The influence of compensation interdependence on risk-taking: the role of mutual monitoring

Bolduan, Felix; Schedlinsky, Ivo; Sommer, Friedrich Article — Published Version The influence of compensation interdependence on risktaking: the role of mutual monitoring Journal of Business Economics Provided in Cooperation with: Springer Nature Suggested Citation: Bolduan, Felix; Schedlinsky, Ivo; Sommer, Friedrich (2021) : The influence of compensation interdependence on risk-taking: the role of mutual monitoring, Journal of Business Economics, ISSN 1861-8928, Springer, Berlin, Heidelberg, Vol. 91, Iss. 8, pp. 1125-1148, https://doi.org/10.1007/s11573-021-01030-3 This Version is available at: https://hdl.handle.net/10419/287367 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Vol.:(0123456789) Journal of Business Economics (2021) 91:1125–1148 https://doi.org/10.1007/s11573-021-01030-3 1 3 ORIGINAL PAPER The influence ofcompensation interdependence onrisk‑taking: therole ofmutual monitoring FelixBolduan1· IvoSchedlinsky1· FriedrichSommer1 Accepted: 21 January 2021 / Published online: 10 February 2021 © The Author(s) 2021 Abstract This study investigates if and how the influence of compensation interdependence on risk-taking depends on mutual monitoring of risky investment decisions. We argue that individuals under compensation interdependence have a behavioral incentive for higher risk-taking if mutual monitoring is present. Impression management is hypothesized to be the driving force behind this effect, with the visibility of actions to the peers through mutual monitoring as an important prerequisite. The results of a laboratory experiment support our predictions. Additional analyses reveal that impression management drives our results because participants incorporate their peers’ preferences in their decision process. This reasoning is further substantiated as individuals increase their risk-taking if they took less risk than their peers in previous experimental rounds and thus adjust to their respective peer group. Our findings inform firms about the effect of compensation interdependence in working environments with differing opportunities for mutual monitoring. Keywords Risk-taking· Compensation interdependence· Mutual monitoring· Impression management· Social reasoning We thankWolfgang Breuer (Editor-in-Chief), two anonymous reviewers, Jeremy Douthit (discussant), Marvin Göbel (discussant), as well as participants of the 2018 Experimental Research in Management Accounting (EXRIMA) Summer School, the Doctoral Seminar at the University of Bochum, the 2019 Accounting Behavior and Organizations Research Conference, the 1st Conference on Behavioral Research in Finance, Governance, and Accounting of Giessen University and the 7th Annual Conference on Risk Governance of the University of Siegen for their helpful comments and suggestions. We appreciate the financial support provided by Dr. Werner Jackstädt-Stiftung. * Friedrich Sommer [email protected] Felix Bolduan [email protected] Ivo Schedlinsky [email protected] 1 University ofBayreuth, Nuernberger Str. 38, 95448Bayreuth, Germany 1126 F.Bolduan et al. 1 3 JEL Classification M12· M41· M52 1 Introduction Designing incentive systems that promote organizationally desirable behavior is an essential aspect of management accounting (Luft and Shields 2009). To promote team-oriented behavior and emphasize the importance of collaboration within a firm, tying incentives to group performance instead of individual performance has evermore gained firms’ interest (Merriman 2008). This is not surprising, as prior research has shown positive effects of such compensation interdependence, as it promotes, for example, performance in collaborative working environments (Blasi etal. 2010) as well as cooperation and coordination (FitzRoy and Kraft 1987). However, prior research also suggests that compensation interdependence might influence other aspects of employee behavior. One important aspect that might influence achieving organizational goals is risk-taking. Hence, when firms consider implementing compensation interdependence, they should also consider the influence on risk-taking, as dysfunctional effects may arise, for example, risk-taking that might be excessive from a firm’s perspective (Lahno and Serra-Garcia 2015). As compensation interdependence is defined as compensation being dependent on a group’s performance instead of individual performance (Nalbantian and Schotter 1997), it is a specific form of decision-making in groups. Prior research on decision-making in groups demonstrates the existence of risky (cautious) shifts if decisions are made in groups instead of individually; this is more generally referred to as “choice shifts” (Davis 1992). Contrary to these typical group settings, many daily business decisions are made on an individual basis and, at the same time, influence other employees or departments of a firm. Examples are salespeople or key-account managers who decide which customers to approach in which specific way and whose compensation is interrelated, for example, through incentives based on divisional or firm performance. Hence, compensation interdependence and decision-making in groups do not necessarily go hand in hand (Bushman etal. 1995; Keating 1997). We aim at contributing to prior research by analyzing this highly relevant aspect. As employee compensation systems do not operate in isolation, research needs to assess whether the impact of such management control systems, i.e., compensation interdependence, differs depending on the environment they are operating in. An aspect of growing