Corporate Governance and Accountability: the Interdependence Between Performance Measurement Systems, Governance Structure and Firm Performance

Performance measurement and incentive compensation are considered two primary and interrelated business control systems. A performance measurement system provides information that is essential for understanding managerial decisions that affect firm value, thereby playing a key governance role in developing strategies, evaluating the achievement of organizational objectives, and determining managerial compensation. This study examines the drivers of the board of director's choice of performance measures in the CEO incentive compensation plan. Results show that performance measurement diversity increases with the increasing proportion of outsider directors on the board and decreases with the increasing informativeness of the firm's traditional financial performance measures. Results also demonstrate how the performance measures choice explains the portion of the CEO incentive compensation that is not explained by the firm's current observable financial performance measures. Overall, the findings should help boards of directors improve the design of performance measurement and incentive systems for better management monitoring.