Target Ambiguity and Ratchet Effect

Prior literature documents that the subordinate has an incentive to reduce the effort level when current performance affects future target performance, which is known as the ratchet effect. The ratchet literature, however, assumes that the superior can discern the true (desired) level of target performance in the short run, and it does not explicitly explain how the ratchet effect varies along the process of identifying the true target performance. This study analytically investigates the impact of target ambiguity on the magnitude of the ratchet effect. The analysis shows stronger ratchet effect when the superior possesses limited prior knowledge about the indubitable target performance. With higher ambiguity that the superior faces in setting target performance, the superior must depend largely on the subordinates actual performance. As a consequence, the subordinate becomes more reluctant to exert effort for the best level of current performance because it will influence the future standard to be substantially tough. It also shows that the subordinates effort reduction following a highly ambiguous performance target can be alleviated when the subordinate actively participates in the target setting process and when performance measures are adequately noisy.This study was supported by the Institute of Management Research at Seoul National University

Signaling Mechanisms and Survival of Service Providers in an Electronic Market

This research studies the survival of software implementation service providers in an electronic market (or e-market), and the role that vendor characteristics such as reputation, education, experience, ‘preferred provider’ status, and references play in predicting which service providers will exit the e-market after it (the e-market) implements trust enhancing mechanisms. Using theories from asymmetric information, signaling, and trust literatures, we propose a model to examine the relation between firm characteristics and survival. Our empirical results support the key role played by these signals in inducing the separating equilibrium that leads to the shakeout among software service providers in an e-market

Dual Time Series of Annual Earnings Based on the Direction of Sales Changes

This study characterizes annual earnings as a mixture of two random-walk processes along two states of sales change, sales-increase and sales-decrease, thereby providing new insights into the earnings response coefficient (ERC). The dual earnings process is based on the premise that sales changes in the opposite direction convey different information about firms future cash flows or earnings. Building on the extant ERC models, this study shows that the ERC is significantly larger in sales-increase periods than in sales-decrease periods and its magnitude increases as firms experience the increase of sales in multiple consecutive years

Managerial Ability and Dividend Policy

This study investigates the relationship between managerial ability and a firm’s dividend policy in the Korean stock market. Korean firms have been criticized for low dividend payments. Foreign investors in Korean firms, taking a dramatically increasing portion of the ownership, are demanding management to raise dividends. However, dividend policy must involve not only the fair distribution of profits to shareholders but firm growth and investment opportunities. Also, in the recession period, managers should be able to evaluate the costs and benefits of paying dividends to decide an optimal size of distribution. Motivated by the fact that managers have discretion over the firm’s payout policy, we examine how the firm’s dividend payout and its performance depend upon the ability of management. Using Korean firms listed in KOSPI market during 2003-2013, we find the following results. First, high-ability managers show the higher propensity of paying dividends and the larger size of dividends than low-ability managers. Second, the positive relationship is more pronounced in the firms with higher information asymmetry and weaker corporate governance. Lastly, among the competent managers, the future performance is greater for managers who pay larger dividends than those who pay smaller dividends. This study contributes to the literature by providing evidence that high-ability managers are more willing to pay larger dividends to benefit shareholders, and the dividend payments do not harm future firm performance.N

Vendor Certification and Appraisal: Implications for Supplier Quality

We examine the buyer's problem of inducing the supplier's quality effort using two arrangements: the appraisal regime and the certification regime. In the appraisal regime, the buyer inspects the units supplied and either charges a penalty for defective units identified during inspection or pays the unit price for good units. In the certification regime, the supplier obtains vendor certification and the buyer pays the unit price for all units supplied. The inspection technology and the certification process provide noisy information on the supplier's quality effort. In the appraisal regime, the buyer implements the supplier's high-quality and low-inspection. The supplier's expected profit is greater than his reservation profit because of an additional agency cost: The buyer has to prevent the supplier from performing unwanted/preemptive inspection (which gives rise to indirect costs from delay, etc.). This additional agency cost arises precisely when the effectiveness of inspection is high. This provides a moral-hazard-based rationale for the increasing use of certification (such as ISO 9000) in spite of (in fact, because of) the increasing effectiveness of inspection. The potential for additional agency cost incurred by the buyer in the appraisal regime highlights an indirect cost associated with inspection.incentives, supply chain, moral hazard, quality management, inspection, appraisal, vendor certification, game theory, ISO 9000, supplier quality