relevance is alternative working environments such as digital workplaces outside the conventional office setup, e.g., telecommuting and workspaces without fixed workplaces (hot-desking), which are continually spreading (Global Workplace Analytics 2020). These alternative working environments have one aspect in common: reduced possibilities for interaction among employees and mutual monitoring. While they offer the potential to increase productivity and job satisfaction and reduce costs, a potential downside is less employee-employee interaction in telecommuting (Harris 2003; Hislop and Axtell 2007) and hot-desking setups (Brown and O’Hara 2003; Hirst 2011). Hence, research needs to assess not only the direct influence of such differing possibilities for interaction among employees 1127 1 3 The influence ofcompensation interdependence onrisk‑taking:… but also how these possibilities affect the influence compensation systems have on employee behavior. For this reason, we analyze whether the influence of compensation interdependence on risk-taking depends on mutual monitoring. While mutual monitoring, in general, refers to individuals’ ability to observe each other’s actions (Towry 2003), it refers specifically to the ability to observe each other’s decisions in terms of risktaking in our experimental setting.1 This setting is of particular importance, as compensation systems are implemented for many employees, while alternative working environments often affect only parts of the employees. Being monitored by others makes individuals think about the impression others are forming of them (Leary and Kowalski 1990) and, consequently, adjust their behavior to create a positive impression (Bolino etal. 2008). However, which decisions individuals believe to create a positive impression depend on organizational and situational circumstances. Under individual performance-based compensation, other-regarding preferences should not play a role, and the individual risk preferences are reinforced. As most individuals are considered risk-averse, risk-taking is reduced. However, individuals under compensation interdependence are not only responsible for themselves but also for other individuals. Hence, they try to adjust their decisions to the other individuals’ preferences to make a good impression on peers (impression management). Consequently, their decision depends on what they believe the others’ preferences to be. If individuals under compensation interdependence perceive their investments as riskier than the peers’ investments, they are likely to reduce risk-taking to adjust to the group. If the opposite is true and risk-taking is lower in comparison, there is an incentive to adjust to the peer group and take additional risk. Hence, upwardadjustments are only reasonable under compensation interdependence in the presence of mutual monitoring. As stated above, this impression-management process requires that peer decisions are observable, i.e., it hinges on mutual monitoring. In the absence of mutual monitoring, individuals have no information which would allow them to harmonize their decisions. Thus, we predict that compensation interdependence leads to higher risk-taking if mutual monitoring is present. However, if mutual monitoring is absent, the motivation described above diminishes, as impression management is not possible under the absence of mutual monitoring. To test our predictions, we conduct a laboratory experiment with 120 business students. We manipulate compensation interdependence (absent versus present) and mutual monitoring (absent versus present) between subjects. We use an investment task with ten rounds, where subjects have to decide in each round how to split an endowment between two risky investment alternatives, with one alternative being riskier than the other. Hence, this task measures “pure risk” instead of also adding 1 Thus, unlike formal mutual monitoring models, which study a principal’s opportunity to exploit mutual monitoring among agents in a multi-agent setting (e. g. Ma 1988; Zhang 2008), our study focuses on non-contractible mutual monitoring between employees. 1128 F.Bolduan et al. 1 3 an effort perspective.2 Importantly, choosing the riskier alternative goes together with foregoing expected value. As companies are typically assumed to maximize expected value, the riskier alternative would be considered suboptimal from the firm’s perspective. Also, we assume a linear relationship between the investment proceeds and the subjects’ compensation. This resembles the typical incentive zone in contracts with variable compensation.3 As predicted, we find that the effect of compensation interdependence on risktaking depends on mutual monitoring. In particular, compensation interdependence leads to higher risk-taking in the presence of mutual monitoring, but not in its absence. Our findings contribute to both management accounting theory and practice. From a practical perspective, we inform firms that compensation interdependence is associated with higher risk-taking when mutual monitoring is present, but not when mutual monitoring is absent. Therefore, firms should consider if the working environment allows mutual monitoring when deciding about implementing an interdependent compensation system to actively manage risk-taking, especially if risktaking can be suboptimal from a firm’s perspective. From a theoretical perspective, we add to the stream of research investigating the existence of choice shifts in groups.4 However, in contrast to prior literature, we analyze a particular characteristic of decision-making common in practice: 4 Previous research in this field has investigated whether and how group decision rules, e.g., unanimity (e.g., Ambrus etal. 2015; Baker etal. 2008; Bougheas etal. 2013; Brunette etal. 2015; Keller etal. 2007; Keck etal. 2014; Masclet etal. 2009; Nieboer 2015; Sheremeta and Zhang 2010; Shupp and Williams 2008; Zhang and Casari 2012), majority votes (e.g., Brunette etal. 2015; Harrison etal. 2013), and dictatorship procedures (e.g., Bolton etal. 2015; Ertac and Gurdal 2012) affect risk-taking of groups compared to risk-taking of the individual. 