Now all employees must contribute value by what they know and by the information they can
provide. Investing in, managing, and exploiting the knowledge of every employee have become
critical to the success of information age companies.
In accordance with the latter line of research discussed above, I define human capital as the firm’s
workforce (i.e., the value contributed through the workforce’s contribution via skills and knowledge).
I also investigate an important contextual factor that may influence the relation between the use of
performance measures and the reliance on human capital—the firm’s design of its pay structure.
I draw on both economic theory (i.e., the informativeness principle) and social psychology theory (i.e.,
equity theory) to develop hypotheses. Agency theory embraces rational choice models; research often
investigates how performance measures can be used to more closely align employee actions with the
objectives of owners (Ittner et al., 1997). However, employees work in a social environment and “one’s
actions frequently and unavoidably shape, and are shaped by, the actions of others” (Sprinkle, 2003, p.
295). In this setting, agency theory generally disregards effects from salary and bonus apportionment;
however, since research shows that matters of equity are important to employees (Cowherd and Levine,
1992), incorporating both theories allows me to undertake a more complete investigation of the use of
performance measures. Indeed, Sprinkle (2003) calls for research that incorporates the apportionment of
rewards on performance-based contracts.
Ittner et al. (1997) use the informativeness principle as the basis of an investigation of the use of
performance measures in CEO bonus compensation. They argue that traditional financial measures may be
appropriate for CEOs in firms focused on cost minimization; however, for CEOs in firms following either
a quality or an innovation-oriented strategy, non-financial measures will provide incremental information
regarding the firm’s long-term strategic objectives and help better align interests within the firm. Extending
this, I rely on the informativeness principle to argue that the use of non-financial information will provide
relevant information incremental to that provided by traditional financial measures when the firm relies
on human capital. I then draw on equity theory, which predicts that employees’ behaviors and attitudes
are negatively affected when they perceive inequity in the firm’s pay structure. Sprinkle (2003) notes that
issues of fairness and equity may well influence contracting. In my setting, it is likely that the perception
of (a lack of) fairness will (exacerbate) mitigate moral hazard issues. I argue, therefore, that the association
between the likelihood of using non-financial measures in bonus compensation and the use of human
capital will depend on the design of the firm’s pay structure.
Using disclosure information from the proxy statements of 177 firms, I classify the use of information in
bonus compensation into two categories: (1) firms that emphasize financial measures versus (2) firms that
use both financial and non-financial measures. Using a cross-sectional, binary logistic model I find that
the likelihood of using both financial and non-financial measures is increasing in labor intensity3 and that
the relation is more positive when the firm employs a hierarchical pay structure. This finding supports
the argument that the pay structure moderates the association between the use of human capital and
the use of non-financial measures in executive bonus compensation. Thus, the incremental information
content of non-financial measures is important in the monitoring and control process in labor-intensive
firms. I extend the analysis by subdividing the two broad categories of performance measures into four
categories characterized as firms that rely on: (1) financial information only, (2) financial and non-
financial information, but a financial threshold must be met, (3) financial and non-financial information