On Multiple Measures of Performance : A Theoretical Investigation of Production and Internal Quality Measures

Multiple measures of managerial performance, including the increased use of non-financial measures exist widely in the business world. Using a principal-agent model with moral hazard, we study a special case of two performance measures - production and internal quality. We derive a condition when agents respond to an increase in incentives for internal quality performance by decreasing the level of internal quality effort provided. This happens where the agent's effort can be allocated between internal quality performance and production performance and incentives for internal quality performance are at a sufficiently high cost of incentives for production performance. We further show with numerical analysis that such a condition is possible in the optimal solution. In the benchmark case with one measure of performance, this condition did not arise. Our results provide analytical support to the notion that the use of multiple measures of performance should be accompanied by a careful analysis of their interactions