2 In practice, risk decisions can hardly be separated from effort decisions. E.g., Hakenes and Schnabel (2014) present a theoretical analysis that combines risk decisions and (costly) effort decisions, with both decisions being potentially interrelated. This paper chooses a behavioral approach and relies on the experimental research method. Combining risk and effort decisions is also possible in experimental research. However, for the ease of exposition we exclusively study risk-taking decisions. Moreover, combining risk and effort decisions in the experiment would further impede the advantage of the experimental method, i.e., causal inference. 3 Many compensation contracts entail a variable bonus component with variable pay as a linear function of performance between a minimum level that does not warrant variable pay (floor) and a cap (Bennett etal. 2017; Murphy 2001). While floors induce an incentive to take additional risk, caps are intended to induce a more prudential behavior (Murphy 2013; Asai 2016). This is why, for example, lawmakers in the U.S. and Europe introduced mandated caps in compensation contracts such as through the Troubled Asset Relief Program (Garner and Kim 2010) or the Capital Requirement Directive IV (European Parliament and the Council 2013). We acknowledge that total compensation is frequently characterized by a convex curvature. Especially the limited liability due to a fixed baseline component without loss participation is assumed to drive risk-taking. Focusing on the incentive zone as a part of compensation contracts is a conservative test of our theory given the lack of these risk-inducing situational characteristics. At the same time, subjects in the experiment receive a show-up fee that is not at risk. Further, an alternative design choice could have been to endow subjects with an amount that could be (partly or fully) invested while the amount not invested would be saved. The task by Gneezy and Potters (1997) that underlies our experiment adopts this idea by giving participants the opportunity to choose an alternative that safely pays the endowment or a lottery. However, we do not expect this design choice to interact with our manipulations. 1129 1 3 The influence ofcompensation interdependence onrisk‑taking:… compensation interdependence with individual decisions. Our results show that well-documented choice shifts in groups do not necessarily depend on interaction or particular decision rules in groups. They also occur in less salient forms of groups, where decision-making takes place on an individual basis under compensation interdependence. We further substantiate that impression management concerns drive the effects of mutual monitoring. While Yechiam etal. (2008) find that mutual observability of choices and outputs between two individuals increases risk-taking, impression management concerns are unlikely to be the driver of this effect as they investigate groups of two without compensation interdependence. Lahno and Serra-Garcia (2015) show that relative payoff concerns and a “norm to conform” influence an individual’s risk-taking behavior in groups of two. Other studies focus on the effects of social comparison on risk-taking based on the obtained payoffs and find significant effects on risk-taking (Bault etal. 2008; Linde and Sonnemans 2012). Hence, prior literature on the subject does not include any research investigating settings where impression management can play a role in influencing risk-taking within groups of more than two individuals. Therefore, our study contributes to existing research by examining such situations, which are widespread in practice, for example, in the form of annual bonus payments based on firm performance or department performance (Lazear and Shaw 2007). Further, we are strict in only allowing monitoring decisions and not outcomes. This choice rules out alternative explanations like learning by trial and error (Schedlinsky etal. 2016) and provides an opportunity for a suitable test of our hypothesized effects. 2 Background andDevelopment ofHypotheses 2.1 Background 2.1.1 Setting In line with Lefebvre and Vieider (2013, 2014), we classify an investment H as riskier if it offers a higher standard deviation (σH) and a lower expected value (EVH) than another investment L (EVH < EVL; σH > σL).5 This setting rests upon the idea of mean–variance analysis, which is frequently used to compare uncertain prospects (Rothschild and Stiglitz 1970). Under this approach, means of the alternatives are often held constant and the alternative with the lower variance is assumed preferable. However, under the expected utility maximization theory, this approach requires severe restrictions regarding the underlying distribution to be theoretically sound.6 5 Given this simultaneity of standard deviation and expected value, it is hardly possible to disentangle the direction, i.e., if the investment returns or the standard deviation drive the effect. 