The Effect of Information Asymmetry and Participative Target Setting on Target Ratcheting and Incentives

ABSTRACT

Using the performance evaluation data of Korean SOEs, the impact of information asymmetry within target setting on ratcheting intensity and the ratchet effect is investigated. It was found that ratcheting intensity is substantially greater (lower) for target-setting methods that have utilized limited (plenty of) information on past performance and that the ratchet effect increases with ratcheting intensity. These results indicate that information asymmetry between the superior and subordinates is one of the crucial drivers of the ratchet effect. It was also documented that when subordinates sufficiently beat target, the ratchet effect is much greater for relatively “top-down” target setting than that for relatively “bottom-up” target setting. This finding suggests that securing subordinates’ active participation in the target-setting process can alleviate their effort reduction incentive.