Performance Measurement, Value-Creation and Managerial Compensation: The Missing Link

The discussion on value-based performance measures is centered around the concept of residualincome. The main property of residual income is its connection to capital budgeting and the net-present-value-rule. This property is, however, not sufficient to guarantee strong goal congruencebetween management decisions and the firm´s ob jectives. So far, the literature suggests compensa-tion schemes based on modified accounting rules in order to induce the manager to make optimalinvestment decisions. In contrast, we show that strong goal congruence is also attainable by mod-ifying the compensation function. We develop an incentive scheme based on a bonus bank, whichcan be interpreted as a nonlinear contract. Within this concept, we provide a link between theincentive system and the actual creation of value, measured by a performance measure derived fromExcess Value Created.