6 Rothschild and Stiglitz (1970) discuss the mean–variance analysis intensively and summarize that it can yield unjustified conclusions, i.e., that risk-averse individuals may prefer high-variance projects over low-variance projects depending on the underlying function, more precisely for any nonquadratic concave function. In turn, mean–variance analysis is unproblematic for distributions that are identical apart from their location parameters, i.e., affine transformations. 1130 F.Bolduan et al. 1 3 We assign the higher-variance alternative also the lower expected value to facilitate the identification of an organizationally desired result.7 Firms are typically characterized as risk-neutral and would hence always prefer the investment with the higher expected value and avoid risk-taking beyond the level needed to maximize expected value. This notion is in line with prior research (Lefebvre and Vieider 2014). Under this frequent assumption, individuals choosing investment H on behalf of the firm would deviate from corporate objectives. We investigate different incentive schemes, which firms introduce to direct employee behavior also in terms of risk-taking. Employees, though, may have objectives and preferences that diverge from those of the firm. As individuals are frequently assumed risk-averse, they could exhibit risk behavior that entails lower risk-taking than the firm’s risk-neutral expectations. However, individuals may also be risk-seeking by disposition or show situational risk-taking behavior, leading to higher risk than the firm expects (Sitkin and Weingart 1995). For example, individual decision-makers’ decisions, deviating from organizational objectives, policies, or guidelines, were assumed drivers of the financial crisis. 2.1.2 Compensation interdependence Literature investigating the difference between risk-taking in groups and risk-taking by individuals shows mixed results as far as the existence and direction of a choice shift is concerned. While many studies identify a risky shift in groups,8 other studies discover a cautious shift,9 or no choice shift at all.10 Even when accounting for the different decision-making rules, for example, unanimity after discussion or majority votes, results remain ambiguous. As noted in the introduction, we focus on compensation interdependence, as this is a more common feature in decision-making practice than actual group decisions. In line with Nalbantian and Schotter (1997) and Lill (2020), we define compensation interdependence as the degree to which the compensation depends on groupbased rather than individual-based outcomes. Compensation interdependence is beneficial for firms as it strengthens cooperation and coordination among employees (FitzRoy and Kraft 1987). However, research on compensation interdependence also finds that individual misreporting increases if another individual benefits as well (Church etal. 2012; Lill 2020). Further, Maas and van Rinsum (2013) find that individually beneficial misreporting is higher if another person is also affected positively compared to when another person is affected negatively. Di Cagno etal. (2012) find that compensation interdependence increases risk-taking in a two-person environment (without risk-taking to be suboptimally high from a firm perspective) 7 We discuss the reason for not holding the expected values constant in more detail when introducing the experimental task. 8 For example, Bougheas etal. 2013; Brunette etal. 2015; Nieboer 2015; Sutter 2007; Zhang and Casari 2012. 9 For example, Ambrus etal. 2015; Keller etal. 2007; Masclet etal. 2009; Sheremeta and Zhang 2010. 10 For example, Baker etal. 2008; Harrison etal. 2013; Keck etal. 2014. 1131 1 3 The influence ofcompensation interdependence onrisk‑taking:… and that—when they have the choice—individuals choose team partners with similar risk preferences. From all other decision-making rules, the dictatorship procedure has the most substantial similarity to our definition of compensation interdependence, even though it is less common in practice. The procedure is not a group-decision rule in a narrow sense, as only one person decides without coordinating the decision technically or personally. This procedure is related to compensation interdependence in the sense of not coordinating decisions, but not regarding the number of people making decisions that impact other people’s compensation. Research considering the dictatorship procedure finds that group risk-taking is higher than individual risk-taking if individuals take turns in deciding for a group of three, with each person deciding for three out of nine rounds (Sutter 2009). Contrarily, one individual dictating the decision, and thus the compensation for all group members, leads to a cautious shift compared to individual risk-taking (Bolton etal. 2015; Ertac and Gurdal 2012). 2.1.3 Mutual monitoring Mutual monitoring refers to the ability of individuals to observe each other’s actions (Towry 2003). As we focus on risk-taking, mutual monitoring in this study’s context consequently refers to the ability to observe each other’s decisions that involve risk-taking. Mutual monitoring is ascribed mainly positive effects. Prior literature has shown that mutual monitoring increases the pressure to act following behavior principles in social groups and, therefore, can increase productivity (Mas and Moretti 2009). Hannan etal. (2013) find that mutual monitoring can positively and negatively influence effort when employees are compensated based on rank-order tournaments depending on the tendency to either compete or collude. Towry (2003) shows that mutual monitoring can be utilized in contract design to increase effort, while Chong and Khudzir (2018) show that mutual monitoring mitigates budgetary slack creation. 