and faculty should have access to e-learning tools. This report encourages open access to e-learning material, platforms and programs. The quality of such learning materials must have well defined learning objectives and involve peer review to ensure content validity, accuracy, currency, the use of evidence-based data and the use of best practices. To ensure that the developers' intellectual rights are protected, the original content needs to be secure from unauthorized changes. Strategies and recommendations on how to improve the quality of e-learning are outlined. In the area of assessment, traditional examination schemes can be enriched by IT, whilst the Internet can provide many innovative approaches. Future trends in IT will evolve around improved uptake and access facilitated by the technology (hardware and software). The use of Web 2.0 shows considerable promise and this may have implications on a global level. For example, the one-laptop-per-child project is the best example of what Web 2.0 can do: minimal use of hardware to maximize use of the Internet structure. In essence, simple technology can overcome many of the barriers to learning. IT will always remain exciting, as it is always changing and the users, whether dental students, educators or patients are like chameleons adapting to the ever-changing landscape.

Identity, incentives and the value of information

We examine the impact of identity preferences on the interrelation between incentives and performance measurement. In our model, a manager identifies with an organization and loses utility to the extent that his actions conflict with effort-standards issued by the principal. Contrary to prior arguments in the literature, we find conditions under which a manager who identifies strongly with the organization receives stronger incentives and faces more performance evaluation reports than a manager who does not identify with the organization. Our theory predicts that managers who experience events that boost their identification with the firm can decrease their effort in short-term value creation. We also find that firms are more likely to employ less precise but more congruent performance measures, such as stock prices, when contracting with managers who identify little with the organization. In contrast, they use more precise but less congruent measures, such as accounting earnings, when contracting with managers who identify strongly with the firm.