LAUSR

Abstract Target setting by superiors and their discretion in compensation decisions are important interrelated pieces in an organization's control system. Thus, we examine how these processes influence each other and superiors' decisions therein. We predict, and experimentally find, superiors with ex post compensation discretion set more difficult targets and put less effort into the target-setting process. This suggests that providing ex post compensation discretion fundamentally changes the ex ante target-setting process. We further analyze how superiors use their discretion and find superiors who set targets knowing they can make ex post compensation adjustments are more likely to make both positive and negative adjustments to subordinate compensation compared to those who set targets without the benefit of ex post discretion, whereas past research findings suggest that superiors are reluctant to make negative adjustments to compensation. Thus, our study illustrates that target setting and compensation discretion influence each other to affect superiors' decisions concerning subordinates, providing insight into the use of these processes in management control systems.