2.2 Hypotheses development Economic theory provides ambiguous explanations for risk-taking behavior depending on the level of compensation interdependence. The individual claim is ceteris paribus less risky under compensation interdependence because of diversification effects, which may increase individual risk-taking. Simultaneously, being dependent on others’ decisions (as a larger part of the compensation is out of one’s control) increases the level of external influences on compensation, which could motivate individuals towards taking less risk. In this paper, we rely on impression management as a behavioral theory and predict that the influence of compensation interdependence on risk-taking depends on the presence of mutual monitoring, as impression management requires a working environment in which the decision-maker can observe peers’ risk-taking and knows that his or her risk-taking can be observed. Hence, individuals get an impression of the others’ preferences by their behavior and know that others form an impression 1132 F.Bolduan et al. 1 3 of them. Theories on impression management postulate that individuals care about how others see them and try to model others’ impressions towards various dimensions (Jones and Pittman 1982; Goffman 1959). According to attribution sought, Jones and Pittman (1982) classify impression management strategies in five categories: ingratiation, intimidation, self-promotion, exemplification, and supplication. In this framework, opinion conformity is an important example of an ingratiation action conducted to manage the impression others form of a person. Notably, Jones and Pittman (1982) state that ingratiation is “shaped and constrained by moral or evaluative factors” (Jones and Pittman 1982, p. 237). This emphasizes the strong relation of actions within this strategy to conformity theories and to (descriptive) norms. Such norms describe how individuals commonly behave in a particular situation, i.e., a “‘normal’ or ‘regular’ behavior” (Bicchieri 2006, p. 29). Notably, it does not need acknowledgment (group pressure or punishment) when (not) following the norm; instead, the motive to follow a descriptive norm is (as the reason for impression management) self-interested, because individuals want to belong to a system or “do things right” (Bicchieri 2006). A descriptive norm can be to “do things right” in terms of risk-taking. What is considered as “right”, however, depends on compensation interdependence.11 Individuals under individual compensation are solely responsible for themselves. Hence, other-regarding preferences should not play a role. This should reinforce that the “right” decision in this context is following the own risk preferences. Consequently, mutual monitoring enforces existing riskpreferences in the absence of compensation interdependence, which is (at least for the majority of individuals) risk aversion. Also, if such individuals opted for higher risk in past decisions, seeing their peers taking lower risk could motivate them to take fewer risks as well, as they see that their peers even share their risk preferences. However, if such individuals took less risk than their peers in the past, there is no descriptive norm for increasing risk-taking, as everyone is solely responsible for themselves. To sum up, individuals under mutual monitoring without compensation interdependence have no incentives to adjust their risk-taking upwards if they took less risky decisions than their peers did in the past. However, under compensation interdependence, a “right decision” in terms of risk-taking incorporates affected peers’ preferences. Hence, a positive impression can be generated by opinion conformity to the average risk-taking of affected peers. Thus, individuals under compensation interdependence develop a desire to consider their peers’ preferences motivated by impression management. More precisely, if individuals under compensation interdependence realize that they 11 Another important stream of literature explaining why individuals follow other individuals’ actions is the work on herding behavior (e.g., Bikhchandani etal. 1992; Banerjee 1992). A common notion in this literature is that people infer the private information of preceding individuals from their actions. As a result of this, individuals are likely to act in accordance with other people’s decisions, even against the actions suggested by own private information. In our setting, we emphasize that nobody can receive any signals regarding the “true” states of nature; hence, subjects are aware that private information cannot exist. Thus, our experiment is closer to the “conformity preference” that can exist next to herding behavior (in a narrow sense) through informational cascades examined in Bikhchandani etal. (1992). 