Timeliness versus Accuracy and Information Externalities

Abstract

In this paper, we employ a sequential production setting in order to study the tradeoff between timeliness and accuracy of a signal about productivity. An information externality arises because the upstream agent’s information is disseminated to the downstream agent, and affects production decisions and incentives. The signal can be produced early, before both agents choose effort, in which case the signal is less accurate, or the upstream agent can produce a more accurate signal based on effort, but before the downstream agent chooses effort. When the signal can be verified, as with public information, the principal’s preference for an early versus a late signal depends on the effect of the upstream agent’s effort on the outcome of the signal. For the upstream agent, the tradeoff involves generating an early, inaccurate signal useful for decision-making, while a late signal is more accurate, but is only useful for performance evaluation. If either the incentive problem is insignificant or the use of the late signal as a performance measure is diminished, the principal will prefer an early signal. For the downstream agent, the signal is always pre-decision, and an early, inaccurate signal may be less costly because of stronger incentives with better quality information. With private information, the upstream agent must be paid information rents with both an early or late signal. The information rents dampen the use of the late signal as a performance measure, and the principal may prefer an early signal if the upstream agent’s productive impact on the signal is low, or if the early signal is sufficiently accurate.

Keywords: principal-agent theory, asymmetric information, timeliness, accuracy

JEL Classification: D82, L20, L23, M41