Ignorance is Bliss: Effects of Real Activities Management by Employees and the Role of Managers

Empirical evidence shows that engaging in real activities management (RAM) to meet performance targets is prevalent in practice. We experimentally investigate how RAM by employees to meet internal targets set by managers affects their performance, and whether this effect depends on managers’ awareness of employees’ opportunity to engage in RAM. We predict and find that when managers’ awareness is low, employees use RAM to restore their effort incentives under suboptimally set targets, resulting in an increase in performance. However, when managers’ awareness of employees’ RAM opportunity is high, managers overattribute observed performance to RAM. This leads to less effective target adjustments and less trusting employee-manager relations, resulting in a decrease in performance. Overall, notwithstanding the direct costs of RAM, our findings suggest that the opportunity to engage in RAM can motivate higher employee performance, but increasing managers’ awareness of this has negative performance and relational effects.