1139 1 3 The influence ofcompensation interdependence onrisk‑taking:… Table 1 Descriptive statistics Panel A: Descriptive statistics per treatment and round (mean [standard deviation]) Compensation interdependence (CI)a Absent Present Total Mutual monitoringbMutual monitoring Absent Present Absent Present Number of subjects (n) 29 28 27 27 111 High risk-taking (in Lira)c Round 1 d326.79 [205.46] 291.93 [199.88] 295.07 [184.92] 331.26 [195.90] 311.37 [195.00] Round 2 309.55 [230.64] 260.82 [205.03] 289.63 [190.62] 368.52 [273.32] 306.76 [227.27] Round 3 303.86 [236.49] 208.96 [180.25] 235.85 [145.69] 358.63 [221.48] 276.70 [205.53] Round 4 239.90 [212.14] 180.18 [154.77] 206.85 [151.66] 255.59 [190.67] 220.61 [179.52] Round 5 318.14 [273.32] 113.43 [124.80] 235.85 [181.21] 324.07 [206.83] 247.93 [219.26] Round 6 238.07 [231.14] 154.86 [163.91] 223.00 [196.64] 225.26 [169.18] 210.30 [192.82] Round 7 248.97 [259.55] 123.46 [125.28] 257.85 [280.25] 215.33 [179.46] 211.29 [223.72] Round 8 296.62 [284.80] 168.11 [142.64] 252.78 [254.81] 339.33 [278.40] 263.93 [251.70] Round 9 308.45 [252.83] 163.68 [134.98] 224.00 [225.89] 231.00 [188.24] 232.55 [209.58] Round 10 214.41 [211.72] 161.50 [125.31] 196.52 [210.39] 289.07 [253.30] 214.87 [207.49] Total high risk-taking (in Lira) 2,804.76 [1,702.72] 1,826.93 [1,216.90] 2,417.41 [1,606.15] 2,938.07 [1,416.64] 2,496.31 [1,540.83] Panel B: Descriptive statistics (all rounds) by treatment (mean [standard deviation]) Compensation interdependence Absent Present Total Mutual monitoring Absent 2,804.76 [1,702.72] 2,417.41 [1,606.15] 2,618.00 [1,653.37] Present 1,826.93 [1,216.90] 2,938.07 [1,416.64] 2,372.40 [1,421.61] 1140 F.Bolduan et al. 1 3 a In the presence of compensation interdependence (CI), subjects’ variable compensation is calculated as the sum of the financial returns of five peers sitting in a row equally divided between the peers for each participant. In the absence of compensation interdependence, participants’ variable compensation stems from the financial return from their investment. Compensation interdependence is a between-subjects factor b In the presence of mutual monitoring, subjects are shown the amounts allocated onto the investment alternatives by themselves and their four peers in the preceding round. In the absence of mutual monitoring, subjects only see their own invested amounts. Mutual monitoring is a between-subjects factor c High risk-taking is the dependent variable and measures the amount invested in the investment alternative H containing higher risk (in the experimental currency “Lira”, 65 Lira/€) d Round is a within-subjects factor. In every round, subjects need to make one investment decision Table 1 (continued) Panel B: Descriptive statistics (all rounds) by treatment (mean [standard deviation]) Compensation interdependence Absent Present Total Total 2,324.42 [1,551.40] 2,677.74 [1,522.85] 2,496.31 [1,540.83] 1141 1 3 The influence ofcompensation interdependence onrisk‑taking:… preferences into their own decisions more strongly (incorporation, 3.33 vs. 2.32, p = 0.047, two-tailed). These findings support our theoretical reasoning regarding the intentions of individuals. Our argumentation further relies on the assumption that individuals change their behavior if they receive information under mutual monitoring. Hence, we analyze how participants under mutual monitoring change their investment decision from one round to another. As stated in the hypothesis development, individuals on average have—irrespective of compensation interdependence—personal motives to take less risks, that is, avoiding risks to raise the expected value of payoffs. However, only individuals under compensation interdependence have an impression-management-based reasoning to increase their risk-taking: they wish to harmonize their own decisions and their peers’ decisions, provided they took less risk in the previous round than their peers. To test this prediction, we investigate the effect of compensation interdependence on risk-taking for subjects in the mutual-monitoring condition that took less than average risk in previous rounds. Therefore, we pool observations and run an ANOVA with the change in risk-taking from one round to another being the dependent variable. As independent variables, we include mutual monitoring, compensation interdependence, and the latter two’s interaction. Further, we create a dummy that takes the value of 1 (0) if individuals took less or equal (more) risk than the average of peers’ risk-taking in the previous round. This dummy also interacts with the two (original) independent variables and their interaction. We are only interested in the 55 subjects under mutual monitoring from rounds two to ten, as mutual monitoring is first present after round one (n = 495). In the overall sample, risk-taking below or equal to the average value occurred 282 times, and above-average risk-taking 213 times. A post-hoc contrast for compensation interdependence under the mutual monitoring and below-or-equal-toaverage conditions reveals that participants increased their risk-taking significantly stronger under compensation interdependence (79.99 vs. 29.63, F = 4.71, p = 0.030, two-tailed).22 Further, we do not find a difference in adjustments under the same conditions if individuals took more risk than their peers did on average in the previous round, with both averages showing downward adjustments, as expected in this case (− 108.78 vs. − 77.28, F = 1.39, p = 0.238, two-tailed).23 These findings support our prediction that the difference is driven by upward adjustments under mutual monitoring and compensation interdependence. To further validate this result, we investigate if compensation interdependence makes a difference regarding risk-taking in the first round in mutual monitoring conditions. No difference in risk-taking between individuals with compensation interdependence and individuals without compensation interdependence under mutual monitoring is observed in the first round (p = 0.453, two-tailed). This highlights the 22 These results are robust for a split of lower (n = 258) versus higher or equal (n = 237) risk compared to the peers’ average in the previous round, with averages of 91.44 (34.40) for compensation interdependence present (absent) (F = 5.57, p = 0.019, two-tailed). 