Dynamic Incentives and Responsibility Accounting
University of Michigan at Ann Arbor - Accounting
University of Miami - School of Business Administration
In dynamic principal-agent relationships, unless a principal can precommit to a multiperiod contract, incentives are affected by a problem known as the ratchet effect. We present a two period agency model to show that the use of more aggregate performance measures and greater consolidation of responsibility helps mitigate the ratchet effect. For example, an aggregate measure may be preferred to a set of disaggregate measures to avoid aggravating the ratchet effect. Similarly, it may be preferable to consolidate responsibility for two activities in the hands of one agent despite the potential loss of performance evaluation information implied by consolidation.
Number of Pages in PDF File: 37
JEL Classification: J23, L22, M41, M46working papers series
Date posted: April 8, 1998
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