Perceptions of organizational justice in incentive contracts and their effect on congruence between personal and organizational goals.
| Autor | Klein, Luciana |
1 Introduction
The study aims to verify if perceptions of organizational justice in incentive contracts have a positive effect on the congruence between personal and organizational goals in organizations with a decentralized structure. The investigation envisages that higher levels of perceptions of organizational justice in incentive contracts might be associated with a greater alignment between personal and organizational goals, thus motivating managers to act more consistently as regards to the company's interests.
Brealey, Myers, and Allen (2014) argue that trustees should behave according to owners' interests in order to maximize their own wealth. However, managers also have personal goals, which may not match those of their organizations (Anthony & Govindarajan, 2008). At the core of agency theory is the idea of conflict of interest. Jensen and Meckling (1976) and Easterbrook (1984), among others, describe the agency relationship as both explicit and implicit contracts in which the principal concedes decision-making power to the agent to perform services. In these contracts, it is assumed that the principal will give control of the company to agents with more expertise in the business. In exchange for this, the agents will be rewarded with both financial and non-financial goods.
Usually, contracts established between parties take place in an environment impregnated with informational asymmetry, in which agents have some informational advantage over the principal. So, agents can act according to their own interests, overlooking the principal's wellbeing, as they may feel wronged in a contract relationship, even formal ones.
A typical conflict situation between agent and principal takes place when trustees take conflicting decisions as regards to investments, financing, and the distribution of dividends, since these might affect their share of the company's earnings, when a great extent of their income is based on incentives. Studies suggest a manager will create additional costs or benefits for the company if their perception of justice regarding their interactions is lower than or above their expectation, respectively (Bosse & Phillips, 2016).
One of the mechanisms to reduce agency costs resulting from agency conflicts is the establishment of a system of incentives focused on improving their individual perception of justice, thus influencing the agents' behavior. Incentive contracts are agency agreements dedicated to aligning interests linked to managers' compensation by means of financial and non-financial performance measurements set by owners (Maher, Stickney, & Weil, 2012; Milgrom & Roberts, 1992).
Anthony and Govindarajan (2008) claim that the more the agent's income depends on performance evaluation parameters, the more they will feel stimulated to improve their performance. Parameters set by owners when designing the system for performance evaluations may affect agents' behavior in several ways, triggering both commitment to the company's scopes (congruence) and perceptions of a lack of organizational justice if they judge there to be inconsistencies in the delineation of the metrics of incentive contracts. Even though one of the main goals of such incentive contracts is to persuade workers to perform in favor of the best interests of the organization (Maher et al., 2012; Milgrom & Roberts, 1992) and contracts can be either individual or collective, monetary or non-monetary, they will not remain unscathed from perceptions of a lack of justice by trustees (agents).
The alignment promoted by performance evaluations is one of the main aspects considered in the formulation of incentive contracts because they cause a direct impact on the intensity of efforts made in task performance in the company (Santos, 2012) and on the organizational climate. The management area literature considers congruence to be the compatibility between the trustees' and the company's interests. Such congruence has an impact on several aspects, including perceptions of justice, worker stability, efficacy in the organizational environment, and feelings of belonging to the company (Brito & Magalhaes, 2018). A lack of congruence between the trustees' and the company's interests can be considered a classic agency problem, which substantially affects the design, symbolism, and acceptance of management control systems, triggering a series of questions that are worth both theoretical and empirical discussion, regarding moral risk, adverse selection, and behavioral aspects related to organizational justice, which will be discussed below.
Cases of establishing contracts among the agents themselves are typical of decentralized companies or those whose responsibility centers are clearly delimited. According to Anthony and Govindarajan (2008, p. 180), the concept of responsibility centers applies to any organizational unit driven by a responsible manager. Thus, companies can be composed by several decentralized responsibility centers, each representing a link in the organizational structure. Units acquire inputs and produce outputs, these being either goods or services. Evidently, management units differ in terms of the ease with which outputs can be measured and the controlling rules applied regarding how the inputs are obtained, which can have a clear relationship with measurements of trustees' performance and, consequently, their perceptions of organizational justice.
Maher et al. (2012) state that almost all big, decentralized corporations offer bonuses and financial incentives linked to profit to their responsibility center trustees. However, monetary incentives do not always lead to congruence between organizational and personal goals. In this sense, many studies have suggested that non-economic factors influence agents' decisions. Milgrom and Roberts (1992) state that a given level of revenue can be seen as good or bad, acceptable or unacceptable, according to the financial compensation of people other than those in the reference group, which can result in different behaviors, this being a significant limitation to the use of any incentive. The authors take a very clear position as to incentive contracts when they state that considering only economic aspects when conceiving incentive schemes may not be enough.
Anthony and Govindarajan (2008, p. 556) argue that trustees must be aware of the fact that "goals, scopes, and rules may offer strong incentives only if trustees see them as fair." Kaplan and Atkinson (1998, p.682) are even more incisive and argue that there are important behavioral considerations that performance measurement systems must take into account. They emphasize that "first and above all the individual must believe the system is fair. When this belief is absent the motivational potential of incentives compensation will be lost." therefore, they argue that behavioral aspects must be taken into account in incentive contracts, especially to identify the perceptions of justice in both explicit and implicit incentive contracts.
Omar (2006) warns that if workers see that their company treats them fairly, this will contribute to an increase in positive attitudes as regards to their work, supervisors, and the organization as a whole. On the other hand, if they feel they receive unfair treatment, it will result in tensions, feelings of dissatisfaction, a lack of motivation, absenteeism, reduced quality of work, and lower productivity (Omar, 2006).
Lubatkin, Ling, and Schulze (2007) state that perceptions of injustice trigger behaviors that can be discussed under the lens of agency theory. From the point of view of agency theory, individuals are naturally opportunistic and will always try to maximize their own interests up to the point that their actions are limited by organizational restrictions (incentive contracts). On the other hand, constructs of organizational justice consider that individuals will only behave opportunistically if they perceive unfair treatment. Consequently, perceptions of justice will increase agency costs (Lubatkin, Ling, & Schulze, 2007).
Organizational justice has come under the focus of theoretical and empirical studies that try to show whether higher levels of perceptions of justice are associated with positive attitudes and behavior at work, but there are still few empirical studies on their effect in the context of agency conflicts (Cohen, Holder-Webb, Sharp, & Pant (2007). In Brazil, the use of agency theory in the management area is still modest and previous research has not linked organizational justice in incentive contracts to congruence between personal and organizational goals according to the perceptions of trustees in decentralized companies. This is one of the advances made by the present research in the area of Accounting Science in Brazil.
It is believed that incentive systems must take the conception of perceptions of justice into account when trying to align trustees' behavior. Studies suggest that trustees will create additional costs or benefits for the company if their perception of justice in their interactions is either lower or higher than their expectation, respectively (Bosse & Phillips, 2016). So, the potential findings in this research, besides contributing to the advancement of knowledge in the management area, will support policies for formulating incentive contracts in structurally decentralized Brazilian companies. A better understanding of the phenomenon can improve the strategies adopted by corporations when issuing and using incentive contracts that lead to better feelings of justice in organizational relations. So, the potential findings in this research, besides contributing to the advancement of knowledge in the management area, will support policies for formulating incentive contracts in structurally decentralized Brazilian companies, and this also represents a corporate and practical contribution for trustees and company owners.
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