23 Again, the results are robust for a configuration of lower versus higher or equal risk compared to the peers’ average in the previous round (-104.85 vs. -70.02, F = 1.91, p = 0.167, two-tailed). 1142 F.Bolduan et al. 1 3 importance of the informational value mutual monitoring has for participants in our setting. 5 Conclusion Compensation systems in practice often include aspects of compensation interdependence between employees for various reasons, such as an instrument to elicit effort and performance or increase team cohesion. We investigate whether compensation interdependence, besides its positive aspects, also involves hidden costs of higher risk-taking. Importantly, risk-taking is not necessarily a problem per se, as taking risks is essential to exploit entrepreneurial opportunities (Kreilkamp et al. 2020). Thus, as employees are frequently risk-averse, motivating them to take more risks is often necessary. However, we investigate a situation in which risk-taking is suboptimal from the firm’s perspective in that additional units of risk go together with lower expected values. Thus, firms must carefully trade-off the benefits of Table 2 Hypothesis test a All p-values are reported on a two-tailed basis b p-values within subjects are calculated based on the Huynh–Feldt correction to account for sphericity c Panel B reports contrast testing following a pooled ANOVA containing the between-subjects factors CI, mutual monitoring, and CI × mutual monitoring. Ex-ante risk preferences are included in the pooled ANOVA to rule out that subjects’ risk preferences drive the results Panel A: Repeated measures ANOVA results (n = 111) Dependent variable = high risk-taking per round through rounds 1–10 Source Df Type 3 SS F-value p-valuea, b Between subjects CI (absent, present) 1 338,148.89 1.51 0.222 Mutual monitoring (absent, present) 1 169,860.40 0.76 0.386 CI × mutual monitoring 1 1,654,173.60 7.37 0.008*** Risk preference 2 236,428.55 1.05 0.352 Within subjects Round 9 78,940.29 3.36 0.001*** Round × CI 9 15,876.76 0.68 0.703 Round × mutual monitoring 9 40,937.87 1.74 0.091* Round × CI × mutual monitoring 9 37,311.35 1.59 0.131 Round × risk preference 18 17,346.32 0.74 0.746 Panel B: Simple effects tests for CI (contrasts following pooled ANOVA)c Dependent variable = high risk-taking through rounds 1–10 Source Df Mean difference F-value p-valuea CI under mutual monitoring present 1 1,111.14 7.71 0.007 *** CI under mutual monitoring absent 1 − 387.35 1.12 0.293 1143 1 3 The influence ofcompensation interdependence onrisk‑taking:… compensation interdependence against the hidden costs of higher risk-taking beyond the expected value-maximizing risk-neutral decision. We analyze if the risk-inducing effect of compensation interdependence on risk-taking depends on an important aspect of the working environment: traditional workplaces or modern workplaces like telecommuting or hot-desking— with the ability (not) to mutually monitor peers’ behavior as the key distinctive feature. To rule out alternative explanations, we focus on a major difference between these working environments: employees may observe each other in terms of mutual monitoring of risky decision-making. In a laboratory experiment in which participants decide how to split an endowment between two investment alternatives, we find that the effect of compensation interdependence depends on mutual monitoring. Specifically, under mutual monitoring, risk-taking is higher if compensation interdependence is present rather than absent. We demonstrate that impression management is the driving force of this effect. We further show that individuals under compensation interdependence use “upward adjustments” more strongly to respond to their peer group’s average decision in the previous rounds. Our results also show no difference in risk-taking Table 3 Additional analysis a This table reports the mean values for answers in the post-experimental questionnaire for the conditions in which mutual monitoring is present, separately for conditions with compensation interdependence absent and present. The means are tested for differences using an ANOVA, with F-values and p-values reported in the table b All p-values are two-tailed c Impression management concerns reports to what extent participants agree with the following statement: “I wanted to be perceived as reasonable by other participants.”, based on a 7-point Likert scale (1-do not agree at all, 7-completely agree) d Thoughts about decisions of other participants reports the answer to the question “How often did you think about the other participants’ decisions during the experiment?” based on a 7-point Likert scale (1-never, 7-very often) e Importance to consider what other participants likely regard as the correct decision reports to what extent participants agree with the following statement: “It was important to me to consider what other participants likely regard as the correct decision.”, based on a 7-point Likert scale (1-do not agree at all, 7-completely agree) f Incorporation of other participants’ preferences reports to what extent participants agree with the following statement: “When making my decision I incorporated what other participants likely regarded as the correct decision.”, based on a 7-point Likert scale (1-do not agree at all, 7-completely agree) Responses to post-experimental questions (mutual monitoring present, n = 55)a Item CI absent (mean) CI present (mean) F-value p-valueb Impression management concernsc2.68 4.37 10.30 < 0.01*** Thoughts about the decisions of other participantsd2.86 3.78 3.59 0.064* Importance to consider what other participants likely regard as the correct decisione 2.43 3.33 3.75 