Ittner, Larcker, and Rajan (1997; ILR) studied the relative weights placed on financial and non-financial performance measures in CEO bonus contracts, for a sample of 317 U.S. firms across 48 industries for 1993- 1994.

We outlined the RBC compensation plan in Section 10.3. Non-financial performance measures in the RBC plan include client satisfaction and loyalty, risk management, adher- ence to the RBC code of conduct, and succession planning.

ILR found empirical support for the following hypotheses about the relative weights on financial and non-financial performance measures in compensation plans:

i. Noise in net income. The lower the correlation between manager effort and net income (measured by the correlation between stock market and accounting-based returns). the less the relative weight on financial performance measures.

ii. Firm strategy. "Prospector firms" (growth- and innovation-oriented, identify and adapt quickly to new product/service opportunities) will have greater relative weight on non-financial performance measures than "defender" firms (stable set of products/ services, emphasis on increasing efficiency to reduce operating costs).

iii. Product quality. The greater the firm commitment to quality, the greater the relative weight on non-financial performance measures.

iv. Regulation. Regulated firms will have greater relative weight on non-financial perfor- mance measures than non-regulated firms.

Required

a. Give intuitive arguments to explain these four hypotheses.

b. 2016 incentive awards to the RBC CEO and senior executives put 60 percent weighting on financial performance measures, 10 percent on client satisfaction, and 30 percent on risk management. This 60 percent weighting on financial performance is relatively high, dominating both client satisfaction and risk management. Which hypothesis above best explains this incentive weighting for RBC? Why?