On the Effects of the Degree of Discretion in Reporting Managerial Performance
CentER Discussion Paper No. 2008-21
33 Pages Posted: 20 Feb 2008
Date Written: February 2008
We consider a principal-agent setting in which a manager's compensation depends on a noisy performance signal, and the manager is granted the right to choose an (accounting) method to determine the value of the performance signal. We study the effect of the degree of such reporting discretion, measured by the number of acceptable methods, on the optimal contract, the expected cost of compensation and the manager's expected utility. We find that while an increase in reporting discretion never harms the manager, the effect on the expected cost of compensation is more subtle. We identify three main effects of increased reporting discretion and characterize the conditions under which the aggregate of these three effects will lead to a higher or lower cost of compensation.
Keywords: managerial compensation, reporting flexibility
JEL Classification: D82, D86, M41
Suggested Citation: Suggested Citation