0.058* Incorporation of other participants’ preferencesf2.32 3.33 4.14 0.047** 1144 F.Bolduan et al. 1 3 depending on compensation interdependence when mutual monitoring is absent. We attribute this to the absence of an impression-management-based motivation, as peers cannot observe the decision-making process in such situations. Our findings have important implications for theory and practice. We add to prior research by identifying compensation interdependence as an important determinant for risk-taking. Prior research in this field has focused on the effect of compensation interdependence on misreporting (Church et al. 2012; Lill 2020; Maas and van Rinsum 2013) and free-riding (Holmstrom 1982), but it has not considered the effect on risk-taking in conventional and alternative workplaces. Moreover, we add to the stream of literature investigating the link between mutual monitoring and dysfunctional behavior (Hannan etal. 2013; Orr 2001; Towry 2003). Finally, we add to the stream of literature examining choice shifts in groups by separating the effect of a particular characteristic of decisionmaking in groups on risk-taking, that is, compensation interdependence. We also inform firms that the hidden costs of using compensation interdependence depend on the respective working environment. In traditional workplaces, where mutual monitoring of decisions is often present, firms should consider that compensation interdependence influences not only performance and cooperation but also the risk-taking behavior of employees. Compensation interdependence, however, does not increase risk-taking in workplaces where mutual monitoring is absent. This finding also emphasizes the necessity for managers and human resource management to develop different compensation systems depending on the working environment. For example, if firms wish to reduce or maintain overall risktaking in their operations, they should be cautious when implementing interdependent compensation for traditional working environments, while this approach is less problematic in alternative working environments like telecommuting or hot-desking. Risk-taking that goes beyond the expected value-maximization of risk-neutral decisions can be considered a facet of suboptimal decision-making from a firm’s perspective. Thus, our results can potentially generalize to other types of suboptimal decision-making beyond different risk-taking forms, in which individuals have an impression-management-based reason to incorporate their affected peers’ preferences in their decision-making process. Thereby, compensation interdependence can potentially lead to inferior decision-making in other domains as well. Fruitful areas of research arise from limitations of our study. First, we assume a linear relationship between performance and compensation. While such a linear compensation component is usually contained in compensation contracts by the incentive zone of bonus payments, total compensation is often shaped differently. It would be interesting to investigate the effects of compensation interdependence under different functional forms between performance and compensation. Especially in settings with option-based compensation, which is only relevant for (larger) stock companies, visibility of decisions might play another role. Second, while we focus on mutual monitoring of decisions rather than on the outcomes of these decisions to provide a suitable test of our hypotheses, future research could examine the influence of mutually monitored decision outcomes to expand the findings to other areas of 1145 1 3 The influence ofcompensation interdependence onrisk‑taking:… practical relevance. Third, we can show how risk-taking differs depending on mutual monitoring—however, we do not test mechanisms that potentially reduce risk-taking under compensation interdependence. Moreover, as telecommuting agreements are gaining importance, future research might further explore the effects of alternative control mechanisms on risk-taking when mutual monitoring is absent. Appendix1 See Table 4. Table 4 Multipliers and probabilities in the investment task Probabilities Multiplier Investment H Investment L State of nature 1 State of nature 2 State of nature 1 (%) State of nature 2 (%) State of nature 1 (%) State of nature 2 (%) Round 1 1/3 2/3 162 44 122 89 Round 2 7/15 8/15 142 32 116 86 Round 3 1/3 2/3 180 35 128 86 Round 4 1/3 2/3 150 50 116 92 Round 5 11/30 19/30 172 32 119 89 Round 6 1/3 2/3 166 42 124 88 Round 7 1/3 2/3 184 33 130 85 Round 8 13/30 17/30 140 40 117 87 Round 9 1/3 2/3 170 40 126 87 Round 10 1/3 2/3 160 45 120 90 1146 F.Bolduan et al. 1 3 Funding Open Access funding enabled and organized by Projekt DEAL. Open Access This article is licensed under a Creative Commons Attribution 4.0 International License, which permits use, sharing, adaptation, distribution and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence, and indicate if changes were made. The images or other third party material in this article are included in the article’s Creative Commons licence, unless indicated otherwise in a credit line to the material. If material is not included in the article’s Creative Commons licence and your intended use is not permitted by statutory regulation or exceeds the permitted use, you will need to obtain permission directly from the copyright holder. To view a copy of this licence, visit http://creat iveco mmons .org/licen ses/by/4.0/. References Ambrus A, Greiner B, Pathak PA (2015) How individual preferences are aggregated in groups: an experimental study. 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